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Behavioral biases of individuals (Behavioral biases (Emotional biases …
Behavioral biases of individuals
Behavioral biases
Cognitive errors
faulty cognitive reasoning
stem from basic statistical, information-processing or memory errors
easily corrected with better info, education, advice
Belief perseverance biases
tendency to cling to one's previous held beliefs irrationally or illogically
Conservatism
inadequately incorporating new information
overweight initial beliefs about probabilities
under-react to new information
Confirmation bias
only notice what confirms their beliefs and to ignore or undervalue what contradicts beliefs
Representativeness
classify new into based on past experience & classifications
Base-rate neglect
categorization without considering the probability
sample-size neglect
assume small sample size represent population
Illusion of control
believe that they can control or influence outcome when they don't
Hindsight
see past events as having been predictable and reasonable to expect
tend to remember own prediction as having been more accurate
Information processing biases
Anchoring & adjustment biases
when estimating, begins with some initial default number and then adjust up/down
too much weight on the anchor
Mental accounting bias
treat one sum of money differently from another equal-sized sum based on which mental account the money is assigned to (current income, current assets, future income)
Framing bias
responds different based on how problem is framed
Availability bias
based on how easily something comes to mind
Emotional biases
reasoning influenced by feelings or emotions
stem from impulse or intuition
best to adapted to
Loss aversion
prefer avoiding losses
selling winners too son, holding losers too long
Overconfidence
unwarranted faith in their own abilities, reasoning & judgement
self-attribution: claim success, blame external events for failures
trade excessive
Self-control bias
fail to act in pursuit of their long term goals because of self discipline
save insufficiently for the future
Endowment
value asset more when they have right to it than when they do not
fail to sell off certain assets and replace them with other assets
Regret aversion
avoid making decision that will result in action out of fear the decision will turn poorly
Status quo bias
do nothing instead of making change
maintain risk characteristics that are inappropriate
Investment policy & asset allocation
Goal-based investing
behavioral bias can and should be account for the IPS and AA process
Behaviorally modified asset allocation