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51 Cards in this Set
- Front
- Back
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Cognitive errors result from... |
the inability to analyse info or from basing decisions on partial info. Individuals try to process info into rational decisions but they lack the capacity or sufficient info to do so. |
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Cognitive errors can be divided into? (2) |
1. Belief perseverance errors 2. Processing errors |
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Emotional biases are caused.... |
by the way individuals frame the info and the decision rather than the mechanical or physical process used to analyse and interpret it. Emotional biases is more of a spontaneous reaction. |
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Cognitive Errors: Belief Perseverance (5) |
- Conservatism bias - Confirmation bias - Representativeness bias - Control bias - Hindsight bias |
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Cognitive Errors: Information Processing (4) |
i) Anchoring & adjustment bias ii) Mental accounting bias iii) Framing bias iv) Availability bias |
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Emotional Biases (6) |
> Loss aversion bias > Overconfidence bias > Self-control bias > Status quo bias > Endowment bias > Regret aversion bias |
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Conservatism Bias occurs when... (Cognitive Error: Belief perseverance) |
market participants rationally form an initial view but then fail to change the view as new info becomes available. |
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Conservatism Bias - Impact? (Cognitive Error: Belief perseverance) |
Slow to react to new info or avoid difficulties associated with analyzing new info. Can also be explained i.t.o. Bayesian statistics = place to much weight on base rates. |
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Conservatism Bias - Mitigation? (Cognitive Error: Belief perseverance) |
Look carefully at new info itself to determine its value. |
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Confirmation Bias occurs when... (Cognitive Error: Belief perseverance) |
marketparticipants look for new info ordistort new info to support an existing view. |
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Confirmation Bias - Impact? (Cognitive Error: Belief perseverance) |
Focus on positive info about an investment and ignore or dismiss anything negative. Leads to too much confidence in the investment and an over weighting in portfolio. |
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Confirmation Bias - Mitigation? (Cognitive Error: Belief perseverance) |
Actively seek out info that seems to contradict your opinions and analyse it carefully. |
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Representativeness Bias occurs when.. (Cognitive Error: Belief perseverance) |
New info is evaluated based on past classification or experience without more thorough analysis. |
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Representativeness Bias - Impact? (Cognitive Error: Belief perseverance) |
Place info into categories utilizing an if-then heuristic. Place too much emphasis on perceived category of new info. Likely to change strategies based on small sample of info. |
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Representativeness Bias - Mitigation? (Cognitive Error: Belief perseverance) |
Consciously take steps to avoid base rate neglect and sample size neglect. Consider the true probability that info fits a category. Use periodic table of investment returns. |
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Illusion of control bias exists when.. (Cognitive Error: Belief perseverance) |
market participants think they can control or affect outcomes when they cannot. |
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Illusion of control bias - Impact? (Cognitive Error: Belief perseverance) |
Illusion of control over ones investment outcomes can lead to excessive trading with the accompanying costs. Can also lead to concentrated portfolios. |
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Illusion of control bias - Mitigation? (Cognitive Error: Belief perseverance) |
Seek opinions of others. Keep records of trades to see if successful at controlling investment outcomes. |
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Hindsight bias is.. (Cognitive Error: Belief perseverance) |
a selective memory of past events, actions or what was knowable in the past. |
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Hindsightbias - Impact? (Cognitive Error: Belief perseverance) |
Overestimate the accuracy of their forecasts and take too much risk. |
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Hindsight bias - Mitigation? (Cognitive Error: Belief perseverance) |
Keep detailed record of all forecasts, including the data analysed and the reasoning behind the forecast. |
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Anchoring and adjustment bias occurs when... (Cognitive Error: Info-Processing) |
changes are made but in relation to an initial view and therefore changes are inadequate. |
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Anchoring and adjustment bias - Impact? (Cognitive Error: Info-Processing) |
Tend to remain focused on and stay close to their original forecasts or interpretations. |
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Anchoring and adjustment bias - Mitigation?(Cognitive Error: Info-Processing) |
Give new info thorough consideration to determine its impact on the original forecast or opinion. |
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Mental accounting bias arises when... (Cognitive Error: Info-Processing) |
