Behavioral finance

Question 1

Traditional finance

Answer 1

Investors are rational, markets are efficient, returns are determined by risk mean variance; portfolio governs

Question 2

Behavioral finance

Answer 2

Investors are “normal”, markets aren’t efficient, behavioral portfolio theory governs. Risk alone, doesn’t determine returns

Question 3

Hueristic

Answer 3

Approach to problem solving that employs a practical method “rule of thumb”. Easier to make decisions

Question 4

Affect Heuristic

Answer 4

occurs when our current emotional state or mood influences our decisions. Instead of evaluating the situation objectively, we rely on our “gut feelings” and respond according to how we feel. As a result, the affect heuristic can lead to suboptimal decision-making

You might invest in a company because you like the company’s values or mission, even if the stock performance isn’t strong

Think Ceirra B

Question 5

Affinity Bias

Answer 5

Investing in things you love, rather than what’s optimal

Question 6

Anchoring

Answer 6

Holding an investment too long. Anchored to one piece of data rather than looking at the full picture

Fixating on reference points, usually the first piece of info

if an investor reads a positive analyst report about a company’s future prospects, they may anchor their perception of the stock’s potential to that report, ignoring subsequent negative news or changes in market conditions

Question 7

Availability Heuristic

Answer 7

We rely on immediate examples that are available in our mind while making judgements

When trying to decide which store to visit, you choose the one you most recently saw an ad for

Question 8

Bounded rationality

Answer 8

Decision making is bound by limited information. They make the easy choice, not the optimal choice.

when choosing what to wear in the morning, we only consider some outfits we can select

Question 9

Confirmation Bias

Answer 9

We tend to find and remember information that confirms our perceptions

if markets are falling and you form an opinion that it will fall further, you will look for information that reaffirms your belief that the market will fall

Question 10

Conservatism Bias

Answer 10

The tendency to prefer existing evidence over new evidence that might change your view on something, which is caused by resistance to change your opinion about something

Question 11

Cognitive Dissonance

Answer 11

Conflicting believes

Discomfort from having two conflicting beliefs.

“I want to be more aggressive” market correction “i’m so stressed out about the market going down”

Question 12

Disposition Effect

Answer 12

Sell winners quickly, hold losers, comparing price to the purchase price, not market value.

An investor sells a stock that’s increased in value, but holds onto a stock that’s decreased in value

Question 13

Endowment Effect

Answer 13

You value things that you own more than if you have no connection to it.

An investor who inherits stock from a relative might be reluctant to sell it, even if it’s not a good fit for their portfolio or investment goals, simply because they feel attached to it.

Question 14

Familiarity Bias

Answer 14

Bias to overestimate risk of an investment that they are familiar with, and underestimate things they are unfamiliar with

we may only invest in companies with brands that we recognize

Question 15

Flat Rate Bias

Answer 15

Rather pay flat rate, even when a per-use amount might be more optimal

Question 16

Framing Bias

Answer 16

How things are presented determine how we respond

Meat says “80% lean, 20% fat” instead of “20% fat, 80% lean”

Question 17

Gambler’s Fallacy

Answer 17

Must be due for a win

Mistaken belief that if an independent event happens more frequently, it should start occurring less frequently

Question 18

Herding

Answer 18

Do what everyone else is

Follow what everyone else is doing due to fear of missing out

bandwagon effect

Question 19

Hindsight Bias

Answer 19

Looking back, after the fact is known, and assuming they can predict the future

Question 20

House Money Effect

Answer 20

Take more risk: a lot more risk. Disassociate with it emotionally

more willing to spend and take risks with money we’ve obtained easily or unexpectedly

Question 21

Snakebite Effect

Answer 21

Take less risk: makes you timid. Avoiding participating to avoid the pain

become scared to consider the risky securities for investment after a big loss, which is none other than the feeling of “snakebite” effect

Question 22

Breakeven-itis

Answer 22

Take more risk to get back to baseline

Question 23

Illusion of control

Answer 23

People overestimate their ability to control events

Investors may believe they can predict stock market movements or pick winning investments

Question 24

Law of small numbers bias

Answer 24

Generalizations about group based on behaviors of a few

An investor might see a stock perform well for a short period (a small sample) and incorrectly conclude that it’s a long-term winner, ignoring potential market volatility or other factors.

