Behavioral Finance Flashcards

Question

What is Status-Quo Bias?

Answer 1

When facing an array of options, people tend to select the option that keeps conditions the same Bias Type: Emotional The investor that has been doing things a certain way for many years, and then hires a new financial advisor. The new advisor may propose practical changes only to find that the investor takes only part of or none of the advice. It’s not that the client doesn't need good advice – they are simply stuck in the “status quo”.

Answer 2

Valuing an object more when you hold or own it; discounting the value of objects you do not currently possess Bias Type: Emotional Endowment bias occurs when a person assigns greater value to an object he or she possesses and may lose compared to an object of the same value he or she does not possess and has the potential to gain.

Answer 3

avoiding making decisions or taking action because of fear of making a mistake; or that looking back a decision will prove less than optimal Bias Type: Emotional It can cause investors to be too conservative in their investment choices. Having suffered losses in the past, some investors have trouble making sensible new investments. This behavior can lead to long term underperformance and can jeopardize investment goals.

Answer 4

Making an irrational decision or choice based on how a person believes a certain product or service will reflect their values Bias Type: Emotional Investors subject to affinity bias may make investments in companies that make products or deliver services that they like but don’t examine carefully enough the soundness of the investment characteristics of those companies.

Answer 5

Investors may continue to hold an investment and even invest more (e.g., double down) in large part because of the time, effort and energy they have already invested in the idea behind the investment. They are emotionally tied to the initial choice. The sunk-cost fallacy is often tied to anchoring and status-quo bias.

Answer 6

Holding on to losing investments, hoping that the value will rise back up to the point at which they purchased the asset at which time they would plan to sell. They do so in an effort to prevent realizing a loss and the negative feelings or pain associated with losses.

Answer 7

This occurs when investors experience losses and then become more risk-adverse, even to the extent of not wanting to invest in the same investment or even asset class, based on their painful experience in the past. The snake-bit effect associated with a number of biases including anchoring, recency, conservatism, and representativeness.

Answer 8

Investors often take more chances (take on more risk) once they have gained, won, or experienced profits. It's the feeling that they are playing with someone else’s money and feel more comfortable taking on additional risk.

Answer 9

Bias Type: Emotional | Many overly optimistic investors believe that bad investments can happen to others but not them.

Answer 10

Creators of prospect theory

Answer 11

holding on to losing investments too long but sell winning investments too early. Holding losing positions an be tied back to the “snake-bit effect” where investors are seeking to avoid losses. Selling winners too early may be traced to an investor seeking to lock in a gain and in doing so either avoid the risk of losing said gain, and/or to experience the immediate gratification that comes from the realized gain.

Answer 12

1. Individualists – They are confident and careful. Generally do not go to a consultant to manage their investments but do it themselves. 2. Adventurers – Generally go for only big bets. have the resources to do so and willing to take risks. investment ms are generally focused and not diversified. 3. Celebrities – Swayed too much by the trend and do not have any expertise or opinion about investments. approach investment managers frequently. 4. Guardians – Both anxious and careful. Lacking confidence, they approach investment counsels. Generally emphasize safety of the capital while making the investments and a significant proportion of their investments is generally devoted to government securities and guaranteed return investments. 5. Straight arrows – Halfway between complete confidence and anxiety, and extreme carefulness and impetuousness.

Answer 13

Basic type: Passive Risk tolerance level: Low Primary bias: Emotional Passive investors who place emphasis on financial security and preserving wealth rather than taking risks to grow wealth. ``` Subject to: Loss-Aversion Bias Status-Quo Bias Endowment Bias Anchoring Bias Mental Accounting Bias ```

Answer 14

Basic type: Passive Risk tolerance level: Low to medium Primary bias: Cognitive Passive investors who do not have their own ideas about investing. They follow the lead of their friends and colleagues in investment decisions, and want to be in the latest, most popular investments without regard to a long-term plan. ``` Subject to: Recency Bias Framing Bias Cognitive Dissonance Bias Regret Aversion Bias ```

Answer 15

Basic type: Active Risk tolerance level: Medium to high Primary bias: Cognitive active investor with medium- to high-risk tolerance who is strong-willed and an independently minded thinker. Independents are self-assured and “trust their instincts” when making investment decisions. ``` Subject to: Conservatism Bias Availability Bias Representativeness Bias Self-Attribution Bias Confirmation Bias ```

Answer 16

Basic type: Active Risk tolerance level: High Primary bias: Emotional Active investor who have been actively involved in their wealth creation, typically risking their own capital in achieving their wealth objectives. ``` Subject to: Overconfidence Bias Self-Control Bias Affinity Bias Illusion of Control Bias Outcome Bias ```