This type of investor is more subject to overconfidence, less self-control, affinity bias, and illusion of control. A) accumulator B) independent Making decisions based more on probabilities than potential outcomes. Making decisions on mental shortcuts and biases. Feeling the impact of losses more than Gain’s. This describes what? Prospect theory Confusion or frustration that arises when an individual receives new information that does not match up with or conform to pre-existing beliefs or experiences. This describes what? Cognitive dissonance Bias were people cling to their prior views or forecast at the expense of acknowledging new information. Individuals are inherently slow to change. Conservatism Cognitive bias were people observe, overvalue or actively seek out information that confirms what they believe while ignoring or devaluing information that contradicts their beliefs. This is called what? Confirmation A cognitive bias through which individuals process new information using preexisting ideas or beliefs. An Investor views a particular situation or information a certain way because of similarities to other examples even if it does not really fit into that category. This is called what?. Representativeness A cognitive bias where people believe they can control or influence investment outcomes when in reality they cannot. This is called what? Illusion of control Cognitive bias where investors perceive investment outcomes as if they were predictable, even if they were not. Sometimes gives investors a false sense of security when making investment decisions leading them to excessive risk taking. This is called what? Hindsight bias a cognitive bias in which individuals treat various sums of money differently based on where these monies are mentally categorized (e.g., retirement, college, etc.) Mental Accounting • a cognitive bias where investors are influenced by purchase point or arbitrary price levels and cling to these numbers when deciding to buy or sell and investments • individuals often rely too heavily on certain information (often the first data points received) when making decisions Anchoring cognitive bias where an individual responds to similar situations differently based on the context in which the choice is presented Framing a cognitive bias where easily recalled outcomes (often from more recent information) are perceived as being more likely that those that are harder to recall or understand Availability a cognitive bias where people ascribe successes to their innate talents and blame failures on outside influences Self Attribution a cognitive bias in which people often make decisions or take action based on the outcome of past events rather than by observing the process by which that outcome occurred Outcome Bias investors tend to believe that patterns, trends and movements in the recent past are likely to repeat themselves • individuals put too much weight on and make decisions based on inputs and feedback they have recently received Recency Bias • emotional bias where an investor finds the idea of losses twice as painful as the pleasure of gains • core tenant of Prospect Theory Loss Aversion emotional bias where an investor has unwarranted faith in his or her own thoughts and abilities Overconfidence • human tendency to focus on instant gratification due to lack of discipline • consequently failing to act in the best interest of long-term goals Self Control an emotional bias where when faced with an array of options, an investor is predisposed to select the option that keeps conditions the same Status Quo • an emotional bias where an individual assigns a greater valued to an object already held or owned, or an object that he may actually lose • example: investors may assign additional value to stocks they have inherited Endowment Effect an emotional bias where investors avoid taking decisive action because they are afraid that when looking back at the course they select, it will prove less than optimal Regret Aversion • an emotional bias where investors make decisions based on how they believe a product or service reflects their values • example: individuals with ________bias are prone to purchase stocks that reflect their self-image Affinity Bias ————— can cause investors to hold losing securities positions that they otherwise would sell because they want to avoid mental pain associated with admitting that they made a bad decision. Cognitive dissonance —————- can cause investors to a View or forecast, behaving to inflexibly when presented with new information. For example, assume an investor purchases a security based on the knowledge that the company is planning a forthcoming announcement regarding a new product. The company then announces that it has experienced problems bringing the product market. The investor may cling to the initial, optimistic impression of some imminent, positive development by the company and fail to take action on the negative announcement. Conservatism bias ————— can cause investors to seek out only information that confirms their beliefs about an investment that they have made and to not seek out information that may contradict their beliefs. This behavior can leave investors in the dark regarding, for example, imminent decline of a stock Confirmation bias ——————-can lead investors to trade more than his prudent. Researchers have found that traders, especially online traders, believe them selves to possess more control over the outcomes of their investments that they actually do. An excess of trading results, in the end, in decreased returns. Illusion of control When an investment appreciates,—————— investors tend to rewrite their own memories to portray the positive developments as if they were predictable. Overtime, this rationale can inspire excessive risk taking because __________– biased investors begin to believe that they have superior predictive powers, when, in fact, they do not. The bursting of the technology bubble is an example of this by his actions. Hindsight bias Conventional theories presume that