week 7

Question 1

 Emotions

Answer 1

o Strong evidence to show human decisions are affected by emotion
o An emotional understanding of the market could lead investors into more fear than is realistic
 Narrative seems so inconsistent to what is happening in the market
 E.g. Donald Trump
o Managing emotions
 How the emotions influence you

Question 2

 Cheerleader effect

Answer 2

o As a group, you create a stir and look more attractive

o Evaluate the averages

Question 3

 Ebbinghaus Illusion

Answer 3

o The way your brain has evolved
o Evaluating stimuli from a group perspective and perceive the average
o Classifying items as averages
o E.G. doge-coin
 Valuing the cryptocurrency as a group, valuing them relative to other assets?
 Can not change the way that we look at stimuli, but we can understand and control them

Question 4

 Would we make better decisions if we were emotionless?

Answer 4

o Not influenced by emotions -> do not focus on noise -> perfectly rational
o Most people are not as confident about their estimates of value
 They are heavily influenced by people / others
o Value investors focus on the net cash flow
 However price of the stock is also influenced by market sentiment

Question 5

 Different models

Answer 5

o Neoclassical finance
 Investors maximise return whilst minimizing risk
 Are rational and unbiased in evaluating and acting on information
o Behavioural finance
 Uses psychology and economics to explain investor behaviour
 Descriptively detailed model of investors
o Competing perspectives

Question 6

 Behavioural finance principles

Answer 6

o Classical finance assumes investors are rational
 Exhibit consistent preferences and evaluate information without bias
 Based on an evolutionary perspective
o Behavioural finance
 Brain uses heuristics to cope with limited capacity and information
• Brain has limited processing power
 In natural settings, heuristics work effectively
 In unusual settings, heuristics can mislead
• E.g. financial markets
 Financial markets are unusual -> potential for huge mistakes

Question 7

 Framing

Answer 7

o How we are influenced by context
o The way information is presented
o Framing influences the choice

Question 8

 Implications to heuristics

Answer 8

o Beings may be insufficient to counteract their effects
o Have to manipulate the context to ensure we are not mislead
o E.g. setting yourself up to fail

Question 9

 Identifying the heuristic biases

Answer 9

 Preference for Familiarity: more information or familiarity generates confidence
 2. Availability heuristic: most recent examples and underweight earlier
 3. Representative heuristic: good company with good investment
 4. Illusion of Truth: more people believe familiar information
 5. Illusion of Control: overestimate ability to control events
 6. Anchoring and adjustment: forming estimates people adjust away
 Mental Accounting: separate cost irrationality

Question 10

SELF DECEPTION

Answer 10

Overconfidence: confidence intervals assigned to estimates are too low
• People calibrate poorly when estimating events
2. Optimism & wishful thinking: unrealistic views of their abilities and prospects
• Why? What circumstances?
• Normals inflate others view of them
• Non-depressive underestimate the amount of negative feedback/outcomes

Question 11

EMOTIONAL LOSS OF CONTROL

Answer 11

o Loss aversion: the disutility of giving up is greater than acquiring
E.g. tell the 18 year olds, overconfidence -> think they will do it
On average, best chance of sending them out there and killing them
Creating over-confidence
• People don’t want to give away their belongings