Behaviour Finance

Question 1

Behavioural Finance

Answer 1

The field of behavioural finance looks at how a variety of mental biases and decisionmaking errors affect financial decisions. It relates to the psychology that underlies and drives financial decision-making behaviour

Question 2

Prospect Theory

Answer 2

Prospect Theory details how human decision-making differs systematically from that predicted by expected utility theory, and how human beings consistently violate the rationality axioms that form the basis of the theory

Question 3

2 Phases of Decision-Making in Prospect Theory

Answer 3

• Editing/Framing - Outcomes are initially appraised and ordered
• Evaluation - A choice is made from the appraised options

Question 4

2 Basic Operations in the editing processes (Prospect Theory)

Answer 4

• Acceptance - People are unlikely to alter the formulation of the choices presented
• Segregation - People tend to focus on the most “relevant” factors of a problem

Question 5

Recency effect

Answer 5

The final option (presentation) is preferred.

Question 6

Myopic loss aversion

Answer 6

Investors less risk-averse when faced with a

multiple periods of gambles.

Question 7

Primary effect

Answer 7

People are more likely to choose the first option presented.

Question 8

Effect of options

Answer 8

A greater range of options tends to discourage decision making.

Question 9

Status Quo bias

Answer 9

People like to keep things the way they are.

Question 10

Regret aversion

Answer 10

By retaining the existing arrangements people minimise the possibility
of regret

Question 11

Dislike of negative events

Answer 11

The degree to which an outcome is considered negative or positive has a significant influence on an estimate of its likelihood. In general, people are
optimists and overestimate the likelihood of positive events.

Question 12

Heuristics

Answer 12

Shortcut used by the brain to deliver a quick decision

Heuristics include:

• Anchoring and adjustment
• Availability
• Representative heuristics
• Familiarity

Question 13

Representative heuristics

Answer 13

People find more probable that which they find easier to imagine. As the amount of detail increases, it becomes easier to imagine

Question 14

Availability

Answer 14

People are influenced by the ease with which something can be brought to
mind. This can lead to biased judgements when examples of one event are inherently
more difficult to imagine than examples of another.

Question 15

Anchoring and adjustment

Answer 15

People base future perceptions based on past experience and expert opinion. The valuation is then amended for the scenario to fit the assumptions.

Question 16

Overconfidence

Answer 16

Individuals are typically overconfident about their own skills and insights.

This arises from

• Hindsight bias
• Confirmation bias

The discrepancy between confidence and accuracy increases as an individual’s expert knowledge increases (even where accuracy improves with knowledge, confidence increases by more).

Question 17

Hindsight bias

Answer 17

Events that happen will be thought of as having been predictable prior to the event, events that do not happen will be thought of as having been unlikely prior to the event.

Question 18

Confirmation bias

Answer 18

People will tend to look for evidence that confirms their point of view (and will tend to dismiss evidence that does not justify it).

Question 19

Ambiguity aversion

Answer 19

People are willing to pay a higher premium to receive more detailed rules.

Question 20

Daar is nog

Answer 20

Gaan soek in die handboek en nie net die tut memo nie. Hou op lui wees