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18 Cards in this Set
- Front
- Back
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Modern portfolio theory (MPT) |
It relies on the ability of every investor to be perfect decision making agents. Does not mean they don’t lose money it is prevents them from investing in assets with expected returns that are inconsistent with risk levels |
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Efficient Market Hypothesis by Fama 3 market sets |
Weak form efficiency: market prices are functions of historical prices and volume data semi strong form efficiency: market prices are functions of publicly available information Strong form efficiency : market prices are functions of all relevant information (includes private) |
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Weak form market |
Investors cannot use this information set to generate excess return |
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Semi strong form market |
Asset prices reflect all publicly available information Firm specific and economic |
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Strong form market |
Asset prices reflect all relevant information, including private information Examples, dividend decisions discussed at the Board of Directors meeting before it becomes public knowledge |
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Cognitive errors: representativeness |
An assessment by investors of new information or decisions, based on superficial traits rather than fundamental analysis Ex: people thinking a change in the companies name means it’s more valuable |
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Common cognitive errors: Anchoring |
The use of immaterial information in making investment decisions Ex: buying a stock based on a round number, like 100 |
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Common cognitive errors: cognitive dissonance |
Process of ignoring or discounting any new information that is not consistent with the fundamental view the investor has of the company |
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Common cognitive error: gamblers fallacy |
The mistaken notion that the onset of an outcome either increases, or decreases the probability of the outcome occurring again |
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Common cognitive error: mental accounting |
Investors make decisions based on individual mental categories, which can be unique to each investor Ex: someone being upset more about losing a gift card rather than cash |
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Emotional biases |
Occur when the investors emotions and personality drive the decision making process |
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Loss aversion |
Emotional trait that is very different than the risk aversion, exhibited by the rational investor Hold on to losing securities much too long Structuring a portfolio to avoid losses rather than gains |
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Regret, aversion |
Investors, fear, making poor decisions Allowing fear of potential embarrassment to dictate financial decisions |
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Overconfidence bias |
Applies mostly to the difference between what an investor thinks they know, and the reality of the information |
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Clustering illusion |
The tendency to believe that short term trends will repeat over subsequent short terms |
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Imperfect diversification (Emotional) |
Representativeness Gambler's Fallacy Illusion of Control Loss Aversion Overconfidence Optimism Bias |
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Missed Opportunities (Cognitive) |
Anchoring Cognitive Dissonance Mental Accounting Hindsight Bias Lack of Self-Control Clustering Illusion |
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Prospect Theory |
Individuals are faulty in their estimation of probabilities and the associated outcomes Investors overweight small chance outcomes to avoid a loss |
