Chapter 6

Question 1

What are heuristics? (3)

Answer 1

rule of thumb
educated guesses
gut feelings

Question 2

What situation makes us more mental shortcuts?

Answer 2

under stress
emotions are running high

Question 3

What is inertia or myopia in investments?

Answer 3

when someone has made a decision, they tend to leave them unchanged

Question 4

What is status quo bias? (2)

Answer 4

when people stick with their prior choices

especially when its too complex

Question 5

What is the availability heuristic?

Answer 5

if something comes to mind when asked a question

it must be relevant or important

Question 6

Give an example of availability heuristic (2)

Answer 6

When someone ask about cause of death

they say what they heard recently in news

Question 7

What is confirmation bias?

Answer 7

more likely to seek information that confirms existing position

Question 8

What happens in confirmation bias?

Answer 8

ignore potentially useful information that refutes their preconceptions

Question 9

What is overreaction bias? (2)

Answer 9

overreact to new information

investments overbought or oversold

Question 10

How do people try to profit from overreaction?

Answer 10

look for companies that price fell more than should have because of bad news

Question 11

What is representativeness?

Answer 11

assuming that similarity in one aspect leads to similarity in other aspects

Question 12

What is herd behaviour?

Answer 12

following each other irrationally

Question 13

Why does herding happen? (2)

Answer 13

social pressure to conform
decisions less likely to be incorrect if more people make them

Question 14

what is another term for herd behaviour?

Answer 14

also referred to as a self-fulfilling prophecy

Question 15

What is anchoring?

Answer 15

fix on an initial value as an unconscious reference point

Question 16

how to prevent anchoring in investments?

Answer 16

base decisions on fundamentals rather than in relation to the ‘anchor price’

Question 17

What is overconfidence?

Answer 17

exaggerated view of one’s own abilities and judgement

Question 18

how does overconfidence apply to investments?

Answer 18

investors overestimate their predictive ability

Question 19

Example of overconfidence in analysts

Answer 19

slow to revise their previous assessment of a company’s future performance

Question 20

Example of overconfidence in clients (2)

Answer 20

clients answers to risk questionnaires

might suggest they are more risk tolerant than is true

Question 21

What is gambler’s fallacy?

Answer 21

failure to appreciate the implications of randomness and probability

Question 22

Example of gambler’s fallacy in gambling

Answer 22

there is a pattern on outcome of roulette wheel

Question 23

Example of gambler’s fallacy in investing (2)

Answer 23

mean reversion

performance of asset market will correct itself to long average

Question 24

What is hindsight bias?

Answer 24

when investor find event to have been entirely predicable after the fact

Question 25

What is naive diversification?

Answer 25

individuals often find it difficult to evaluate, and choose between, different options

Question 26

Example of naive diversification (3) 🍕

Answer 26

pension asked to pick 5 different funds

splits money equally to each five

doesn’t think about the interaction between them or their risk profiles

Question 27

What is mental accounting? (2)

Answer 27

people mentally frame assets as belonging to different categories or accounts

fail to recognise that all money is equivalent

Question 28

What irrational decisions can happen with mental accounting? (3)

Answer 28

propensity to consume from each account is different

might save at low-interest rates

borrow at high rates

Question 29

What is loss aversion?

Answer 29

more discomfort from loss than positive emotions from a gain

Question 30

what is implication of loss aversion for investment behaviour? (2)

Answer 30

premature realisation of investment gains

loss aversion and even avoidance

Question 31

Why might some people be more loss averse?

Answer 31

• lack of financial capacity to bear loss
• lack of financial capability to understand the meaning of investment loss
• Psychological reluctance or unwillingness to bear a loss

Question 32

What is interim loss?

Answer 32

loss during period of investment not near the end of investment horizon

Question 33

five different loss types

Adfrl

Answer 33

amount

duration

frequency

relative

linearity

Question 34

What is regret aversion?

Answer 34

desire to avoid feeling the pain of regert from a poor investment decision

Question 35

What bad investment decisions might be made with regret aversion (2)

Answer 35

hold poor performing shares

less likely to invest in markets that have performed poorly in the past

Question 36

What is framing?

Answer 36

individuals influenced by the form in which decisions are presented to them

Question 37

What is mood and emotion heuristic?

Answer 37

decisions based on mood or emotions is not rational

Question 38

what is local bias?

Answer 38

invest in stocks of local companies

Question 39

what is local bias?

Answer 39

invest in stocks of local companies

Question 40

why does local bias happen?

Answer 40

investors think they have more information about companies near them, helping them outperform

Question 41

what is path of least resistance?

Answer 41

people make the easy choice as they don’t want to struggle

Question 42

What is prospect theory? (2)

Answer 42

people respond differently to equivalent situations

depending on whether it is presented in context of a loss or a gain

Question 43

What is regret theory about?

Answer 43

people’s emotional reaction to having made an error of judgement