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Behavioral Finance - Coggle Diagram

- - - - Representativeness
        
        tendency to use past experiences or belief to guide decision making. compare subject to a representative idea
        
        Associated biases
        
        1) Law of small numbers
        
        assume small sample represent larger population
        
        2) Mean reversion / regression to mean fallacy
        
        statistical phenomenon- extreme (random) outcome in the first case, second or later outcomes will be less extreme. close to the mean of the distribution
        
        investors ignorance that extreme performance usually return to average. both high and low performing fund tend to revert to avg over time. investors inclined to under- overestimate performance
        
        To mitigate
        
        introduce objectivity to decision making
        
        seek people to challenge your opinions
        
        be aware of the likelihood of particualr event based on situational information
      - Availability
        
        mental shortcut based on information that is easy to recall, widely available, highly publicised
        
        partly happens bcs of limitation of memory
        
        predisposed to over emphasize, overestimate the likelihood or misinterpret information
        
        To mitigate
        
        retain a sense of perspective
        
        avoid being caught up in the latest news
        
        avoid short term approaches, focus on long term picture
      - Anchoring
        
        tendency to rely on the first piece of information as a subjective reference point for making future judgements
        
        "first impression bias"
        
        have difficulty altering viewpoints when faced with new information
        
        problem: reject a correct decision / accept an incorrect decision
        
        To mitigate
        
        awareness
        
        critical thinking and reflecting past decision making
        
        careful evaluation of investment's potential by
        
        identifying factors that underlie the anchor
        
        replacing guesswork with quantifiable data
    - - Affect
        
        emotions coloring beliefs
        
        mental shortcut - reliance on emotion, intuition to make decision
        
        positive feeling
        
        perceive investment as having high return, low risk
        
        negative feeling
        
        more critical when evaluating investment
        
        To mitigate
        
        third person self talks can improve emotion regulation and self control by facilitating self distancing and reducing egocentric bias
- - - - promote the benefits of actions
      - people tend to avoid risk, bcs risk averse
    - - emphasize the consequence of failing to take actions
      - people tend to seek risk, because loss-averse
  - - - financial decision makers view all decisions through the same objective and transparent lens of risk and return
- - - - can't exist in rational markets. it implies deviation of prices from intrinsic values
      - characteristics
        
        rapid acceleration of asset prices due to over confidence and speculation
        
        overheated economic activity
        
        uncontrolled money supply and credit expansion