investors ____________ and behavioral finance presumes that they ____________. are rational; may not be rational Some economists believe that the anomalies literature is consistent with investors ____________ and ____________. inability to always process information correctly and therefore they infer incorrect probability distributions about future rates of return; given a probability distribution of returns, they often make inconsistent or suboptimal decisions ____________ may be responsible for the prevalence of active versus passive investments management. Overconfidence If a person gives too much weight to recent information compared to prior beliefs, they would make ________ errors. Forecasting Statman argues that ________ is consistent with some investors' irrational preference for stocks with high cash dividends and with a tendency to hold losing positions too long. mental accounting Arbitrageurs may be unable to exploit behavioral biases due to ____________. fundamental risk, implementation costs, model risk __________ was the grandfather of technical analysis. charles dow A long-term movement of prices, lasting from several months to years is called _________. a primary trend The Dow theory posits that the three forces that simultaneously affect stock prices are ____________. ) primary trend II) intermediate trendminor trend The put/call ratio is computed as ____________ and higher values are considered ____________ signals. the number of outstanding put options divided by outstanding call options; bullish or bearish Conventional Finance Prices are correct; equal to intrinsic value. Resources are allocated efficiently. Consistent with EMH Two categories of irrationalities: Investors do not always process information correctly. Result: Incorrect probability distributions of future returns. Even when given a probability distribution of returns, investors may make inconsistent or suboptimal decisions. Result: They have behavioral biases. framing How the risk is described, "risky losses" vs. "risky gains", can affect investor decisions. Mental accounting Investors may segregate accounts or monies and take risks with their gains that they would not take with their principal. Regret avoidance Investors blame themselves more when an unconventional or risky bet turns out badly. Prospect theory Conventional view: Utility depends on level of wealth. Behavioral view: Utility depends on changes in current wealth. Fundamental risk "Markets can remain irrational longer than you can remain solvent." Intrinsic value and market value may take too long to converge. implementation cost Transactions costs and restrictions on short selling can limit arbitrage activity. model risk What if you have a bad model and the market value is actually correct? Siamese twin companies Royal Dutch should sell for 1.5 times Shell Have deviated from parity ratio for extended periods Example of fundamental risk Equity carve-outs 3Com and Palm Arbitrage limited by availability of shares for shorting closed-end funds May sell at premium or discount to NAV Can also be explained by rational return expectations Disposition effect The tendency of investors to hold on to losing investments. Demand for shares depends on price history Can lead to momentum in stock prices Dow Theory Primary trend : Long-term movement of prices, lasting from several months to several years. Secondary or intermediate trend: short-term deviations of prices from the underlying trend line and are eliminated by corrections. Tertiary or minor trends: Daily fluctuations of little importance. Confidence index The ratio of the average yield on 10 top-rated corporate bonds divided by the average yield on 10 intermediate-grade corporate bonds. dow theory attempts to identify underlying trends in stock indexes. moving averages, relative strength, and breth are used in other trend strategies Some sentiment indicators are trin statistic, confidence index, and the put/call nformation processing errors consist of I) forecasting errors. II) overconfidence. III) conservatism. IV) framing. I, II, and III Forecasting errors are potentially important because research suggests that people overweight recent information. DeBondt and Thaler believe that high P/E result from investors' earnings expectations that are too extreme. If a person gives too much weight to recent information compared to prior beliefs, they would make ________ errors. forecasting Single men trade far more often than women. This is due to greater ________ among men. Overconfidence ____________ may be responsible for the prevalence of active versus passive investments management. Overconfidence Barber and Odean (2000) ranked portfolios by turnover and report that the difference in return between the highest and lowest turnover portfolios is 7% per year. They attribute this to overconfidence. ________ bias means that investors are too slow in updating their beliefs in response to evidence. Conservatism Psychologists have found that people who make decisions that turn out badly blame themselves more when that decision was unconventional. The name for this phenomenon is regret avoidance. An example of ________ is that a person may reject an investment when it is posed in terms of risk surrounding potential gains, but may accept the same investment if it is posed in terms of risk surrounding potential losses. Framing Statman (1977) argues that ________ is consistent with some investors' irrational preference for stocks with high cash dividends and with a tendency to hold losing positions too long. mental accounting An example of ________ is that it is not as painful to have purchased a blue-chip stock that decreases in value, as it is to lose money on an unknown start-up firm. regret avoidance Arbitrageurs may be unable to exploit behavioral biases due to I) fundamental risk. II) implementation costs. III) model risk. IV) conservatism. V) regret avoidance. I, II, and III ____________ are good examples of the limits to arbitrage because they show that the law of one price is