Behavioral finance is a sub-field of finance that seeks to understand how psychological factors and biases can influence the financial decision-making process of individuals and institutions.
Which of the following behavioral finance concepts refers to the tendency to rely too heavily on the first piece of information encountered when making decisions?
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A) Anchoring refers to the tendency to rely too heavily on the first information encountered when making decisions. B) Confirmation bias is the tendency to search for, interpret, and remember information in a way that confirms one's preexisting beliefs or hypotheses. C) Hindsight bias is the tendency to believe that after an event, one would have predicted or expected the outcome. D) Loss aversion is avoiding losses over acquiring equivalent gains.
Which behavioral finance concept is most closely related to the preference for the current state of affairs and resistance to change?
A) Mental accounting treats money differently depending on its source, intended use, or location. B) Overconfidence is the tendency to overestimate one's abilities or the accuracy of one's beliefs and predictions. C) Recency bias is the tendency to weigh recent events more heavily than earlier events when making decisions. D) Status quo bias is the preference for the current state of affairs and resistance to change.
In the late 1990s, many investors exhibited overconfidence and recency bias, leading them to believe that the stock market would continue to rise indefinitely. This resulted in the dot-com bubble, which eventually burst in 2000, causing significant losses for many investors.
An investor who avoids making decisions that may result in feelings of regret is exhibiting which behavioral finance concept?
A) Loss aversion is avoiding losses over acquiring equivalent gains. B) Regret aversion is the tendency to avoid making decisions that may result in feelings of regret. C) Representativeness heuristic is the tendency to judge the probability of an event based on how similar it is to a prototype. D) Confirmation bias is the tendency to search for, interpret, and remember information in a way that confirms one's preexisting beliefs or hypotheses.
An investor who recently experienced a significant loss in a particular stock may exhibit loss aversion and be hesitant to invest in similar stocks, even if they present a good investment opportunity. This could lead to suboptimal investment decisions and lower overall portfolio returns.
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Example Series 65 Example Practice Question
Anchors, bias, and hindsight too, behavioral finance affects what we do. Loss aversion, mental accounts, and more, these factors shape how we explore. So when advising clients, keep in mind, these psychological quirks we often find.