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CIMA > Behavioral Finance Theories > Flashcards

Behavioral Finance Theories Flashcards

1
Q

Prospect Theory state that people make decisions based on

A

probabilities more than potential outcomes

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2
Q

Prospect Theory state that people make decisions using

A

mental heuristics (mental shortcuts and biases)

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3
Q

Loss Aversion

A

the tendency to feel the impact of losses more than gains

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4
Q

Prospect Theory can be illustrated graphically using an

A

asymmetrical s shapred curve

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5
Q

Cognitive dissonance

A

confusion or frustration that arises when an individual receives new information that does not match up with or confirm to preexisting beliefs or experiences

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6
Q

Cognitive dissonance causes invstors to

A

hold losing securities that they otherwise would sell because they want to avoid the mental pain associated with admitting that they made a bad decision

average down investing

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7
Q

Average down investing

A

throwing good money after bad

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8
Q

Cognitive dissonance can cause investors to get caught up in

A

herds of behavior - people avoid information that counters an earlier decision

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9
Q

Conservatism

A

bias where people cling to their prior views or forecasts at the expense of acknowledging new information

Slow to change

Difficulty in processing new information

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10
Q

Confirmation

A

Where people observe, overvalue, or actively seek out information that confirms what they believe while ignoring or devaluing information that contradicts their beliefs

Believe strongly in predetermined screens.

Cause employees to over concentrate in company stock

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11
Q

Representativeness

A

Bias through which individuals process new information using preexisting ideas or beliefs

views a particular situation or information a certain way because of similarities to other examples even if it does not really fit into that category

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12
Q

Illusion of control bias investors tend to

A

trade more than is prudent

maintain underdiversified portfolios

use limit orders

overconfidence

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13
Q

Anchoring bias investors tend to succumb to

A

house money effect - where risk-taking behavior escalates as wealth grows

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14
Q

Anchoring and adjustment

A

Cognitive bias where investors are influenced by purchase price points or arbitrary price levels and cling to these numbers when deciding to buy or sell

often rely too heavily on certain information when making decisions

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15
Q

Framing

A

cognitive bias, where an individual responds to similar situations differently based on the context in which the choice is presented

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16
Q

Framing and loss aversion can work together by

A

To explain excessive risk aversion. An investor who has incurred a net loss becomes likelier to select a riskier investment, whereas a net gainer feels redisposed toward less risky alternatives.

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17
Q

Availability

A

cognitive bias where easily recalled outcomes are perceived as being more likely that those that are harder to recall or understand

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18
Q

Examples of availability

A

choose investments based on information that is available to them by advertising, suggestions from advisors, friends, etc…

Choose investments that resonate with them

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19
Q

Loss aversion

A

emotional bias where an investor finds the idea of losses twice as painful as the pleasure of gains

core tenet of prospect theory

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20
Q

Loss aversion investors tend to

A

hold losing investments too long

get-even-itis - hold losing investments in the hope that they get back what they lost

unknowingly take on more risk in their portfolio

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21
Q

Examples of self control bias

A

cause investors to spend more today at the expense of saving for tomorrow

fail to plain for retirement

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22
Q

Status quo bias

A

emotional bias where when faced with an array of options, an investor is predisposed to select the option that keeps conditions the same

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23
Q

Examples of status quo

A

Cause investors to take no action to hold investments inappropriate to their own risk. This can mean that investors take an excessive risk or invest too conservatively.

Can be combined with loss aversion bias

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24
Q

Endowment effect

A

an emotional bias where an individual assigns a greater value to an object already held or owned

Investors may assign additional value to stocks they have inherited or purchased because they do not want to incur the transaction costs associated with selling the securities.

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25
Q

Regret aversion

A

An emotional bias where investors avoid taking decisive action because they are afraid that when looking back at the course they select it will prove less than optimal

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26
Q

Examples of regret aversion

A

Having suffered losses in the past, investors tend to be too conservative in their investment choices.

Hold onto losing positions for too long

Herding behavior

Hold onto winning stocks for too long

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27
Q

Affinity

A

emotional bias where investors make decisions based on how they believe a product or service reflects their values

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28
Q

Examples of affinity

A

are prone to purchase stocks that reflect their self image

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29
Q

Sunk cost fallacy

A

investors may continue to hold an investment and even invest more (double down) in large part because of the time, effort and energy they have already invested

Often tied back to anchoring and status quo bias

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30
Q

Get Even Itis

A

investors will often hold 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.