violated. I) Siamese twin companies II) Unit trusts III) Closed-end funds IV) Open-end funds V) Equity carve-outs I, III, and V A trin ratio of less than 1.0 is considered as a bullish signal. In regard to moving averages, it is considered to be a ____________ signal when market price breaks through the moving average from ____________. bullish; below Two popular moving average periods are 200-day and 53 week. ___________ is a measure of the extent to which a movement in the market index is reflected in the price movements of all stocks in the market. Breadth The confidence index is computed from ____________, and higher values are considered ____________ signals. bond yields; bullish The put/call ratio is computed as ____________, and higher values are considered ____________ signals. the number of outstanding put options divided by outstanding call options; bullish or bearish he efficient market hypothesis mplies that security prices properly reflect information available to investors and that active traders will find it difficult to outperform a buy-and-hold strategy. Tests of market efficiency have focused on strategies that would have provided superior risk-adjusted returns and results of actual investments of professional managers. The anomalies literature suggests that several strategies would have provided superior returns. Behavioral finance argues that even if security prices are wrong, it may be difficult to exploit them and the failure to uncover successful trading rules or traders cannot be taken as proof of market efficiency. Markets would be inefficient if irrational investors __________ and actions of arbitragers were __________. existed; limited If prices are correct, __________, and if prices are not correct, __________. there are no easy profit opportunities; there are no easy profit opportunities __________ can lead investors to misestimate the true probabilities of possible events or associated rates of return. Information processing errors Kahneman and Tversky (1973) report that __________ and __________. people give too much weight to recent experience compared to prior beliefs; tend to make forecasts that are too extreme given the uncertainty of their information Errors in information processing can lead investors to misestimate true probabilities of possible events and associated rates of return. DeBondt and Thaler (1990) argue that the P/E effect can be explained by forecasting errors and earnings expectations that are too extreme. Barber and Odean (2001) report that men trade __________ frequently than women and the frequent trading leads to __________ returns. more; inferior Conservatism implies that investors are too __________ in updating their beliefs in response to new evidence and that they initially __________ to news. slow; under react If information processing was perfect, many studies conclude that individuals would tend to make __________ decisions using that information due to __________. less than fully rational; behavioral biases The assumptions concerning the shape of utility functions of investors differ between conventional theory and prospect theory. Conventional theory assumes that utility functions are __________ whereas prospect theory assumes that utility functions are __________. concave and defined in terms of wealth; s-shaped (convex to losses and concave to gains) and defined in terms of losses relative to current wealth The law of one price posits that ability to arbitrage would force prices of identical goods to trade at equal prices. However, empirical evidence suggests that __________ are often mispriced. A. Siamese twin companies B. equity carve-outs C. closed-end funds D. Siamese twin companies and closed-end funds E. All of the options** Kahneman and Tversky (1973) reported that people give __________ weight to recent experience compared to prior beliefs when making forecasts. This is referred to as ____________. too much; memory bias Kahneman and Tversky (1973) reported that __________ give too much weight to recent experience compared to prior beliefs when making forecasts. People Barber and Odean (2001) report that men trade __________ frequently than women. More Barber and Odean (2001) report that women trade __________ frequently than men. Less Barber and Odean (2001) report that men __________ women. earn lower returns than Barber and Odean (2001) report that women __________ men. earn higher returns than __________ effects can help explain momentum in stock prices. Mental accounting Studies of Siamese twin companies find __________, which __________ the EMH. correct relative pricing; does not support Studies of equity carve-outs find __________, which __________ the EMH. evidence against the law of one price; violates Studies of closed-end funds find __________, which __________ the EMH. prices at premiums and discounts to NAV; is inconsistent with ____________ measures the extent to which a security has outperformed or underperformed either the market as a whole or its particular industry. Relative strength A sub sidiary is _____ necessarily affected by changing governments. Not A subsidiary _____ be affected by new policies of the host govt. or by a changed attitude toward the subsidiaries home country, even when the host govt. has no risk of being overthrown. Can A govt. may require the use of local employees for managerial positions at a subsidiary. Furthermore..... a host government may impose extra tax or restrictions on the subsidiary or take actions that protect or subsidize competitors. An MNC considering direct foreign investment to attract demand in that country must be highly concerned about.... Financial risk An MNC establishing a foreign manufacturing plant and planning to export the products from there should be more concerned about... political risk If a projects political risk is considered much more important that its financial risk, then the political risk rating will receive a ______ weight than the financial risk rating (as before, both weights should add up to 100 percent). Higher
