Chapter 01-02 Behavioral Finance

Question 1

Anchoring and adjustment

Answer 1

An information-processing bias in which the use of a psychological heuristic influences the way people estimate probabilities.

Question 2

Anomalies

Answer 2

Apparent deviations from market efficiency.

Question 3

Availability bias

Answer 3

An information-processing bias in which people take a heuristic approach to estimating the probability of an outcome based on how easily the outcome comes to mind.

Question 4

Base-rate neglect

Answer 4

A type of representativeness bias (belief perserverence) in which the base rate or probability of the categorization is not adequately considered.

Question 5

Behavioral finance macro

Answer 5

A focus on market level behavior that considers market anomalies that distinguish markets from the efficient markets of traditional finance.

Question 6

Behavioral finance micro

Answer 6

A focus on individual level behavior that examines the behavioral biases that distinguish individual investors from the rational decision makers of traditional finance.

Question 7

Cognitive cost

Answer 7

The effort involved in processing new information and updating beliefs.

Question 8

Cognitive dissonance

Answer 8

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

Question 9

Cognitive errors

Answer 9

Behavioral biases resulting from faulty reasoning; cognitive errors stem from basic statistical, information processing, or memory errors. Moderate with better information processing (structure, process), awareness.

Question 10

Confirmation bias

Answer 10

A belief perseverance bias in which people tend to look for and notice what confirms their beliefs, to ignore or undervalue what contradicts their beliefs, and to misinterpret information as support for their beliefs.

Question 11

Conjunction fallacy

Answer 11

An inappropriate combining of probabilities of independent events to support a belief. In fact, the probability of two independent events occurring in conjunction is never greater than the probability of either event occurring alone; the probability of two independent events occurring together is equal to the multiplication of the probabilities of the independent events.

Question 12

Conservatism bias

Answer 12

A belief perseverance bias in which people maintain their prior views or forecasts by inadequately incorporating new information.

Question 13

Disposition effect

Answer 13

As a result of loss aversion, an emotional bias whereby investors are reluctant to dispose of losers. This results in an inefficient and gradual adjustment to deterioration in fundamental value.

Question 14

Emotional biases

Answer 14

Behavioral biases resulting from reasoning influenced by feelings; emotional biases stem from impulse or intuition. Emotional biases must be adapted as they are more difficult to correct.

Question 15

Endowment bias

Answer 15

An emotional bias in which people value an asset more when they hold rights to it than when they do not.

Question 16

Framing

Answer 16

An information-processing bias in which a person answers a question differently based on the way in which it is asked (framed).

Question 17

Framing bias

Answer 17

An information-processing bias in which a person answers a question differently based on the way in which it is asked (framed).

Question 18

Gamblers’ fallacy

Answer 18

A misunderstanding of probabilities in which people wrongly project reversal to a long-term mean.

Question 19

Halo effect

Answer 19

An emotional bias that extends a favorable evaluation of some characteristics to other characteristics.

Question 20

Herding

Answer 20

When a group of investors trade on the same side of the market in the same securities, or when investors ignore their own private information and act as other investors do.

Question 21

Hindsight bias

Answer 21

A belief perserverence bias with selective perception and retention aspects in which people may see past events as having been predictable and reasonable to expect.

Question 22

Home bias

Answer 22

A preference for securities listed on the exchanges of one’s home country.

Question 23

Illusion of control

Answer 23

A belief perserverence bias in which people tend to believe that they can control or influence outcomes when, in fact, they cannot. Illusion of knowledge and self-attribution biases contribute to the over confidence bias.

Question 24

Loss-aversion bias

Answer 24

An emotional bias in which people tend to strongly prefer avoiding losses as opposed to achieving gains.

Question 25

Mental accounting bias

Answer 25

An information-processing bias in which people treat one sum of money differently from another equal-sized sum based on which mental account the money is assigned to.

Question 26

Overconfidence bias

Answer 26

An emotional bias in which people demonstrate unwarranted faith in their own intuitive reasoning, judgments, and/or cognitive abilities.

Question 27

Regret

Answer 27

The feeling that an opportunity has been missed; typically an expression of hindsight bias.

Question 28

Regret-aversion bias

Answer 28

An emotional bias in which people tend to avoid making decisions that will result in action out of fear that the decision will turn out poorly.

Question 29

Representativeness bias

Answer 29

A belief perseverance bias in which people tend to classify new information based on past experiences and classifications.

Question 30

Sample-size neglect

Answer 30

A type of representativeness bias (belief perserverence) in which financial market participants incorrectly assume that small sample sizes are representative of populations (or “real” data).

Question 31

Self-attribution bias

Answer 31

A bias (other) in which people take personal credit for successes and attribute failures to external factors outside the individual’s control.

Question 32

Self-control bias

Answer 32

An emotional bias in which people fail to act in pursuit of their long-term, overarching goals because of a lack of self-discipline.

Question 33

Social proof

Answer 33

A bias (other) in which individuals tend to follow the beliefs of a group.

Question 34

Status quo bias

Answer 34

An emotional bias in which people do nothing (i.e., maintain the “status quo”) instead of making a change.