CPWA BM > Human Dynamics Behavior Finance Section2 > Flashcards

Human Dynamics Behavior Finance Section2 Flashcards

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1
Q

behavioral finance

A

The study of how psychological factors and biases influence financial decisions and market outcomes.

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2
Q

What research laid the foundation for behavioral finance?

A

Work by Kahneman and Tversky on decision-making under uncertainty, including Prospect Theory.

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3
Q

How does behavioral finance differ from traditional finance?

A

Traditional finance assumes rational investors; behavioral finance recognizes cognitive and emotional biases that lead to irrational decisions.

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4
Q

Nobel Prize winners associated with behavioral finance?

A

Daniel Kahneman (2002), Robert Shiller (2013), Richard Thaler (2017).

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5
Q

What book popularized behavioral finance concepts?

A

Thinking, Fast and Slow by Daniel Kahneman.

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6
Q

Explain how behavioral finance theory evolved over time.

A

It began with psychology-based research on decision-making, expanded through Prospect Theory, and integrated into wealth management practices emphasizing behavioral coaching.

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7
Q

What is intuitive decision-making?

A

Fast, automatic, emotional thinking (System 1).

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8
Q

What is deliberative decision-making?

A

Slow, analytical, logical thinking (System 2).

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9
Q

Describe biological processes in financial decision-making.

A

Emotional triggers activate the limbic system, influencing risk perception and decisions, while rational thinking engages the prefrontal cortex.

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10
Q

What is Expected Value Theory?

A

Optimal decision rule where decisions aim to maximize expected monetary value.
EV = Σ (Probability × Outcome).

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11
Q

What is Utility Function Theory?

A

A model where decisions aim to maximize satisfaction (utility), not just monetary value.

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12
Q

Difference between descriptive vs. prescriptive utility theory?

A

Descriptive explains actual behavior; prescriptive suggests optimal behavior.

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13
Q

What is the Mean-Variance Model?

A

A portfolio theory model that balances expected return against risk (variance).

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14
Q

What is Prospect Theory?

A

A behavioral model showing people weigh losses more heavily than gains, leading to loss aversion and risk-seeking in losses.

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15
Q

What is the Adaptive Market Hypothesis?

A

Suggests markets evolve like biological systems, adapting to changing environments and investor behaviors.

a framework for connecting the theories of efficient markets with the findings of behavioral economics

sometimes investors act rational, sometimes they act irreational

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16
Q

What is a behavioral bias?

A

A systematic deviation from rational judgment caused by cognitive or emotional factors.

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17
Q

Define loss aversion.

A

Feeling losses about twice as strongly as equivalent gains.

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18
Q

Define herding bias.

A

Following the crowd rather than independent analysis.

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19
Q

Define recency bias.

A

Overweighting recent events when making decisions.

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20
Q

Define availability bias.

A

Relying on information that is most easily recalled or readily available.

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21
Q

Define overconfidence bias.

A

Overestimating one’s own knowledge or predictive ability.

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22
Q

What is framing bias?

A

Decisions influenced by how information is presented (gain vs. loss framing).

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23
Q

What is mental accounting?

A

Treating money differently based on its source or intended use.

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24
Q

What is anchoring bias?

A

Relying too heavily on an initial reference point when making decisions.

