Behavioral Finance Flashcards
Financial Counseling - Cognitive-Behavioral Approach
This approach believes that a client’s attitudes, beliefs, and values influence the client’s behavior and that tries to replace negative beliefs with positive attitudes that should result in better financial results
Financial Counseling - Economic and Resource Approach
Focuses on obtaining and analyzing quantitative data, such as cash flow, assets, and debt
Financial Counseling - Classical Economics Approach
Planners attempt to achieve better financial outcomes by increasing financial resources or reducing expenditures
Financial Counseling - Strategic Management Approach
Client’s goals and values drive the client-planner relationship and the planner serves as a consultant
Illusion of Control Bias (C)
Exists when market participants think they can influence outcomes when they cannot
Conservatism Bias (C)
Occurs when clients initially assume a rational view but fail to change that view as new information becomes available. They overweigh the initial probabilities and do not adjust for new information.
Hindsight Bias (C)
A selective memory of past events, actions, or what was knowable in the past. Clients tend to remember their correct views and forget the errors.
Confirmation Bias (C)
Occurs when market participants look for new information to support an existing view. Only bring up information favorable to the holding.
Representativeness (C)
Based on a belief that the past will persist and, as a result, new information is classified on previous experiences.
Base Rate Neglect: where the base rate (probability) of the initial classification is not adequately considered. Classification is presumed to be 100% correct.
Sample-Size Neglect: makes the initial classification based on an overly small and potentially unrealistic sample of data.
Mental Accounting (C)
Money jar mentality, involves the tendency of individuals to put their money into separate accounts based on the function of these accounts. Keeping money in a vacation bucket when you owe considerable debt.
Self-Attribution Bias (C)
an ego defense mechanism that occurs to avoid the cognitive dissonance associated with having to admit you made a mistake
Anchoring (C)
Irrational decisions based on information that should have no influence on the decisions at hand. Anchoring is especially risky when people know little about the product being purchased, the service being delivered, or the investment being made.
Adjustment (C)
Involves clients clinging on to an initial estimate and not adjusting for new information
Outcome Bias (C)
Tendency for individuals to take a course of action based on the outcomes of prior events. An investor may choose a particular stock because that stock had superior performance over the last three years.
Framing Bias (C)
Asserts that people are given a frame of reference, a set of beliefs or values, which they use to interpret facts or conditions as they make decisions.
Recency Bias (C)
Recent information is given more importance because it is most vividly remembered. Also called “Availability Bias” because it is based on data that are readily available, including small data samples or data that do not provide a complete picture.
Herding (C)
When investors trade in the same direction or in the same securities, and possibly, trade contrary to the information they have available.
Prospect Theory (E)
Clients fearing losses much more than valuing gains. Often, they will choose the smaller of two potential gains if it avoids a sure loss.
Loss Aversion Theory (E)
Involves clients valuing gains and losses differently and, as a result, will make decisions based on perceived gains rather than perceived losses.
Overconfidence (E)
Investors exhibiting overconfidence believe they can control random events merely by acquiring more knowledge and consider their abilities to be better than they are. They take credit for any financial decisions that have positive results. Any negative outcomes are attributed to external sources.
Self-Control Bias (E)
Occurs when individuals lack self-discipline and favor immediate gratification over long-term goals.
Status Quo Bias (E)
Occurs when comfort with an existing situation leads to an unwillingness to make changes.
Endowment Bias (E)
Occurs when an asset is deemed special and more valuable simply because it is already owned
Regret-Aversion Bias (E)
Occurs when market participants do nothing out of excess fear that actions could be wrong. Their sense of regret and pain is stronger for acts of doing something.
