PowerPoint Presentation

Heuristic and Behavioral Biases of Investors.

Overview:. In this module, you are introduce to the Availability Bias Representativeness Bias Overconfidence Bias Anchoring Bias Ambiguity Bias.

Learning Outcomes :. At the end of this module, you should be able to: Describe the Anchoring Bias, Limited Attention, Storing and Retrieving Information, Availability Bias, and Familiarity Bias. Explain the Risk Preference, Framing Bias as well as the Mental Accounting, and Representative..

One kind of investor behavior that leads to unexpected decisions is bias , a predisposition to a view that inhibits objective thinking. Biases that can affect investment decisions are the following: Availability Representativeness Overconfidence Anchoring Ambiguity.

Availability bias. occurs because investors rely on information to make informed decisions, but not all information is readily available. Investors tend to give more weight to more available information and to discount information that is brought to their attention less often..

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Representativeness. is decision making based on stereotypes, characterizations that are treated as “representative” of all members of a group. In investing, representativeness is a tendency to be more optimistic about investments that have performed well lately and more pessimistic about investments that have performed poorly. In your mind you stereotype the immediate past performance of investments as “strong” or “weak.” This representation then makes it hard to think of them in any other way or to analyse their potential. As a result, you may put too much emphasis on past performance and not enough on future prospects ..

How the Representativeness Heuristic Affects Decisions and Bias.

Overconfidence. also comes from the tendency to attribute good results to good investor decisions and bad results to bad luck or bad markets..

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Anchoring. happens when you cannot integrate new information into your thinking because you are too “anchored” to your existing views. You do not give new information its due, especially if it contradicts your previous views. By devaluing new information, you tend to underreact to changes or news and become less likely to act, even when it is in your interest..

Ambiguity. aversion is the tendency to prefer the familiar to the unfamiliar or the known to the unknown. Avoiding ambiguity can lead to discounting opportunities with greater uncertainty in favor of “sure things.” In that case, your bias against uncertainty may create an opportunity cost for your portfolio. Availability bias and ambiguity aversion can also result in a failure to diversify, as investors tend to “stick with what they know.”.

LEARNING ACTIVITY 1. Using terms and concepts from behavioral finance, how might you evaluate the consumer or investor behavior shown in the following photos? In what ways might these economic behaviors be regarded as rational?.