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25
What is status quo bias?
Preference for maintaining current conditions rather than making changes.
26
What is regret aversion?
Avoiding decisions to prevent future regret.
27
What is confirmation bias?
Seeking information that confirms existing beliefs while ignoring contradictory evidence.
28
How are biases categorized?
Emotional, cognitive/information-processing, and belief-based.
29
Which biases are best handled by education vs. accommodation?
Cognitive biases → education; emotional biases → accommodation.
30
What is familiarity bias?
Preference for familiar investments, leading to under-diversification.
31
What is hindsight bias?
Believing past events were predictable after they occurred.
32
What is illusion of control bias?
Overestimating ability to control outcomes.
33
How does social media amplify behavioral biases?
Increases herding, recency, and overconfidence through constant exposure to trending opinions and headlines.
34
What are the four common investor personality types?
Preservers, Followers, Independents, Accumulators.
35
How do personality types affect decision-making?
They influence risk tolerance, investment horizon, and susceptibility to biases.
36
What are the Big Five personality traits?
Agreeableness, Neuroticism, Conscientiousness, Extraversion, Openness.
37
Which trait predicts wealth accumulation?
High conscientiousness.
38
Which trait is linked to impulsive spending and higher debt?
High extraversion.
39
Which trait is linked to loss aversion and over-monitoring investments?
High neuroticism.
40
Which trait correlates with openness to new investment ideas?
High openness.
41
Which trait correlates with trust and susceptibility to persuasion?
High agreeableness.
42
What personality clusters exist?
Resilients (stable, confident), Undercontrollers (impulsive), Overcontrollers (emotionally fragile).
43
How do personality clusters relate to risk propensity?
Higher openness and extraversion → higher risk-taking; high neuroticism → lower risk tolerance.
44
What is a Behavioral Wealth Advisor (BWA)?
An advisor who integrates behavioral coaching into wealth management to reduce biases and improve outcomes.
45
What are the pillars of behavioral wealth management?
Reframing risk, planning, active equity investing, and behavioral coaching.
46
What is goals-based planning?
Aligning investment strategies with multiple client goals, each with its own horizon and risk profile.
47
How should risk be reframed?
Focus on long-term goals and portfolio underperformance risk, not short-term volatility.
48
What is asset bucketing?
Segregating assets into buckets for short-term liquidity, income, and long-term growth.
49
What is the role of an Investment Policy Statement (IPS)? how does it help during volatility?
Provides a disciplined framework for asset allocation, benchmarks, and rebalancing.Provides discipline and reduces emotional reactions.
50
Why is rebalancing important?
Maintains target allocation, enforces discipline, and reduces emotional decision-making.
51
How does automation help?
Systematic investing and model portfolios reduce timing errors and emotional biases.
52
What is the advisor’s role in behavioral coaching?
Set expectations, appeal to emotions, maintain perspective, and implement strategies like IPS and rebalancing.
53
What best practices help mitigate behavioral biases?
IPS, systematic rebalancing, diversification, automation, and model portfolios.
54
What is the rule of 55/65/75?
Stock market produces positive returns in 55% of days, 65% of months, and 75% of years.
55
What is the behavior gap?
The difference between investment returns and investor returns caused by poor timing and emotional decisions.
56
How much value can behavioral coaching add annually?
Approximately 150 basis points (Vanguard study).
57
What is the impact of bad behaviors on portfolio returns?
DALBAR study shows investor returns lag investment returns by ~2% annually due to timing mistakes.
58
What is the benefit of systematic rebalancing?
Reduces drawdowns and accelerates recovery after market declines.
59
What is the advantage of model portfolios?
Consistency, reduced dispersion, and mitigation of recency bias.
60
What is mental accounting’s impact on portfolio design?
Leads to suboptimal allocation by treating accounts separately instead of holistically.
61
How does framing affect client decisions?
Gain framing encourages risk aversion; loss framing encourages risk-seeking.
62
What is the link between personality and risk propensity?
High openness and extraversion → higher risk-taking; high neuroticism → lower risk tolerance.
63
What is the role of diversification in behavioral coaching?
Reduces volatility and emotional stress, helping clients stay invested.
64
Why is automation critical for behavioral guidance?
Removes timing decisions and enforces discipline.
65
Based on John Nersesian's lecture, the optimal portfolio for your client is:
The behaviorally adjusted portfolio your client can live with
66
self-control bias
Emotional bias where investors prioritize current consumption over saving, leading to underfunded retirement and poor asset allocation.
67
How can advisors mitigate self-control bias?
Automate savings, “pay yourself first,” use commitment devices like Save More Tomorrow programs.
68
endowment bias
Emotional bias where investors overvalue assets they own, leading to reluctance to sell even when rational.
69
the two forms of representativeness bias
Base-rate neglect (ignoring statistical probabilities) and sample-size neglect (assuming small samples represent entire populations).
70
conservatism bias
Conservatism bias is the tendency to be slow to revise one's belief even when presented with new evidence.
71
the five BB&K investor personality types
Adventurer: Confident, risk-taker, hard to advise. Celebrity: Seeks excitement, follows trends. Individualist: Rational, analytical, easiest to advise. Guardian: Careful, security-focused. Straight Arrow: Balanced, moderate risk tolerance.
72
Difference between passive and active investors in Barnewall model
Passive gained wealth without risking own capital; active risked own capital and prefers control.
73
the three dimensions in the eight-type investor model
Idealist vs. Pragmatist: Idealists overestimate skill; Pragmatists are realistic. Framer vs. Integrator: Framers view investments in isolation; Integrators see the big picture. Reflector vs. Realist: Reflectors avoid admitting mistakes; Realists act decisively.
74
the most biased combination out of the 8 type investor model
IFT (Idealist, Framer, Reflector).
75
the least biased combination out of 8 type investor model
PNR (Pragmatist, Integrator, Realist).
76
DALBAR finding on investor returns
Investors underperform by ~2% annually due to timing mistakes.
77
the four Behavioral Investor Types and their risk tolerance levels
Conservative (Low), Moderate (Moderate), Growth (Medium–High), Aggressive (High).
78
the Behavioral Investor Types that are emotional vs. cognitive as it relates to risk tolerance
Conservative & Aggressive → Emotional; Moderate & Growth → Cognitive.
79
risk appetite and risk capacity
Risk appetite = willingness to take risk; Risk capacity = ability to bear risk.
80
the critical nature of unknown risk in behavioral finance
Unknown risks often trigger irrational behavior and derail investment plans.
81
the equation for risk tolerance
Risk Tolerance = (Risk Appetite + Known Risks) + (Risk Capacity + Unknown Risks).
82
how advisors should handle cognitive vs. emotional biases
Cognitive biases → education; Emotional biases → accommodation.
83
loss aversion and its impact
Losses feel about twice as strong as gains; leads to holding losing investments too long.
84
overconfidence and why it matters
Unwarranted faith in judgment; common in Aggressive investors, often leads to excessive risk-taking.
85
anchoring/adjustment bias/
Relying too heavily on an initial reference point when making decisions.
86
the biases best handled by education vs. accommodation
Education (Cognitive biases): Anchoring, framing, confirmation, conservatism, representativeness, mental accounting, hindsight. Accommodation (Emotional biases): Loss aversion, regret aversion, endowment, self-control, status quo, overconfidence, familiarity.
87
representivness bias
Representativeness bias occurs when the similarity of objects or events becomes confused with the probability of an outcome. People make the mistake of believing that two similar events are closely correlated.
88
outcome bias
judging decision based on its outcome rather than the quality of the decision process at the time it was made.
89
self attribution bias
investors attribute successes to their own skill and failures to external factors(like bad luck or market conditions)
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