Section 1 - R1 / R2 - Behavioral Biases Flashcards
Types of Biases (List and Describe)
- Cognitive Errors: Faulty cognitive errors. Related to mental procedures. They are like blind spots.
- Emotional Biases: Reasoning influenced by emotions. Related to emotional and/or intellectual predispositions towards certain judgments.
Cognitive Biases (List)
- Conservatism
- Confirmation
- Representativeness
- Illusion of Control
- Hindsight
- Anchoring / Adjustment
- Mental Accounting
- Framing
- Availability Bias
Emotional Biases (List)
- Loss Aversion (Selena Gomez)
- Overconfidence (Beyoncé)
- Self Control (Frank Ocean)
- Status Quo (High School Musical)
- Endowment
- Regret Aversion
Belief Perserverance Bias (Describe)
Tendency to cling to one’s previously held beliefs irrationally. Justified by statistical, information-processing or memory errors.
Conservatism Bias (Description)
People maintain prior views or forecasts by inadequately incorporating new information
Consequence: OW old info, UW new info. Slow updates to forecasts.
Cognitive Cost (Concept)
Effort involved in processing new info and updating beliefs is termed cognitive cost.
Confirmation Bias (Describe)
People tend to look for information that confirms what they already believe.
Consequence: OW in confirmatory information. Consider positive info on existing investment. Hold stocks in ITUB4.
Representativeness Bias (Describe)
People tend to classify new information based on past experiences and classifications
Consequence:
- May lead to statistical and info-processing errors.
- Base rate neglect and sample size neglect are examples
- Adopting a view based in unrepresentative data
Base Rate Neglect (Describe)
Rate or probability of the categorization is not adequately considered.
Ex: Stereotypes without taking into account the probability of the stereotype occurring.
Correction: Do not ignore laws of probability
Sample Size Neglect (Describe)
Assume that small samples are representative of the population (vó do Morandini)
Correction: Do not ignore laws of probability
Illusion of Control Bias (Describe)
People tend to believe they can control or influence outcomes when they can not.
Ex: Outcome Lojas Americanas (grandes credores)
Consequences: Trade more than prudent. Inadequately diversification due to concentration of positions as investors wrongly expect to influence outcomes.
Hindsight Bias (Describe)
Benefício do Retrovisor. People tend to see past events as having been predictable and reasonable to expect.
Consequence:
- Poorly reasoned decision seem as brilliant move
- Poor results of well-reasoned decisions described as avoidable mistakes
- OW outcome prediction, giving false sense of confidence
- Do NOT rewrite the story
Information Processing Cognitive Errors
Systematic biases and mistakes that individuals can make when interpreting and processing information. They can affect decision-making and can be detrimental to accurate analysis and judgment.
Anchoring and Adjustment Bias (Describe)
- Anchor estimates in previously known values, then adjusting up or down
Consequence: You may stick to close to previous forecasts
Mental Accounting Bias (Describe)
People treat one sum of money differently from another equal-sized sum based on which mental account the money is assigned to.
Consequence:
- Not getting the full picture.
- Neglect opportunities to reduce risk
- You should treat everything as a portfolio
Framing Bias (Describe)
Person tend to answer differently depending on the way that the information is provided to them
Consequence:
- Lose big picture
- Focus too much in specific details
- Willingness to bear risk is influenced, misidentifying risks
Availability Bias (Describe)
Rule of thumb / Mental shortcut approach to estimating probability of an outcome based on how easily the outcome comes to mind
Retrievability: Idea comes to mind too quick
Categorization: People gather info from what they perceive as relevant search sets.
Resonance: People are biased by how closely a situation parallels their own personal situation.
Availability Bias (Consequences)
- Limit investment opportunities set due to familiar classification schemes
- Fail to diversify
- Fail to achieve an appropriate asset allocation
Overconfidence Bias (Describe)
People demonstrate unwarranted faith in their reasoning and judgment
Consequences: OW returns and UW risks
Self Control Bias (Describe)
People fail to act in pursuit of their long-term, overarching goals due to lack of self-discipline
Ex: Estudar todo dia para o CFA
Status Quo Bias (Describe)
People tend to do nothing instead of making a change.
