Credence Independent Advisors Key Considerations of Behavioral Finance

asked 2018-02-06 08:12:27 -0500

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July 17th 2014 - Such errors affect prices and returns, creating market inefficiencies. Keindahan Pantai Air Manis Padang It also investigates how other participants take advantage (arbitrage) of such market inefficiencies. Some of the following traits, knows as heuristics follow. Psychology concepts that affect the way you manage your investments. In psychology and more specifically Behavioral Finance, heuristics are simple, efficient rules of thumb which people often use to form judgments and make decisions.

pantai air manisThey are mental shortcuts that usually involve focusing on one aspect of a complex problem and ignoring others. These rules work well under most circumstances, but they can lead to systematic deviations from logic, probability or rational choice theory. The resulting errors are called cognitive biases and many different types have been documented. These have been shown to affect peoples choices in situations like valuing a house or deciding the outcome of a legal case and in making financial decisions.

Heuristics usually govern automatic, intuitive judgments but can also be used as deliberate mental strategies when working from limited information. Investors are normal, not rational. Behavioral finance reconciles the discrepancy between rational valuation and irrational market pricing. It's a booming field of study. Top behavioral finance gurus include Yale Robert Shiller and GMO James Montier. There are several common behavioral biases that drive investor decisions.

Availability Bias is the ease with which a particular idea can be brought to mind. When people estimate how likely or how frequent an event is on the basis of its availability, they are using the availability heuristic. When an infrequent event can be brought easily and vividly to mind, this heuristic overestimates its likelihood. For example, people overestimate their likelihood of dying in a dramatic event such as a tornado or terrorism. Dramatic, violent deaths are usually more highly publicised and therefore have a higher availability.

On the other hand, common but mundane events are hard to bring to mind, so their likelihoods tend to be underestimated. These include deaths from suicides, strokes, and diabetes. This heuristic is one of the reasons why people are more easily swayed by a single, vivid story than by a large body of statistical evidence. It may also play a role in the appeal of lotteries: to someone buying a ticket, the well-publicised, jubilant winners are more available than the millions of people who have won nothing.

When people judge whether more English words begin with T or with K, the availability heuristic gives a quick way to answer the question. Words that begin with T come more readily to mind and so subjects give a correct answer without counting out large numbers of words. However, this heuristic can also produce errors. When people are asked whether there are more English words with K in the first position or with K in the third position, they use the same process. It is easy to think of words that begin with K, such as kangaroo, kitchen, or kept.

It is harder to think of words with K as the third letter, such as lake, or acknowledge, although objectively these are three times more common. This leads people to the incorrect conclusion that K is more common at the start of words.

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