Behavioral Finance Flashcards
What is prudence bias?
Adjusting estimates to be on the ‘safe side’
What is conservative bias, one consequence on portfolio management, and how to overcome it?
A cognitive bias where people underweight/ignore information that contradicts with an existing view (difference from anchoring bias is this is for a view). Slow to update forecasts and hold investments too long. Consider how new information impacts existing view.
What is representative bias (including both types), one consequence on portfolio management, and how to overcome it?
A cognitive bias where new evidence is incorrectly evaluated based on past classifications (librarian example). Based rate neglect is when the accuracy of the base case is not considered and sample size neglect is relying on too few observations. Excessive turnover and higher costs. Do proper statistical analysis.
What is confirmation bias, one consequence on portfolio management, and how to overcome it?
A cognitive bias where people seek out new information that supports an existing view. Under diversify and concentrate in employer stock. Seek out contrary views.
What is illusion of control bias, one consequence on portfolio management, and how to overcome it?
A cognitive bias where people think they can control outcomes (doing more work gives you illusion of having more control). Under-diversify and trade too much. Know that LT trends are out of their control.
What is hindsight bias, one consequence on portfolio management, and how to overcome it?
A cognitive bias where people have selective memory of past events/actions (brexit). overestimate ability. keep past records of decisions prior to event.
What is anchoring and adjustment bias, one consequence on portfolio management, and how to overcome it?
A cognitive bias where an initial anchor point controls subsequent changes (difference from conservative bias is this is for numbers). Failure to update forecasts. Start with analysis again.
What is mental accounting bias, one consequence on portfolio management, and how to overcome it?
A cognitive bias where the portfolio is segregated into parts and treated differently. Sub-optimal asset allocation. Combining sub portfolios to see total risk and return metrics.
What is framing bias and one consequence on portfolio management?
A cognitive bias where decisions are affected by the way information is framed (99% fat free). Failure to assess risk and end up unsuitable risk. Consider how the information was presented.
What is availability bias, one consequence on portfolio management, and how to overcome it?
A cognitive bias where easy to obtain information is over-weighted. Limit portfolio to what they know resulting in under diversification and inappropriate AA. LT focus.
What is loss aversion, one consequence on portfolio management, and how to overcome it?
An emotional bias where people dislike losses more than same size gains. Holding losers too long and selling winners too early. Stop-loss rules and goals-based investing.
What is overconfidence bias (including both types), one consequence on portfolio management, and how to overcome it?
An emotional bias where people overestimate their abilities. Self attribution bias is taking credit for wins and blaming others for losses. Illusion of knowledge bias is overestimating abilities. Under diversify and excessive risk. Acknowledge losses.
What is self-control bias, one consequence on portfolio management, and how to overcome it?
An emotional bias where people lack self-discipline to meet LT goals. Taking excessive ST risk. Stick to investment plan.
What is status quo bias, one consequence on portfolio management, and how to overcome it?
An emotional bias where people do nothing instead of making a decision. Take inappropriate risk and don’t change AA. Stick to an investment plan.
What is endowment bias, one consequence on portfolio management, and how to overcome it?
An emotional bias where people value something more once they own it. Failure to sell assets. Sell small amounts now that get larger.