money is treated differently depending on how it is categorized. |
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Mental accounting bias - Impact? (Cognitive Error: Info-Processing) |
Portfolio tend to resemble layered pyramids of assets. Subconsciously ignore the correlation of assets. May consider income and capital gains separately rather than as part of the same total return. |
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Mental accounting bias - Mitigation? (Cognitive Error: Info-Processing) |
Look at all investments as if they are part of the same portfolio to analyse their correlations and determine true portfolio allocation. |
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Framing bias occurs when... (Cognitive Error: Info-Processing) |
decisions are affected by the way in which the question or data is "framed". |
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Framing bias occurs - Impact? (Cognitive Error: Info-Processing) |
Narrow frame of reference; individuals tend to focus on one piece or category of info and lose sight of the overall situation or how the information fits into overall scheme of things. |
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Framing bias occurs - Mitigate? (Cognitive Error: Info-Processing) |
Investors should focus on expected returns and risk, rather than on gains and losses. That includes assets or portfolios with existing gains or losses. |
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Availability bias starts when... (Cognitive Error: Info-Processing) |
putting undue emphasis on the info that is readily available. Caused are retrievability, categorization, narrow range of experience and resonance. |
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Availability bias starts - Impact? (Cognitive Error: Info-Processing) |
Select investments based on how easily their memories are retrieved and categorized. Narrow range of experience can lead to concentrated portfolios. |
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Availability bias starts - Mitigation? (Cognitive Error: Info-Processing) |
develop an IPS and construct a suitable portfolio through diligent research. |
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Loss aversion bias arises from... (Emotional Bias) |
feeling more pain from a loss than pleasure from a gain. Myopic loss aversion = combines effects of time horizon and framing. |
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Loss aversion bias arises - Impact? (Emotional Bias) |
Focus on current gains and losses. Continue to hold losers in hope of breaking even. Sell winners to capture gains. |
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Loss aversion bias arises - Mitigation? (Emotional Bias) |
Perform a thorough fundamental analysis. Overcome mental anguish of recognizing losses. |
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Overconfidence bias occurs when... (Emotional Bias) |
market participants overestimate their own intuitive ability or reasoning. |
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Overconfidence bias occurs - Impact? (Emotional Bias) |
Hold under diversified portfolios; underestimate the downside while overestimating the upside potential. Trade excessively. |
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Overconfidence bias occurs - Mitigation? (Emotional Bias) |
Keep detailed records of trades, including the motivation for each. Analyse successes and losses relative to the strategy used. |
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Self-control bias occurs when... (Emotional Bias) |
individual lack self-discipline and favour immediate gratification over long term goals. |
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Self-control bias occurs - Impact? (Emotional Bias) |
Lack of discipline to balance short term gratification with long term goals. Tend to try and make up the shortfall by assuming too much risk. |
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Self-control bias occurs - Mitigation? (Emotional Bias) |
Maintain complete clearly identified investment goals and strategies. Budgets help deter the propensity to over-consume. |
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Status Quo bias occurs when... (Emotional Bias) |
comfort with existing situation leads to an unwillingness to make changes. |
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Status Quo bias occurs - Impact? (Emotional Bias) |
Risk characteristics of the portfolio change. Investor loses out on potentially profitable assets. |
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Status Quo bias occurs - Mitigate? C |
Education about risk and return and proper asset. Difficult to mitigate. |
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Endowment bias occurs when... (Emotional Bias) |
an asset is felt to be special and more valuable simply because it is already owned. |
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Endowment bias occurs - Impact? (Emotional Bias) |
Value of owned assets higher than same assets if not owned. Stick with assets because of familiarity and comfort or were inherited. |
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Endowment bias occurs - Mitigation? (Emotional Bias) |
Determine whether the asset allocation is appropriate. |
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Regret aversion bias occurs when... (Emotional Bias) |
market participants do nothing out of excess fear that actions could be wrong. |
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Regret aversion bias - Impact? (Emotional Bias) |
Stay in low risk investments. Portfolio with limited upside potential. Stay in familiar assets or "follow the herd". |
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Regret aversion bias - Mitigate? (Emotional Bias) |
Education is a primary mitigation tool. |
