Question

1. What is anchoring? Explain the social security number experiments. Explain the number of countries from Africa in UN experiments.

1b. Why do we do anchoring?

1c. How can anchoring impact finance? How can anchoring impact real estate? Use examples from the slides in your answers.

1c. What is mental accounting? Explain the lawnmower experiment. Explain the Boston Celtics example.

2. Why do you think we do mental accounting?

3. Explain the House Money effect that comes from mental accounting. How does this impact financial decision making in the stock market?

Answer 1

Answer:

Anchoring Means:

Anchoring is the use of irrelevant information, such as the purchase price of a security, as a reference for evaluating or estimating an unknown value of a financial instrument.

Understanding Anchoring:

Anchoring is a behavioral bias in which the use of a psychological benchmark carries a disproportionately high weight in a market participant’s decision-making process. The concept is part of the field of behavioral finance, which studies how emotions and other extraneous factors influence economic choices.

In the context of investing, one consequence of anchoring is that market participants with an anchoring bias tend to hold investments that have lost value because they have anchored their fair value estimate to the original price rather than to fundamentals. As a result, market participants assume greater risk by holding the investment in the hope the security will return to its purchase price. Market participants are often aware that their anchor is imperfect and attempt to make adjustments to reflect subsequent information and analysis. However, these adjustments often produce outcomes that reflect the bias of the original anchors

Anchoring Bias

An anchoring bias can cause a financial market participant, such as a financial analyst or investor, to make an incorrect financial decision, such as buying an undervalued investment or selling an overvalued investment. Anchoring bias can be present anywhere in the financial decision-making process, from key forecast inputs, such as sales volumes and commodity prices, to final output like cash flow and security prices.

Historical values, such as acquisition prices or high-water marks, are common anchors. This holds for values necessary to accomplish a certain objective, such as achieving a target return or generating a particular amount of net proceeds. These values are unrelated to market pricing and cause market participants to reject rational decisions.

Anchoring can be present with relative metrics, such as valuation multiples. Market participants using a rule-of-thumb valuation multiple to evaluate securities prices demonstrate anchoring when they ignore evidence that one security has a greater potential for earnings growth.

Some anchors, such as absolute historical values and values necessary to accomplish an objective, can be harmful to investment objectives, and many analysts encourage investors to reject these types of anchors. Other anchors can be helpful as market participants deal with the complexity and uncertainty inherent in an environment of information overload. Market participants can counter anchoring bias by identifying the factors behind the anchor and replacing suppositions with quantifiable data.

Comprehensive research and assessment of factors affecting markets or a security's price is necessary to eliminate anchoring bias from decision-making in the investment process.

KEY Points:

• Anchoring is a behavioral finance term to describe an irrational bias towards a psychological benchmark.
• This benchmark generally takes the form of irrelevant information, such as an estimate or figure or event, that skews decision-making regarding a security by market participants, such as analysts or investors.

What Is a Social Security Number (SSN):

A Social Security Number (SSN) is a numerical identifier assigned to U.S. citizens and some residents to track their income and determine benefits. The Social Security Number was created in 1935 as part of The New Deal as a program to provide for retirement and disability benefits for the old and infirm. While the original intention of the program and the individually-assigned identification number was simply to track earnings and provide benefits, it is now also used for a wide range of purposes, such as to identify individuals for tax purposes, to track their credit record, and approve for credit. In the United States, an individual is asked to provide an SSN to obtain credit, open a bank account, obtain government benefits or private insurance, and to buy a home or a car, among many other pursuits.

With very few exceptions, all U.S. legal residents (citizens, permanent residents, and temporary/working residents) have a Social Security Number. Even non-working residents (citizens and non-citizens alike) will have an SSN because of how useful it is to businesses and government entities.The legal framework for assigning a Social Security Number is provided under Section 205(c)(2) of the Social Security Act (42 U.S. Code, Chapter 7, Subsection 405).Social Security Numbers and cards are issued by the Social Security Administration (SSA).Social Security numbers are now random streams of digits, but prior to 2011, they were not. At that time, the first three digits represented the area in which the individual was born or was from. The next pair of numbers was originally slated to represent a year or month of birth. Because they worried about this being falsified, the Social Security Administration instead voted to have it represent a group number. Thus far, no Social Security Numbers have been reused, though there have been some cases in which two people were issued the same number.

Social Security Number: How to Get One

A Social Security Number (and card) may be obtained by filling out Form SS-5 (Application for a Social Security Card) from the Social Security Administration. The form covers obtaining an original card, replacing a card, and changing or correcting SSN records. A full list of requirements (such as documentation that proves age, identity, and U.S. citizenship/immigration status) are listed in the form.6 There is no cost for obtaining a card or number. In some circumstances, an individual may change their Social Security Number.

Social Security Number and Identity Theft

Since the Social Security Number is used so frequently as a personal identifier and to obtain credit, and it contains no biometrics and relies on documentation to prove validity, it is susceptible to use for identity theft and fraud. A notable example is when the CEO of identity theft prevention service LifeLock used his SSN in advertisements as a testament to his company's effectiveness. His identity was later stolen multiple times.There has been some movement among legislators to separate some activities from SSN use, such as renting an apartment or obtaining a hunting or fishing license.

