R08: Behavioural Biases Flashcards
What are the cognitive errors? Can you describe each?
Belief perseverance biases (CIRCH):
- Conservatism
- Confirmation
- Representativeness
- Illusion of control
- Hindsight
Info processing biases (FAMA):
- Anchoring and adjustment
- Mental accounting
- Framing
- Availability
What are the behavioural biases? Can you describe them?
LOSERS
- Loss aversion
- Overconfidence
- Self-control
- Endowment
- Regret aversion
- Status-quo
Behaviourally modified asset allocation:
- Low SLR + cognitive errors
- Low SLR + emotional biases
- High SLR + cognitive errors
- High SLR + emotional biases
- Adapt+Moderate
- Adapt
- Moderate
- Moderate+Adapt
What’s the Barnwell Two-Way Model?
Splits investstors into passive and active.
Passive through inheritance, want security and more risk averse.
Active through wealth creation, high risk tolerance, maintain control of investment.
Which are the three ways to classify investors?
- Barnwell two-way model
- Bailard, Biehl and Kaiser (BBK) five-way model
- Pompian four-way model
What’s the BBK model?
Adventurer Celebrity Individualist Guardian Straight arrow
What’s the Pompian Four-Way Model? What are the emotional biases and cognitive errors for each?
Active accumulator
Independent individualist
Friendly follower
Passive preserver
What are the limitations of classifying investors into behavioural types?
- Both emotional and cognitive
- Characteristics of multiple investor types
- Change behaviour with age
- Unique treatment required
- Act irrationally at different times
What are the advantages of using behavioural finance within advisor-client relationships?
- Enhanced formulation of financial goals
- Maintaining consistency
- Meeting clients’ expectations
- Ensuring mutual benefits (better relationship)
What are the behavioural biases found in DC and retail funds?
Inertia Naive Diversification Overinvestment in company stock (loyalty and overconfidence) Excessive trading Home bias
What are the behavioural biases in analyst forecasting?
Overconfidence (representativeness, availability, illusion of control, self-attribution and hindsight bias)
Company management (framing, anchoring, availability)
Analyst biases in research (confirmation, gambler’s fallacy)
What are the remedies for the behavioural biases in analyst forecasting?
Overconfidence: self-calibrate (prompt and accurate feedback), reward accuracy, unambiguous and detailed forecasts, seek counterargument, sample size, Bayes formula.
Company management: focus on metrics (verifiable and comparable), make sure info framed properly, recognise appropriate base rates.
Bias in conducting research: focus on metrics (be aware of anchoring and adjustment), Bayes formula, seek contradictory opinion, prompt feedback.
What are the behavioural biases found in committees?
Social proof
Info sharing issues
Pressure from powerful individuals
What are the market anomalies explained by behavioural effects?
Momentum effects:
Herding, recency effect (availability bias), regret and hindsight bias.
Contributors to bubbles:
Confirmation, self-attribution, hindsight, overconfidence. ST under-reaction to relevant info, LT over-reaction.
Contributors to crashes:
Anchoring and disposition effect (initial under-reaction, not selling posers due to loss aversion), later capitulation leading to panic selling
What’s the Halo effect?
Value vs growth difference due to misspricing rather than adjustment for risk. Extends favourable evaluation of some characteristics to other parts of an investment.
