Behavioral Finance

Question 1

Heuristics

Answer 1

Mental Short-cuts
Biases

Question 2

Behavioral Biases

Answer 2

1. Anchoring
2. Attachment Bias
3. Endowment Bias
4. Confirmation Bias

Question 3

Financial Infidelity

Answer 3

Lying, keeping secret, accounts, debts, etc

Question 4

Anchoring

Answer 4

The tendency of investors to become attached to a specific price as the fair value of a holding. The psychological strings of past ownership

Ex: evaluate an investment only as if it were a new purchase. If you would NOT make the purchase now, you should not own it.

If your entire brokerage account were suddenly in cash today, what holdings would you repurchase?

Question 5

Attachment Effect

Answer 5

Holding onto an investment for emotional reasons rather than considering more practical applications for the inheritance.

Question 6

Endowment Effect

Answer 6

Value an object at a higher value than FMV. You may not even purchsae the asset now if you didn’t already own it.

Question 7

Financial Enmeshment

Answer 7

Finances of parents and children are inappropriately comingled

Question 8

Cognitive Dissonance

Answer 8

The challenge of reconciling two oppossing beliefs

Question 9

Confirmation Bias

Answer 9

The natural human tendency to accept any information that confirms ouru preconceived position or opinion and to disregard any information that does not support that preconceived notion.

Question 10

Diversificaiton Erros

Answer 10

Investors will diversify across whatever options are offered to them

Question 11

Fear of Regret

Answer 11

The tendency to take no action rather than risk making the wrong one.

Question 12

Gambler’s Fallacy

Answer 12

Belief that the onset of a certain random event is likely to happen following an event or series of events

Question 13

Herd Behavior
aka FOMO

Answer 13

Tendencey for individuals to mimic actions of a larger group

Question 14

Hindsight Bias

Answer 14

Thinking we understand a past event, when it reality we may not.

May lead to overconfidence.

Question 15

Loss Aversion vs. Risk Taking

Answer 15

• GAINS: Investors are risk AVERSE when it comes to gains … they do not want to give them up. Given the choice between a sure gain and a chance to win more, they will pick the sure gain.
• LOSSES: Investors are risk TAKERS when it comes to losses … they will take big risks to avoid realizing them. Investors find losses 2.5 X as painful as gains are pleasurable.

Question 16

Prospect Theory

Answer 16

• Similar to loss aversion/risk taking
• Describes different ways people evaluate losses and gains

Question 17

Mental Accounting

Answer 17

Looking at sums of money differently, depending on their source or intended use.

Question 18

Outcome Bias

Answer 18

Tendency to make a decision based on the desired outcome rather than on the probablity of that outcome.

Question 19

Overconfidence

Answer 19

Tendency to place too much emphasis on one’s own abilities. Often works hand-in-hand with confirmation bias.

Question 20

Inappropriate Extrapolation

Answer 20

The tendency to look at recent events and assume that those events or conditions will continue indefinitely.

Question 21

Analysis Paralysis

Answer 21

Overanalyzing a situation and becoming paralyzed

Question 22

Overreaction

Answer 22

Investors emotionally react towards new market information

Question 23

Overweighting the Recent Past

Answer 23

The assumption that the recent past will repeat itself in the future

Question 24

Self-Affirmation

Answer 24

The belief that when something goes right, it is because you were smart and made the right decision. If it doesn’t work out, it is someone else’s fault or simply bad luck.

Question 25

Spotting trends that are not there

Answer 25

Investors seek patterns that help support decisions sometiems without adequate confirming research.