Behavorial Finance Flashcards
List all biases
Cognitive
Belief perseverance
1) Conservatism
2) Confirmation
3) Representativeness
4) Illusion of control
5) Hindsight
Info processing
1) Anchoring and adjustment
2) Mental accounting
3) Framing
4) Availability
Emotional
1) Loss aversion
2) Overconfidence
3) Self-control
4) Status-quo
5) Endowment
6) Regret-aversion
Conservatism bias
Conservatism bias
Maintain prior views or forecasts by inadequately incorporating new info, by overweighting initial beliefs (base rate) and underweighting new info.
Result
- fail to update with new info or slow to react (underreact)
Confirmation bias
Confirmation bias
Looking for & notice what confirms prior belief or distorting/disregarding info to support existing belief
Result
- Underdiversified portfolios & excessive exposure to risk by holding on to losing stocks too long
- Concentrated holding of employer stock
* must state that they will disregard/ignore the other disconfirming facts in a vignette
Representativeness bias
Representativeness bias
Classify new info based on past experiences and classifications, leads to overweighting new info & small samples, viewing them as representative of the pop as a whole & of future events
Result
- underweight base rates, overweight new info
- hold on to or buy recent winners
- excessive turnover
Illusion of control bias
Illusion of control bias
Belief you can control or influence outcomes, when in fact, you can’t
Result
- overtrading, lower returns
- underdiversification, excessive risk
Hingsight bias
Hindsight bias
See past events as having been predictable and reasonable to expect
Result
- overconfidence
- unfairly assess the performance of others
Anchoring and adjustment bias
Anchoring and adjustment bias
Initial view acts as an anchor, often developedd heuristically, adjustment usually insufficient
Result
- hold too long, sell too early
Mental accounting bias
Mental accounting bias
Treat one sum of money differently to another equal-sized sum based on which mental account the money is assigned to.
Result
- underdiversification and excessive risk
Neglect:
- correlations amongst assets in different accounts
- opportunities to reduce risk by combining assets with low correlations
- total return
Framing bias
Framing bias
A person responds differently depending on how a probkem is framed
Result
- excessive risk: misidentify risk tolerances, choose suboptimal investments, focus on short term price fluctuations
Availability bias
Availability bias
Estimate probability based on how easily something comes to mind, as easily recalled outcomes are perceived as more likely
Result
- underdiversification
- excessive risk
Loss aversion bias
Loss aversion bias
People prefer avoiding losses as opposed to achieving gains, as the losses are more emotionally powerful than the gains.
Results
- Innapropriate risk risk by holding losers longer than justified
- Excessive trading by selling winners too quickly
Overconfidence bias
Overconfidence bias
People demonstrate unwarranted faith in their own abilities, reasoning and judgement
Result
- underdiversified portfolios
- Innapropriate risk due to underestimation
- Overestimate returns as excessive trading will lead to underperformance
Answer - looking for a judgement, estimate, forecast of future outperformance (i’m going to outperform) that is not justified by the facts (5% < 7%) but only by belief
Self-attribution bias contributes to overconfidence bias
- takes personal credit for all successes, as a result, will see past success as a result of personal ability, and will continue (i.e. buying in a rising market)
Self-control bias
Self-control bias
People lack self-discipline and favour immediate gratification over long-term goals
Result
- SAA imbalances due to spending using income producing assets, instead of reinvesting that income. Also lower return’s from income producing assets.
- Innapropriate risk by insufficiently saving for the future, resulting in accepting too much risk to catch up
Status-quo bias
Status-quo bias
Comfort with existing situation leads to unwillingness to make changes
Result
- Innapropriate risk from maintaining portfolios with innapropriate risk charachteristics
- Fail to explore other opportunities
Endowment bias
Endowment bias
An asset is felt to be more special/valuable because it is already owned, with the familiarity adding to perceived value of the asset
Result
- Innapropriate asset allocation in relation to risk tolerance and financial goals
- fail to sell assets and replace them with other assets
