Investor Bias Flashcards
Representativeness, or recency bias
To overweight the importance of the most recent observations and information relative to a longer-dated or more comprehensive set of long-term observations and information. Return chasing is a common result of this bias, and it results in overweighting asset classes with strong recent performance.
Momentum can be explained by hindsight + availability bias: Regret is a type of hindsight bias that can result in investors purchasing securities after a significant run-up in price because of a fear of not participating.
Risk tolerance questionnaire
Risk tolerance questionnaire may fail investors with an emotional bias. Risk tolerance questionnaires will likely work better for investors with a cognitive bias because they are likely to think about risk more logically.
Types of investor styles
Active accumulator = lacks spending controls, does not believe in the benefits of portfolio diversification, has a high risk tolerance, and prefers high-risk investments recommended by friends.a characteristic of the AA; a high turnover rate
Independent individualists have a medium to high risk tolerance
Friendly followers have a low to medium risk tolerance
Guardian or passive-preserver investment type are more receptive to “big picture” advice. Passive preservers display predominantly emotional biases
illusion of control bias, gambler’s fallacy
illusion of control bias can be encouraged by complex models. The illusion of control can lead to analysts being overly confident when forecasting complex patterns, such as future interest rate movements
Self-control bias occurs when individuals deviate from their long-term goals, in this case, the investment policy statement, due to a lack of self-discipline.
gambler’s fallacy is a misunderstanding of probabilities in which analysts wrongly project reversal to a long-term mean. This bias is caused by a faulty understanding of random events and expecting patterns to repeat.
risk aversion
risk aversion—how the individual behaves when faced with negative outcomes.
Status quo bias
Status quo bias reflects the tendency for forecasts to perpetuate recent observations and for managers to then avoid making changes. Status quo bias can be mitigated by a disciplined effort to avoid anchoring on the status quo.
data-mining bias
data-mining bias arises from repeatedly searching a data set until a statistically significant pattern emerges.
should scrutinize the variables selected and provide an economic rationale for each variable selected in the forecasting model. A further test is to examine the forecasting relationship out of sample.
prudence bias
prudence bias is the tendency to temper forecasts so that they do not appear extreme or the tendency to be overly cautious in forecasting.
Forward rate bias is defined as an observed divergence from interest rate parity conditions under which active investors seek to benefit by borrowing in a lower-yield currency and investing in a higher-yield currency. lower-yielding currencies trade at a forward premium. fully hedged foreign currency fixed-income investments will tend to yield the domestic risk-free rate.
