FINMAN E2 TOPIC 4 AND 5

Question 1

• It is a mental shortcut that we use when
  estimating probabilities. When we’re trying to
  assess how likely a certain event is, we often
  make our decision by assessing how similar it
  is to an existing mental prototype.

Answer 1

REPRESENTATIVE BIAS

Question 2

People use unconscious
mental statistics to
figure out what the
“average” member of a
category looks like

Answer 2

Prototype Theory

Question 3

When we are trying to make
decisions about unfamiliar
things or people, we refer to
this average— the prototype—
as a _____ example of
the entire category

Answer 3

representative

Question 4

Types of Representativeness Bias

Answer 4

• BASE-RATE NEGLECT
• SAMPLE-SIZE NEGLECT

Question 5

Some investors tend to rely
on stereotypes when making
investment decisions.

Answer 5

• BASE-RATE NEGLECT

Question 6

When judging the likelihood
of a particular investment
outcome, often fail to
accurately consider the
sample size of the data on
which they base their
judgments

Answer 6

SAMPLE-SIZE NEGLECT

Question 7

Harmful effects of Representativeness
Bias on Investors

Answer 7

When evaluating a money manager’s past performance,
investors have the potential to make costly mistakes. They
review the most recent quarters or even years and draw
the incorrect statistical conclusion that the fund’s
performance is the product of careful security selection
and/or competent asset allocation

Similar errors are made by investors when looking into the
track histories of stock experts. For instance, they
incorrectly judge an analyst’s skill based on the
performance of their last few suggestions, which is a small
sample of data

Question 8

Psychologists have found
that people have
tendencies to rely too
heavily on the very first
piece of information they
learn, which can have a
serious impact on the
decision they end up
makin

Answer 8

ANCHORING BIAS

Question 9

Effects of Anchoring
Bias

Answer 9

Poor decision-making
* Skewed expectations
* Dismissal of new information

Question 10

3 ways to Identify
Anchoring Bias

Answer 10

1. Relying on a single source of
   information
2. Disregarding conflicting facts
3. Being reluctant to accept new idea

Question 11

Tips for reducing
anchoring bias

Answer 11

• Use multiple sources - One way
  to reduce anchoring bias is to
  collect more information.
• Evaluate your reasoning -
  When you arrive at a new
  conclusion, ask yourself how you
  came to that conclusion.
• Ask for a second opinion - If you
  think you’ve used anchoring
  bias, ask someone else for their
  opinion

Question 12

How to avoid
anchoring bias

Answer 12

By becoming more aware of it,
anchoring bias happens
subconsciously, and when one isn’t
aware something is happening, it’s
difficult to interrupt it.

• To look for reasons why that anchor is
  inappropriate for the situation.
• Considering alternative options
• Delay your decision