Behavioral Finance Theories

Question 1

Prospect Theory state that people make decisions based on

Answer 1

probabilities more than potential outcomes

Question 2

Prospect Theory state that people make decisions using

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mental heuristics (mental shortcuts and biases)

Question 3

Loss Aversion

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the tendency to feel the impact of losses more than gains

Question 4

Prospect Theory can be illustrated graphically using an

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asymmetrical s shapred curve

Question 5

Cognitive dissonance

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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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Cognitive dissonance causes invstors to

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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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Average down investing

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throwing good money after bad

Question 8

Cognitive dissonance can cause investors to get caught up in

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

Question 9

Conservatism

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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

Question 10

Confirmation

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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

Question 11

Representativeness

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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

Question 12

Illusion of control bias investors tend to

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trade more than is prudent

maintain underdiversified portfolios

use limit orders

overconfidence

Question 13

Anchoring bias investors tend to succumb to

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

Question 14

Anchoring and adjustment

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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

Question 15

Framing

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

Question 16

Framing and loss aversion can work together by

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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.

Question 17

Availability

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

Question 18

Examples of availability

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

Choose investments that resonate with them

Question 19

Loss aversion

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

core tenet of prospect theory

Question 20

Loss aversion investors tend to

Answer 20

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

Question 21

Examples of self control bias

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

fail to plain for retirement

Question 22

Status quo bias

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

Question 23

Examples of status quo

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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

Question 24

Endowment effect

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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.

Question 25

Regret aversion

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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

Question 26

Examples of regret aversion

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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

Question 27

Affinity

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

Question 28

Examples of affinity

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are prone to purchase stocks that reflect their self image

Question 29

Sunk cost fallacy

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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

Question 30

Get Even Itis

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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.

Question 31

Disposition Effect

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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

Question 32

Snake Bit Effect

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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

Question 33

Snake bit effect is often associated with other biases including

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anchoring, recency, conservatism and representativeness

Question 34

Preservers as typically what type of investors

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

Question 35

Preservers are often subject to what type of biases

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

Question 36

Followers as typically what type of investor

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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

Question 37

Followers are often subject to what type of biases

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

Question 38

Independents are what type of investors

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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

Question 39

Independents are often subject to what type of biases

Answer 39

conservatism, availability, confirmation, representativeness and self attribution

Question 40

Accumulators are what type of investor

Answer 40

active; often entrepreneurial and the first generation to create wealth strong willed and confident often have a higher tolerance for risk

Question 41

Accumulators are often subject to what type of biases

Answer 41

overconfidence, affinity and illusion of control

Question 42

Behavioral portfolio theory assumes what

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investors construct portfolios to satisfy goals

Question 43

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

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Framing bias

Question 44

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

Answer 44

take them all

Question 45

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

Answer 45

Security

Question 46

Passive investors have a greater need for what

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security more so than risk

Question 47

Accumulators typically do not have believe in what

Answer 47

diversification

Question 48

Can cause investors to fell uncomfortable with a security they own

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Cognitive dissonance

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Type of investor most likely not to follow a financial plan

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Independents

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Type of investor most likely to hold concentrated portfolios

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Indpendents

Question 51

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

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Home country bias

Question 52

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

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Recency

Question 53

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

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Recency bias

Question 54

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

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Recency bias

Question 55

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

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Straight arrow

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Investors that are sensible who take risk at appropriate times

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Straight arrow

Question 57

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

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Representativeness

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

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representativeness

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Investor who gathers all investment recommendations from golfing friends

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Representativeness

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House money effect

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Mental accounting

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

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regret aversion

Question 62

Emotional investors who place a great deal of emphasis on security

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Preservers

Question 63

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

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Framing bias

Question 64

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

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Affinity bias

Question 65

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

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regret aversion

Question 66

Hold and no nothing on investments that they own

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likely cognitive dissonance

Question 67

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

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Selective perception

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

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Selective perception

Question 69

Overconfident investors may have what, than they know

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downside risk

Question 70

A patriotic investor displaying home bias without any reasearch

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affinity bias

Question 71

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

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

Question 72

Do not have their own ideas about investing

Answer 72

followers