Question

1. Describe three of the biases or types of framing and make up an example of how each might impact an investment decision.

2. If markets are efficient, how is it possible that market bubbles and crashes occur?

Answer 1

1. Three type of bias that may affect an investment decision would be as follows-

A. Disposition bias effect- this disposition bias effect to reflect that investor will be selling something that has gained the upside quickly and he would be hanging onto his losing investment for a longer period of time so this will be making him prone to risk in the longer period of time by having wrong investment in his portfolio.

B. Confirmation bias-confirmation bias should be reflecting that that investors would be looking for such data which will be supporting his initial research and he would be trying to latch on to those that in order to make the investment decision so investor will be highly biased in order for confirmation of his initial data and these buyers will be affecting the overall investment decision making because they will be leading to selection of bad stocks because of initial bias.

C. Trend chasing bias- trend changing bias should be a bias that investor is trying to change the trend in the market regularly and he is trying to look for the past performance in order to make the future return but he will not be successful easily, because not every stock was performed better in the past will be performing better in the future.

2. Markets are not completely efficient because Efficient market hypothesis will be advocating that an Efficient market will be discounting all the publicly available information as well as privately available information along with past informations so no investor is able to beat the market rate of return but in the current market there are a lot of investors who are able to beat the market rate of interest and they are also leading to the formation of bubbles as privately available information have not been discounted into the stock price and publicly available information are also not completely discounted into the stock price and there is a rate of return which is made by the technical investor so this market is kind of a weak form inefficient, because this will be leading to formation of bubbles because of inefficient in the market and there is a chance of making a higher rate of return as well, so it can be seen that investor can also do fraud management in these scenario and hence these markets are not efficient because there is a high level of inefficiency existing due to inability to discount privately available information as well as publicly available information.