Behavioral Finance

Question 1

What is behavioral finance?

Answer 1

A field studying how psychological biases and emotions impact financial decisions.

Question 2

What is the traditional finance assumption about decision-making?

Answer 2

It assumes individuals are rational and maximize utility based on information.

Question 3

What are heuristics?

Answer 3

Mental shortcuts or rules of thumb that simplify decision-making but can lead to errors.

Question 4

What is the availability heuristic?

Answer 4

Basing decisions on easily recalled information instead of objective analysis.

Question 5

What is prospect theory?

Answer 5

Theory suggesting people value gains and losses differently, leading to inconsistent risk behavior.

Question 6

What is loss aversion in prospect theory?

Answer 6

The tendency to fear losses more than valuing equivalent gains.

Question 7

What is anchoring?

Answer 7

Relying heavily on the first piece of information encountered when making decisions.

Question 8

What is confirmation bias?

Answer 8

Seeking information that confirms pre-existing beliefs and ignoring contradictory evidence.

Question 9

What is overconfidence bias?

Answer 9

Overestimating one’s knowledge or ability to control outcomes.

Question 10

What is hindsight bias?

Answer 10

Seeing events as more predictable after they have occurred.

Question 11

How does anchoring bias affect investment?

Answer 11

Investors may base decisions on outdated information, like a stock’s historical price.

Question 12

What is loss aversion?

Answer 12

A preference to avoid losses rather than acquiring equivalent gains.

Question 13

What is status quo bias?

Answer 13

Preferring existing conditions or familiar options over change.

Question 14

What is the endowment effect?

Answer 14

Overvaluing something simply because one owns it.

Question 15

What is regret aversion?

Answer 15

Avoiding decisions that might lead to regret, often resulting in inaction.

Question 16

What is herd behavior?

Answer 16

Following the crowd or market trends instead of making independent decisions.

Question 17

What is mental accounting?

Answer 17

Treating money differently based on its origin or intended use, rather than considering all assets as a whole.

Question 18

What is self-attribution bias?

Answer 18

Taking credit for positive outcomes but blaming external factors for negative outcomes.

Question 19

What is the disposition effect?

Answer 19

The tendency to sell assets that have increased in value while holding onto assets that have declined.

Question 20

How does behavioral finance contribute to market bubbles?

Answer 20

Biases like herd behavior and overconfidence inflate asset prices, potentially leading to bubbles and crashes.

Question 21

What are underreaction and overreaction in markets?

Answer 21

Underreaction delays price adjustments; overreaction causes excessive price swings.

Question 22

What is noise trading?

Answer 22

Trading activity based on speculation or emotions, adding to market volatility.

Question 23

What is limited arbitrage?

Answer 23

When irrational pricing persists because rational traders are unable to fully exploit mispriced assets.

Question 24

How can awareness and education help with behavioral biases?

Answer 24

By recognizing common biases, individuals can work to counteract irrational behaviors.

Question 25

How does diversification reduce the impact of biases?

Answer 25

It balances risk and reduces reliance on any single investment.

Question 26

What is the benefit of setting rules and limits?

Answer 26

Helps avoid impulsive decisions driven by emotions, such as stop-loss orders.

Question 27

Why is a long-term perspective useful in behavioral finance?

Answer 27

It counters short-term biases and focuses on fundamentals rather than daily market fluctuations.

Question 28

How can professional advice mitigate behavioral biases?

Answer 28

Advisors or robo-advisors provide objective guidance, reducing the impact of personal biases.