chapter 13

Question 1

rational expectations

Answer 1

means that all investors correctly interpret and use their own information, as well as information that can be inferred from market prices or the trades of others.

Question 2

familiarity bias

Answer 2

investors favour investments in companies they are familiar with, which leads to failure to diversify portfolios adequately.

Question 3

relative wealth concerns

Answer 3

investors care most about the performance of their portfolio relative to that of their peers. this desire to keep up leads to choosing undiversified portfolios that match those of their peers.

Question 4

overconfidence bias

Answer 4

occurs when investors believe they can pick winners and losers when in fact they cannot. it leads to too much trading and worse performance taking into account the costs of trading (commissions and bid-ask spreads).

Question 5

sensation seeking

Answer 5

the individual’s desire for novel and intense risk-taking experiences.

Question 6

disposition effect

Answer 6

investors tend to hold on to stocks that have lost value and sell stocks that have risen in value since time of purchase.

Question 7

herd behaviour

Answer 7

investors actively try to follow each other’s behaviour and imitate each other’s actions.

Question 8

information cascade effect

Answer 8

when investors believe others have superior information that they can take advantage of by copying their trade. investors trade ignore their own information hoping to profit from the information of others.

Question 9

underdiversification

Answer 9

occurs when individual investors fail to diversify their portfolios adequately.

Question 10

excessive trading

Answer 10

occurs when investors trade too much (buying and selling shares thinking they can pick winners or losers).