PM MODULE 87

Question 1

87.1 Behavioural biases:

What are cognitive errors?

What are emotional biases?

Answer 1

cog errors - can be minimized/mitigated

emotional - harder to manage

Question 2

87.1 Cognitive errors: What are the 5 belief perseverance phenomena

Answer 2

They reflect a desire to stick with the previous decision

Question 3

87.1 What is conservatism bias?

Answer 3

ignoring new information

Question 4

87.1 What is confirmation bias?

Answer 4

Seeking out information that supports their view

Question 5

87.1 What is representative bias?

Answer 5

The idea that the past will persist

New information is classified based on past experience

“base rate neglect” - refers to investors attempting to determine the potential success of a new investment by comparing it to an already understood category or previously held investment

/”sample size neglect” - relying on a small sample to represent what something might actually do into the future

Question 6

87.1 What is illusion of control bias?

Answer 6

When investors think they can control outcomes
- associated with the illusion of knowledge
- overconfidence bias

Question 7

87.1 What is hindsight bias?

Answer 7

selective memory !

selective memory of past events - they tend to remember correct views, forget losers

Question 8

87.1 Cognitive errors: Name 4 Information-processing biases:

Answer 8

Question 9

87.1 What is Anchoring bias?

Answer 9

This occurs when market participants use experience based on trial and error to unduly affect probabilities

Set an arbitrary number then seek to adjust this with trial and error

result: MARKET PARTICIPANTS MAY STICK TOO CLOSE TO THEIR INITIAL ESTIMATE

Easily mixed up with conservatism (a reluctance to change to new information received)

Question 10

87.1 What is Mental accounting bias?

Answer 10

Money is treated differently depending on how it is categorised

(money jar syndrome)

Question 11

87.1 What is Framing bias?

Answer 11

Occurs when a decision is affected based on the way that the question is framed (affects how the information is process)

Question 12

87.1 What is availability bias?

Answer 12

putting undue emphasis on information that is readily available

Question 13

87.1 Emotional biases: Name the 6 emotional biases:

Answer 13

These are the ones which must be ACCOMMODATED

Question 14

87.1 What is loss aversion bias?

Answer 14

clients hate to lose

This is when the client will feel more pain form a loss than the pleasure of an equal gain

seen by: hold onto a losing position - they dont want to sell it and crystallise a loss

Question 15

87.1 What is Overconfidence bias

Answer 15

we overestimate our ability in our reasoning

desire to feel good in your ability

Question 16

87.1 What is self control bias?

Answer 16

occurs when people lack the self-discipline and favour immediate gratification over long term goals

Question 17

87.1 What is status quo bias?

Answer 17

occurs when a discomfort with an existing situation presents an unwillingness to make a change

if an investment choice includes the option to maintain an existing choice, or a choice won’t happen unless you opt out then the status quo choices are more likely

education becomes paramount here

Question 18

87.1 What is endowment bias?

Answer 18

Bias towards something because we already own it

a fail to sell assets we already own

Question 19

87.1 What is Regret aversion bias

Answer 19

When market participants do nothing out of excess fear that they could be wrong

herding behaviour - a form of retreat aversion where participants go along with the concensus

Question 20

87.1 What is the market impact of behavioural biases?

Answer 20

market anomalie = January effect eg

halo effect = a version of representativeness in which a company’s characteristics such as fast growth or rising stock price are extended into the conclusion that it is a good stock to own

home bias = want to invest in home country