Question 25

Mental accounting

Answer 25

Treating money differently Valuing money differently based on source or intended use

Question 26

Money Illusion

Answer 26

Thinking value today is the same as the value tomorrow A bond with a 5% yield might seem attractive, but if inflation is 6%, the real return is negative, meaning the investor's purchasing power is actually decreasing.

Question 27

Overconfidence bias

Answer 27

over estimating your capabilities resulting in poor decisions Hindsight bias and cognitive dissonance are each a type of overconfidence

Question 28

Overreaction

Answer 28

Disproportionate Response Tendency to over-respond leading to over optimism or over pessimism

Question 29

Outcome bias

Answer 29

Good outcome = good decision Tendency to judge how good a decision was based on its outcome

Question 30

Persuasion bias

Answer 30

The more frequent we hear something, the more we believe it

Question 31

Prospect theory

Answer 31

Riskier when losing People are risk-averse for gains (gotta lock in those gains) but risk-seeking for losses (gotta double down)

Question 32

Loss aversion

Answer 32

Losing hurts twice as much as gains of the same magnitude Investing in low-return, guaranteed investments over more promising investments that carry higher risk. Not selling a stock that you hold when your current rational analysis of the stock clearly indicates that it should be abandoned as an investment Falls under prospect theory

Question 33

Recency bias

Answer 33

Giving too much weight to recent observations/stimuli (short term past performance)

Question 34

Regret Avoidance

Answer 34

(also known as the disposition effect) leads investors to take action or to refuse to act in hopes of minimizing any regret over their actions or inactions. In investments, it leads people to sell winners too soon and to hold on to losers too long

Question 35

Salience Bias

Answer 35

Focusing on the information that's most stimulating and vivid an investor might focus on a stock's recent surge in price, ignoring underlying fundamentals, or become overly pessimistic after a high-profile negative event Think Gamestop stock

Question 36

Self Attribution Bias

Answer 36

"Selective credit taking" Credit success to yourself and failure to external circumstances

Question 37

Similarity Heuristic

Answer 37

You draw a conclusion based on a similar experience, though they're not related

Question 38

Status quo bias

Answer 38

Easier to stick with what you know than test the unknown or change your current course of action

Question 39

Sunk cost fallacy

Answer 39

Irrational propensity to continue making additional investments after incurring initial losses

Question 40

Naive Diversification

Answer 40

Investing in every option available. think 401k target date fund example

Question 41

Representativeness

Answer 41

Thinking a good company is a good investment without looking at analysis

Question 42

Belief perseverance

Answer 42

is evident when people are unlikely to change their views given new information refusing to sell a stock despite negative performance, or ignoring expert advice that contradicts their investment strategy.

Question 43

Dunning-Kruger Effect *

Answer 43

The less you know, the more confident you are. The more you know, the less confident you are. Francis confidently assures the group that there’s no kelp in ice cream. They do not work in the dairy industry.

Question 44

Analysis Paralysis

Answer 44

"data overwhelm" Inability to make a decision due to overthinking a problem

Question 45

Fear of regret

Answer 45

"What if i'm wrong?" Inability to make a decision due to fear of making wrong decisions

Question 46

Attachment Bias

Answer 46

Emotions blurring judgement Connections to people, places, or things interferes with decisions refuse to sell an underperforming stock because of sentimental attachment, even when it's in their best interest

Question 47

Financial Emeshment

Answer 47

Parent-child finances Boundaries between parent and (adult) child finances become blurred

Question 48

Financial Infidelity

Answer 48

Partner Financial deception Deliberating hiding or lying about finances to partner/spouse