Endowment Bias (Describe)
People value an asset more when they hold rights to it than when they do not
Regret Aversion Bias (Describe)
People avoid deciding in action out of fear that the decision will turn out poorly
Investor Clasification (Types)
- Barnewall Two Way: Passive v. Active
- Bailard, Biehl, Kaiser: 5 way model (Individual, Guardian, Adventurer, Celebrity)
- Careful v. Impetuous
- Confident v. Anxious - Behavioural (PP/FF/II/AA)
Individualist Investor (BBK types)
- Easy to advidce
- Process info rationally
Adventurer Investor (BBK Type)
- May hold undiversified portfolio
- Make its own decisions
- Not accepting advice
Celebrity Investor (BBK Type)
- Recognize limitations
- Willing to seek advice
Guardian Investor (BBK Type)
- Concerned about protecting assets
- May seek advice
Behavioural Investor Types (List)
- Passive Preserver (Emotional)
- Friendly Follower (Cognitive)
- Independent Individualist (C)
- Active Accumulator (E)
Passive Preserver (Behavioural Characteristics)
- Emotional
- Emotional Biases: Endowment, Loss Aversion, Status Quo, Regret
- Cognitive Biases: Mental Accounting, Anchor
Friendly Follower (Behavioural Characteristics)
- Cognitive
- Emotional Biases: Regret Aversion
- Cognitive Biases: Availability, Hindsight, Framing
Independent Individualist (Behavioural Characteristics)
- Cognitive
- Emotional Biases: Conservatism, Availability, Confirmation, Representativeness
Active Accumulator (Behavioural Characteristics)
- Emotional
- Emotional Biases: Overconfidence Bias (Self-Attribution) and Self Control Bias (Long Term > Short Term)
- Cognitive Biases: Illusion of Control
Behavioural Investor Types (List)
- Passive Preserver (PP): Financial Security, Wealth Preservation, Slow Financial Decisions
Ex: Milton - Friendly Follower (FF): Herding behaviour. Overestimate risk tolerance. Cognitive Biases.
Ex: Minha avó - Independent Individualist (II): Strong willed, independent. Willing to hear advice.
Ex: Pati - Active Accumulators (AA): Most Aggressive. Entrepeneurial. Tendency to chase higher risk investments.
Ex: Dandahia
Limitations of BIT approach (List)
- Investors shows both cognitive and emotional biases
- Investor shows multiple characteristics of BITs
- Behavior changes during life
Adviser Client Relationship (List)
- Adviser understands client’s financial goals
- Adviser maintains a systematic approach investing
- Adviser invests as client expects
- Relationship benefits both sides
Portfolio Construction Pitfalls (List)
- Inertial and Default: Most members do not change investments
- Naive Diversification: Heuristic Rules
- Investing in the Familiar: Familiarity, Overconfidence, Extrapolation of Past Returns, Framing and Status Quo, Loyalty Effects, Financial Incentives
- Excessive Trading: Disposition Effect
- Home Bias: Invest in BR
Behavioural Portfolio Theory (Concept)
Contrary to Mean Variance Portfolio (MVP), Behavioural Portfolio is built layer by layer. Mental accounting bias is present.
Remedial Actions to Biases in Analyst Forecasts (List)
- Prompt accurate feedback
- Reward accuracy
- Document a decision & reasons for judgment
- Provide counterargument: reduce confirmation, overconfidence
- Minimize non-comparable data
Committee Decision Biases (List)
- May mitigate or worsen biases
- Social Proof Bias
- Reunite people with relevant skills and experiences
- Create a culture of tolerance for dissenting views
Market Anomalies (List)
- Momentum: Future prices behavior correlates with that of recent past.
- ST underreaction: disposition effect
- LT overreaction: availability bias (extrapolate) - Bubbles and Crashes: overconfidence, confirmation, self attribution, regret aversion, illusion of knowledge and hindsight.
