Bias of individuals Flashcards
cognitive errors
biases based on faulty cognitive reasoning (nhan thuc sai)
emotional biases
biases base on feeling or emotions
believe preservarance bias
= cognitive disonance: occurs when new information conflict with previously held belief or cognitions
conservatism bias
- Definition:
Cognitive errors - beleive preservarance bias
people:
+ Maintain prior views
+ Fail to incorporating new information (biet nhung coi thuong thong tin moi) - Consequense:
+ unwilling or slow to update a view or forecast for new information -> hold an investment too long
+ Hold an investment too long to avoid the mental effort or stress of updating a
view, when the new information is complex to understand
cognitive cost
the effort involved in processing new information and updating beliefs
confirmation bias
- Definition:
cognitive error - believe preservarance bias
People tend:
+ look for & notice what confirm their believe
+ ignore & undervalue what contracdict their beliefs - Consequense:
+ Consider positive but ignore negative information and therefore hold
investments too long
+ Set up the decision process or data screens incorrectly to find what they want to see
+ Underdiversify as they become overly convinced their ideas are correct,
resulting in concentrated positions
+ Over concentrate in the stock of their employer believing they have an
information advantage in to that security
representativeness
- Definition:
Cognitive errors - belief preservarance bias
People tend to classification new information base on past experience and classifications - Consequense:
+ Attach too much importance to new pieces of information, or to a small
sample
+ Make decisions based on simple rules of thumb and classification without thorough analysis
base-rate neglect
Cognitive error - belief presevarance bias - representativeness
base rate (probability) of the initial classification is not adequately considered
Eg: MSN is classify as a value stock, new information is analyzed base on that classification
sample size neglect
cognitive errors - belief preservarance bias - representativeness
make initial classification base on overly small and potentially unrealistic sample of data
illution of control bias
- Definition:
cognitive erroer - belief preservarance
people tend to believe they can control /influence outcome, but in fact, they cannot - Consequense:
+ Trade more than is appropriate
+ Fail to adequately diversify
hindsight bias (=I knew it all along bias)
- Definiton:
cognitive error - belief preservarance bias -
People may see past events as having been predictable and reasonable to expect - Consequense:
+ Overestimate the rate at which they correctly predicted events
+ Become overly critical of the performance of others
anchoring and adjustment bias
- Definition: (cognitive information processing):
+ the first information received is overweighted - Consequense: may include market
participants who stay anchored to an initial estimate and do not adjust for new information
mental accounting bias
- Definition: cognitive error - information processing bias
+ separating assets and liabilities into different “buckets” based on subjective criteria
+ violates the traditional violates the traditional finance assumption that: money is fungible and therefore interchangeable between accounts
Notes: Goals-based investing can help overcome mental accounting bias - Eg:
+ client might mentally treat wages differently from a bonus when determining saving and investment goals
+ gasoline declined from $0.90 a liter to $0.45, you spend 60$/week on gasoline, but when gasoline decline, you continued to spend close to $60 a week, by switch to more expensive gasoline - Consequense:
+ Structuring portfolios in layers to meet different priority goals
+ Failing to lower portfolio risk by adding assets with very low correlation
+ Segregating return into arbitrary categories of income, realized gains and
losses, or unrealized gains and losses
framing bias
- Definition: cognitive errors- information processing bias
a person answers a question differently based on the way in which it is asked (framed). - Consequense:
+ Fail to properly assess risk and end up overly risk-averse or risk-seeking.
+ Choose suboptimal risk for their portfolio or assets based on the way a
presentation is made
+ Become overly concerned with short term price movement and trade too
often
availibility bias
- Definition:
+ cognitive error- information processing bias
+ people take a heuristic (sometimes called a rule of thumb or a mental shortcut) approach to estimating the probability of an outcome based on how easily the outcome comes to mind - Consequense:
+ Choose a manager or investment based on advertising or recalling they have heard the name
+ Limit investment choices to what they are familiar with and fail to consider alternative investments, resulting in:- Under-diversification
- Inappropriate asset allocation
+ Overreact to recent market conditions while ignoring data on historic performance
+ Place too much emphasis on events that receive a large amount of media
attention or advertising
Loss aversion bias
- Definition: emotional biases: people tend to strongly prefer avoiding losses as opposed to achieving gains.
