ULO B

Question 1

takes one characteristic of a company and extends it to other aspects of the firm.

Answer 1

The representativeness heuristic

Question 2

Investors do not like losses and often engage in mental gymnastics to reduce their psychological impact.

Answer 2

 Loss Aversion -

Question 3

• Investors do not like to make mistakes.

● Rather than being unable to decide among attractive alternatives, their focus is on the negative: What if they pick the wrong stock?

Answer 3

 Fear of Regret

Question 4

refers to the lemming-like behavior of investors and analysts looking around, seeing what each other is doing, and heading in that direction.

Answer 4

 Herding -

Question 5

Our decisions can be influenced by extraneous information contained in the problem statement.

For example, investors tend to remember the price they paid for a stock, and this information influences their subsequent decisions about what to do

Answer 5

 Anchoring -

Question 6

Our decisions can be influenced by extraneous information contained in the problem statement.

For example, investors tend to remember the price they paid for a stock, and this information influences their subsequent decisions about what to do

Answer 6

 Anchoring -

Question 7

• We like to pretend that we can influence the resulting score by varying the force with which we throw a dice.

Answer 7

 Illusion of Control

Question 8

• Risk averse investors get increasing utility from higher levels of wealth, but at a decreasing rate.

Research shows that while risk aversion may accurately describe investor behavior with gains, investors often show risk seeking behavior when they face a loss.

Answer 8

 Prospect Theory

Question 9

refers to our tendency to “put things in boxes” and track them individually.

For example, investors tend to differentiate between dividend and capital dollars, and between realized and unrealized gains.

Answer 9

 Mental Accounting - Mental accounting

Question 10

refers to our tendency to look at investment decisions individually rather than as part of a group.

The portfolio may be up handsomely for the reporting period, but the investor will still be concerned about the individual holdings that did not perform well.

Answer 10

 Asset Segregation -

Question 11

refers to our tendency to remember positive outcomes and repress negative outcomes.

Investors remember when their pet trading strategy turned up roses, but do not dwell on the numerous times the strategy failed.

Answer 11

 Hindsight Bias -

Question 12

• refers to our tendency to believe that certain things are more likely than they really are.

For example, most investors think they are above-average stock pickers.

Answer 12

 Overconfidence

Question 13

The concept of framing involves attempts to overlay a situation with an implied sense of gain or loss.

It is easier to pay $3,400 for something that you expected to cost $3,300 than it is to pay $100 for something you expected to be free.

Answer 13

 Framing -

Question 14

is the contention that things that are easier to remember are thought to be more common.

Answer 14

 Availability Heuristic -

Question 15

People tend to believe things that are easier to understand more readily than things that are more complicated.

Most investors prefer a low PE ratio, since they prefer to buy low-priced stocks with high earnings

Answer 15

 Illusion of Truth

Question 16

 Our prior experience causes us to anticipate certain relationships or characteristics that may not apply outside our frame of reference.

Answer 16

Biased Expectations -

Question 17

- involve “innumeracy” or a misunderstanding of the likeliness of an event or series of events.

Suppose you demand $75,000 in salary for the next year. Your boss offers you
$60,000 and if things go to arbitration, $50,000.

People currently earning $60,000 tend to accept the offer, while people currently earning $75,000 tend to take the gamble and go to arbitration.

There are some other tendencies that may have a behavioral influence on asset values.

Answer 17

Reference Dependence

Question 18

- investors tend to make disproportionate use of round numbers when placing stop or limit orders.

The Special Nature of Round Numbers

Given a giant lottery wheel with numbers from one to one thousand, many of us would find a random outcome like 287 to be more reasonable than the “unusual” outcome of 1,000.

Similarly, investors tend to make disproportionate use of round numbers when placing stop or limit orders.

Answer 18

Mistaken Statistics

Question 19

• a tendency to assume that the past will repeat itself and to give too much weight to recent experience.

Answer 19

 Extrapolation -

Question 20

• a belief that recent occurrences influence the next outcome in a sequence of independent events .

Answer 20

Gambler’s fallacy -

Question 21

Suppose the incidence of a particular disease rose from 10 in a million to 13 in a million.

We would likely find that to many people, 3 more cases is not a cause for concern, although a 30% increase is.

Answer 21

 Percentages vs. Numbers

Question 22

many instances where people draw incorrect inferences from statistical data.

The probability of a given person winning the lottery twice is very remote. However, the probability of someone winning twice is actually reasonably good.

Answer 22

 Sample Size -

Question 23

• a single occurrence of an unlikely event becomes much more likely as the sample size increases.

However, many people will find a run of six consecutive numbers in a daily state lottery extremely unlikely.

Answer 23

 Apparent Order

Question 24

states that given a series of random, independent data observations, an unusual occurrence tends to be followed by a more ordinary event.

Hence, chasing last year’s winning mutual fund is likely to be a losing strategy, although many investors do precisely this.

Answer 24

 Regression to the Mean -

Question 25

• - the study of logical relationships among assets.

Answer 25

Theoretical finance

Question 26

• the study of data in order to infer relationships.

Answer 26

• Empirical finance -

Question 27

• - integrates psychology into the investment process.

Answer 27

Behavioral finance

Question 28

“Financial economists have been aware for a long time that in laboratory settings, humans often make systematic mistakes and choices that cannot be explained by traditional models of choice under uncertainty.”

Answer 28

– Paul Pfleiderer