Cognitive biases and heuristics that affect investor decision making, such as anchoring, loss aversion, and overconfidence.
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- What is anchoring bias?
- The tendency to rely too heavily on an initial piece of information (the anchor) when making decisions, even if that information is irrelevant.
- Define loss aversion.
- The tendency to prefer avoiding losses over acquiring equivalent gains; losses feel about twice as painful as gains feel good.
- What is overconfidence bias?
- The tendency of investors to overestimate their ability to predict future market movements and the accuracy of their knowledge.
- Define confirmation bias.
- The tendency to search for, interpret, and remember information that confirms one's preexisting beliefs while ignoring contradictory evidence.
- What is the availability heuristic?
- A mental shortcut in which people estimate the probability of events based on how easily examples come to mind, rather than on actual probability.
- Explain the representativeness heuristic.
- A mental shortcut in which people judge the probability of something belonging to a category based on how similar it is to the typical example of that category.
- What is status quo bias?
- The preference for the current state of affairs; a disinclination to make changes even when those changes might improve outcomes.
- Define recency bias.
- The tendency to overweight recent events and information when making decisions, neglecting the longer-term historical context.
- What is the sunk cost fallacy?
- The tendency to continue investing money or effort into something because of the money or effort already spent, even if it is no longer the best choice.
- Define herding behavior.
- The tendency of investors to follow the actions and opinions of other investors, buying or selling in groups rather than making independent decisions.
- What is hindsight bias?
- The tendency to see past events as having been more predictable than they actually were; believing 'I knew it all along' after the outcome is known.
- Define the framing effect.
- The tendency of people to react differently to a choice depending on how it is presented (framed), even when the outcomes are identical.
- What is mental accounting?
- The tendency to categorize, treat, and evaluate financial activities in separate mental accounts rather than as one unified portfolio.
- Define the disposition effect.
- The tendency of investors to sell winning stocks too quickly and hold losing stocks too long, the opposite of 'cut losses, let winners run'.
- What is home bias?
- The tendency of investors to overweight their own country's stocks in their portfolios, neglecting international diversification opportunities.