Bias of individuals

Question 1

cognitive errors

Answer 1

biases based on faulty cognitive reasoning (nhan thuc sai)

Question 2

emotional biases

Answer 2

biases base on feeling or emotions

Question 3

believe preservarance bias

Answer 3

= cognitive disonance: occurs when new information conflict with previously held belief or cognitions

Question 4

conservatism bias

Answer 4

1. Definition:
   Cognitive errors - beleive preservarance bias
   people:
   + Maintain prior views
   + Fail to incorporating new information (biet nhung coi thuong thong tin moi)
2. 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

Question 5

cognitive cost

Answer 5

the effort involved in processing new information and updating beliefs

Question 6

confirmation bias

Answer 6

1. Definition:
   cognitive error - believe preservarance bias
   People tend:
   + look for & notice what confirm their believe
   + ignore & undervalue what contracdict their beliefs
2. 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

Question 7

representativeness

Answer 7

1. Definition:
   Cognitive errors - belief preservarance bias
   People tend to classification new information base on past experience and classifications
2. 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

Question 8

base-rate neglect

Answer 8

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

Question 9

sample size neglect

Answer 9

cognitive errors - belief preservarance bias - representativeness
make initial classification base on overly small and potentially unrealistic sample of data

Question 10

illution of control bias

Answer 10

1. Definition:
   cognitive erroer - belief preservarance
   people tend to believe they can control /influence outcome, but in fact, they cannot
2. Consequense:
   + Trade more than is appropriate
   + Fail to adequately diversify

Question 11

hindsight bias (=I knew it all along bias)

Answer 11

1. Definiton:
   cognitive error - belief preservarance bias -
   People may see past events as having been predictable and reasonable to expect
2. Consequense:
   + Overestimate the rate at which they correctly predicted events
   + Become overly critical of the performance of others

Question 12

anchoring and adjustment bias

Answer 12

1. Definition: (cognitive information processing):
   + the first information received is overweighted
2. Consequense: may include market
   participants who stay anchored to an initial estimate and do not adjust for new information

Question 13

mental accounting bias

Answer 13

1. 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
2. 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
3. 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

Question 14

framing bias

Answer 14

1. Definition: cognitive errors- information processing bias
   a person answers a question differently based on the way in which it is asked (framed).
2. 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

Question 15

availibility bias

Answer 15

1. 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
2. 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

Question 16

Loss aversion bias

Answer 16

1. Definition: emotional biases: people tend to strongly prefer avoiding losses as opposed to achieving gains.
2. 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

Question 17

Overconfidence Bias

Answer 17

1. Definition: people demonstrate unwarranted faith in their own intuitive reasoning, judgments, and/or cognitive abilities.
2. Consequense:
   + Underestimate risk and overestimate return
   + Under-diversification
   + Excessive turnover and transaction costs resulting in lower return
3. Type:
   + Prediction overconfidence: investment prediction are too narrow
   + Certainty overconfidence: the probability of outcome are too high

Question 18

Self-Control Bias

Answer 18

1. Definition: people fail to act in pursuit of their long-term, overarching goals because of a lack of self-discipline
2. 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

Question 19

Status Quo Bias

Answer 19

1. Definition: people choose to do nothing (i.e., maintain the “status quo”) instead of making a change
2. Consequense:
   + Holding portfolios with inappropriate risk
   + Not considering other, potentially better investment options

Question 20

Endowment bias

Answer 20

1. Definition: people value an asset more when they hold rights to it than when they do not
2. 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

Question 21

Regret-aversion bias

Answer 21

1. Definition: people tend to avoid making decisions that will result in action out of fear that the decision will turn out poorly
2. 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

Question 22

Retrievability bias

Answer 22

+ 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

Question 23

Categorization bias

Answer 23

This is the tendency to place items in categories that share what individuals perceive as common characteristics

Question 24

Narrow range of experience bias

Answer 24

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

Question 25

Resonance bias

Answer 25

+ 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

Question 26

self - attribution (belief you personally caused something to happen), and overconfidence biases (an unwarranted belief you are correct)

Question 27

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 ?

Answer 27

conservatism bias

Question 28

cognitive dissonance

Answer 28

is the mental discomfort that occurs when new
information conflicts with previously held beliefs or cognitions.

Question 29

what bias is “stock love bias”

Answer 29

confirmation bias

Question 30

prediction overconfidence

Answer 30

+ overconfidence bias
+ confidence intervals of their investment predictions are too narrow

Question 31

certainty overconfidence

Answer 31

the probabilities prediction of outcome is too high

Question 32

myopic loss aversion

Answer 32

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

Question 33

Error of omission

Answer 33

Regret from an action is not taken

Question 34

error of omission

Answer 34

Regret from an action not taken

Question 35

Familiarity bias

Answer 35

+ It is a form of availability bias
+ Result in overweight home country securities

Question 36

remedy of loss aversion

Answer 36

use goals-based investing

Question 37

remedy of illusion of control

Answer 37

usr CAPM market portfolio