31
Q

Disposition Effect

A

investors typically hold on to losing investments too long but sell winning investments too early

succumb to the so called “snake bit effect” where investors are seeking to avoid lossses

32
Q

Snake Bit Effect

A

investors experience losses and then become more risk averse even to the entent of now wanting to invest in the same investment or even asset class, based on their painful experience in the past

33
Q

Snake bit effect is often associated with other biases including

A

anchoring, recency, conservatism and representativeness

34
Q

Preservers as typically what type of investors

A

passive; who place emphasis on security and preserving wealth rather than taking risks to grow wealth

35
Q

Preservers are often subject to what type of biases

A

endowment, loss aversion, status quo, anchoring and mental accounting

36
Q

Followers as typically what type of investor

A

passive investors; dont have their own ideas about investing so they follow the lead of friends and colleagues

Prone to follow the herd and look for the most popular investments

37
Q

Followers are often subject to what type of biases

A

recency, hindsight, framing, regret , cognitive dissonance and outcome

38
Q

Independents are what type of investors

A

active; higher tolerance of risk than they have need for security

tend to get involved with investment decisions and maintain some amount of control of their own investments

39
Q

Independents are often subject to what type of biases

A

conservatism, availability, confirmation, representativeness and self attribution

40
Q

Accumulators are what type of investor

A

active; often entrepreneurial and the first generation to create wealth

strong willed and confident

often have a higher tolerance for risk

41
Q

Accumulators are often subject to what type of biases

A

overconfidence, affinity and illusion of control

42
Q

Behavioral portfolio theory assumes what

A

investors construct portfolios to satisfy goals

43
Q

Tendency of followers to respond to situations differently based on the context in which a choice is presented

A

Framing bias

44
Q

If presented with too many hot investment ideas, a typical follower will do what

A

take them all

45
Q

In the barnewell two way model, passive investors have a significant need for what

A

Security

46
Q

Passive investors have a greater need for what

A

security more so than risk

47
Q

Accumulators typically do not have believe in what

A

diversification

48
Q

Can cause investors to fell uncomfortable with a security they own

A

Cognitive dissonance

49
Q

Type of investor most likely not to follow a financial plan

A

Independents

50
Q

Type of investor most likely to hold concentrated portfolios

A

Indpendents

51
Q

Can lead to higher risk by limiting investments in a portfolio by concentrating on domestic securities and reducing currency exposure

A

Home country bias

52
Q

Extrapolating patterns based on small historical data is exhibiting which type of bias

A

Recency

53
Q

Investor focused on short term technical trading based on information gathered on a short term bias, may be suffering from what

A

Recency bias

54
Q

Can cause investors to ignore fundamental value and to focus only on recent upward price performances

A

Recency bias

55
Q

Under the Bailard, Biehl and Kaiser five way model, a sensible investor who takes on risk is called a

A

Straight arrow

56
Q

Investors that are sensible who take risk at appropriate times

A

Straight arrow

57
Q

Investor making investment choices based on knowledge of how similar investments have performed in the past may have what kind of bias

A

Representativeness

58
Q

Occurs when we take mental shortcuts and jump to conclusions about one investment based on perceived similarities to other investments

A

representativeness

59
Q

Investor who gathers all investment recommendations from golfing friends

A

Representativeness

60
Q

House money effect

A

Mental accounting

61
Q

Can cause investors to be too conservative in their choices, especially if they have suffered losses in the past

A

regret aversion

62
Q

Emotional investors who place a great deal of emphasis on security

A

Preservers

63
Q

Investors have more equity choices in a 401K than fixed income choices. Although risk averse, this investor picks more equity funds to invest in

A

Framing bias

64
Q

Investors pick investments based products or services that will reflect their values

A

Affinity bias

65
Q

Can lead to an investor to hold on to a security too long for fear of missing out on gains

A

regret aversion

66
Q

Hold and no nothing on investments that they own

A

likely cognitive dissonance

67
Q

An investor chooses to review only investment info that reaffirms the decisions already made

A

Selective perception

68
Q

Individual to miscalculate based on utilization of info that reaffirms a chosen path

A

Selective perception

69
Q

Overconfident investors may have what, than they know

A

downside risk

70
Q

A patriotic investor displaying home bias without any reasearch

A

affinity bias

71
Q

To assist an investor with representative bias, good advice would by

A

past models and experiences may not always apply to a current investment

72
Q

Do not have their own ideas about investing

A

followers

73
Q
A

CIMA (22 decks)

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