Week 10 - Mind of the investor Flashcards
What are the two types of bias?
- cognitive bias
- Bias arising from faulty reasoning - Emotional Bias
- Bias arising from intuition
What is the self-attribution bias and its dangers?
cognitive bias
attributes successful outcomes to own strategy and blames unsuccessful outcomes on bad luck
Dangers
1. inability to recognise errors and correct them
- Leads to undiversified portfolio
What is the confirmation bias
Cognitive bias that leads people to notice and search for information that confirms their beliefs and ignores contradicting information
What are the trading implications of the confirmation bias?
Implications for trading
1. Traders are less likely to update beliefs in same direction as latest signal if different from the last
- Traders are less likely to update beliefs if different from previous belief change
- Difference in opinions grows as signals change from past direction
What is the overconfidence bias and its dangers?
cognitive bias of unreasonable belief in their own ability
Dangers:
1. Undiversified portfolio
2. Excess trading in position and volume
3. Underestimation of risk
More common in men
What is the loss aversion bias
cognitive bias where people dislike loss and disadvantage more than gains and advantage
What is the endowment effect and its implications for finance?
people value something they already own higher than if they did not already own it
Implications
People are less likely to sell shares they already own than to purchase them
What is the anchoring bias?
bias affecting judgement by making estimates based off the initial value presented to them
What are the four features of prospect theory?
- Reference dependant
- Loss aversion
- diminishing sensitivity
- Probability weighting
What is the disposition effect?
Where has it been observed?
Bias exclusive to finance
Desire for investors to sell positive-performing stocks and delay in selling negatively performing stocks
Observed in
- retail investors
- professional investors
- experiments