- Consequense:
+ Feel less preasure in gain for a profit than pain for a loss with equal
+ To avoid having pain in loss, investor hold loser too long and sell winner too qickly
+ Trading too much in small gain -> raise transaction cost, lower return
+ too risky if hold equity is deteriorated in quality and lost value.
Eg: nắm giữ cổ phiếu chờ về bờ
Overconfidence Bias
- Definition: people demonstrate unwarranted faith in their own intuitive reasoning, judgments, and/or cognitive abilities.
- Consequense:
+ Underestimate risk and overestimate return
+ Under-diversification
+ Excessive turnover and transaction costs resulting in lower return - Type:
+ Prediction overconfidence: investment prediction are too narrow
+ Certainty overconfidence: the probability of outcome are too high
Self-Control Bias
- Definition: people fail to act in pursuit of their long-term, overarching goals because of a lack of self-discipline
- Consequences:
+ Insufficient savings accumulation to fund retirement needs, resulting from
favoring current spending over saving.
+ Taking excessive risk in the portfolio to try and compensate for insufficient saving accumulation
+ An overemphasis on income producing assets to meet shorter-term income
needs
Status Quo Bias
- Definition: people choose to do nothing (i.e., maintain the “status quo”) instead of making a change
- Consequense:
+ Holding portfolios with inappropriate risk
+ Not considering other, potentially better investment options
Endowment bias
- Definition: people value an asset more when they hold rights to it than when they do not
- Consequense:
+ Failing to sell an inappropriate asset resulting in inappropriate asset
allocation
+ Holding things you are familiar with because they provide some intangible
sense of comfort
Regret-aversion bias
- Definition: people tend to avoid making decisions that will result in action out of fear that the decision will turn out poorly
- Consequense:
+ Excess conservatism in the portfolio because it is easy to see that riskier
assets do at times underperform.
+ This leads to long-term underperformance and a failure to meet goals
+ Herding behavior is a form of regret-aversion where participants go with the
consensus or popular opinion
Retrievability bias
+ A type belong to availability bias
+ If an idea or answer come to mind quicker than others can, it is often chosen as correct, even if it is not
Categorization bias
This is the tendency to place items in categories that share what individuals perceive as common characteristics
Narrow range of experience bias
This results from an individual with a narrow range of experiences using her experience as a frame of reference when estimating probabilities for the population
Resonance bias
+ 1 type of availablity bias
+ If a piece of information or an event strikes a chord with an individual’s own beliefs and desires, the individual may overweight the importance of this information when making decisions
self - attribution (belief you personally caused something to happen), and overconfidence biases (an unwarranted belief you are correct)
John Mue has carefully analyzed the historical data and concluded that recessionary environments occur on average 20% of the time. Mue has incorporated this probability into his strategic asset allocation recommendations. When new information is presented by a coworker showing that the actions of the central bank significantly affect the recession probabilities and that the new head of the central bank has announced tightening monetary conditions, Mue goes on vacation without making any adjustments to his work.
What kind of bias ?
conservatism bias
cognitive dissonance
is the mental discomfort that occurs when new
information conflicts with previously held beliefs or cognitions.
what bias is “stock love bias”
confirmation bias
prediction overconfidence
+ overconfidence bias
+ confidence intervals of their investment predictions are too narrow
certainty overconfidence
the probabilities prediction of outcome is too high
myopic loss aversion
Investors evaluate their portfolios on a short-term basis, overemphasize short-term gains and losses, and weigh losses more heavily than gains. The overemphasis on short-term losses results in a higher equity risk premium than justified.
Compare to loss aversion:
+ Loss aversion: hold loss longer, hold gain shorter
+ Myopic loss aversion: emphasize short-term basis, weight losses more heavily than gains
Error of omission
Regret from an action is not taken
error of omission
Regret from an action not taken
Familiarity bias
+ It is a form of availability bias
+ Result in overweight home country securities
remedy of loss aversion
use goals-based investing
remedy of illusion of control
usr CAPM market portfolio
