Week 1 - Introduction to Behavioural Finance Flashcards
What is behavioural finance?
Behavioural finance combines the principles of finance and psychology to understand how psychological influences and biases affect the financial behaviours of individuals and the market outcomes.
What are the characteristics of System 1 of the Kahneman (2003) model?
System 1 is characterised as fast, automatic and effortless.
What is System 1 of the Kahneman (2003) model?
It’s the cognitive system that helps in making quick judgements and decisions based on existing, learned patterns without deep analytical thought.
What are the characteristics of System 2 of the Kahneman (2003) model?
System 2 is characterised as slower, logical and conscious.
What is System 2 of the Kahneman (2003) model?
System 2 is engaged when attention is needed for complex computations or when an activity requires focused mental effort.
Do System 1 and System 2 work together?
System 1 and System 2 are not completely independent but interact in various cognitive tasks. System 2 monitors the activities of System 1, often stepping in to override automatic responses when needed. However, it is usually in a ‘low-effort mode’, allowing the automatic functions of System 1 to govern behaviour unless a situation explicitly demands more attention.
What is apophenia?
The tendency to recognise meaningful patterns or connections within random information
What are the 4 types of apophenia?
- Pareidolia - visual stimula e.g. clouds
- Gambler’s Fallacy - patterns in numbers
- Clustering Illusion - Patterns in datasets
- Confirmation Bias - focus on evidence that supports existing beliefs
What are normative theories?
They rely on assumptions of rationality, where economic agents are considered to be completely informed, perfectly rational and always acting in their best interests to maximise utility or profit
Give an example of normative theory
The ‘Expected Utility Theory’ assumes that individuals act rationally and make decisions that maximize their expected utility rather than their expected monetary value.
What are positive theories?
Positive theories are based on actual observations of human behaviour, recognising that individuals often act irrationally or are influenced by a variety of biases
Give an example of positive theory
Prospect Theory suggests that people value gains and losses differently, leading to decisions that deviate from classical rational choices