Explain the number of countries from Africa in UN experiments.

28%

The African Group consists of 54 Members States (28% of United Nations members), and is thus the largest regional group by number of Member States.

Anchoring in Public Markets:

The more relevant the anchor seems, the more people tend to cling to it. Also, the more difficult it is to value something, the more we tend to rely on anchors. So when we think about currency values, which are intrinsically hard to value, anchors often get involved.

How can anchoring impact finance?

The anchoring bias can also make the investors make less than ideal financial decisions, like ignoring an undervalued investment or holding the overvalued investment for too long. Overall, anchoring effect leads to bad investment decisions. Sometimes, anchoring bias also causes the 'post-earnings announcement drift.

How can anchoring impact real estate?

The effect works because when you are given a number (e.g., 1200 meters) that relates to a property of an item (the quality etc) with a question about that property you are likely to, whether knowingly or not, anchor your judgement by using the number as a reference point (i.e. the anchor)

What is Mental Accounting?

Mental accounting refers to the different values people place on money, based on subjective criteria, that often has detrimental results. Mental accounting is a concept in the field of behavioral economics. Developed by economist Richard H. Thaler, it contends that individuals classify funds differently and therefore are prone to irrational decision-making in their spending and investment behavior.

KEY Points:

• Mental accounting, a behavioral economics concept introduced in 1999 by Nobel Prize-winning economist Richard Thaler, refers to the different values people place on money, based on subjective criteria, that often has detrimental results.
• Mental accounting often leads people to make irrational investment decisions and behave in financially counterproductive or detrimental ways, such as funding a low-interest savings account while carrying large credit card balances.
• To avoid the mental accounting bias, individuals should treat money as perfectly fungible when they allocate among different accounts, be it a budget account (everyday living expenses), a discretionary spending account, or a wealth account (savings and investments).

Understanding Mental Accounting

Richard Thaler, currently a professor of economics at the University of Chicago Booth School of Business, introduced mental accounting in his 1999 paper "Mental Accounting Matters," which appeared in the Journal of Behavioral Decision Making. He begins with this definition: "Mental accounting is the set of cognitive operations used by individuals and households to organize, evaluate, and keep track of financial activities." The paper is rich with examples of how mental accounting leads to irrational spending and investment behavior.

Underlying the theory is the concept of fungibility of money. To say money is fungible means that, regardless of its origins or intended use, all money is the same. To avoid the mental accounting bias, individuals should treat money as perfectly fungible when they allocate among different accounts, be it a budget account (everyday living expenses), a discretionary spending account, or a wealth account (savings and investments).

Explain the lawnmower experiment.

A lawn mower (also named as mower, grass cutter or lawnmower) is a machine utilizing one or more revolving blades to cut a grass surface to an even height. The height of the cut grass may be fixed by the design of the mower, but generally is adjustable by the operator, typically by a single master lever, or by a lever or nut and bolt on each of the machine's wheels. The blades may be powered by manual force, with wheels mechanically connected to the cutting blades so that when the mower is pushed forward, the blades spin, or the machine may have a battery-powered or plug-in electric motor. The most common self-contained power source for lawn mowers is a small (typically one cylinder) internal combustion engine. Smaller mowers often lack any form of propulsion, requiring human power to move over a surface; "walk-behind" mowers are self-propelled, requiring a human only to walk behind and guide them. Larger lawn mowers are usually either self-propelled "walk-behind" types, or more often, are "ride-on" mowers, equipped so the operator can ride on the mower and control it. A robotic lawn mower ("lawn-mowing bot", "mowbot", etc.) is designed to operate either entirely on its own, or less commonly by an operator by remote control.

Explain the Boston Celtics example.

The Boston Celtics (/ˈsɛltɪks/ SEL-tiks) are an American professional basketball team based in Boston. The Celtics compete in the National Basketball Association (NBA) as a member of the league's Eastern Conference Atlantic Division. Founded in 1946 as one of the league's original eight teams, the Celtics play their home games at TD Garden, which they share with the National Hockey League (NHL)'s Boston Bruins. The Celtics are regarded as the most successful basketball team in NBA history; the franchise has won the most championships in the NBA with 17 (accounting for 23.9 percent of all NBA championships since the league's founding), and currently hold the record for the most recorded wins of any NBA team.[8][9]The Celtics are one of the two charter BAA franchises (the other being the New York Knicks) still playing in their original city today.

The Celtics have a notable rivalry with the Los Angeles Lakers, who have won 16 NBA championships, second behind the Celtics. The rivalry was heavily highlighted throughout the 1960s and 1980s. The franchise has played the Lakers a record 12 times in the NBA Finals (including their most recent appearances in 2008 and 2010), of which the Celtics have won nine.[10] Four Celtics players (Bob Cousy, Bill Russell, Dave Cowens and Larry Bird) have won the NBA Most Valuable Player Award for an NBA record total of 10 MVP awards.[11] Both the nickname "Celtics" and their mascot "Lucky the Leprechaun" are a nod to Boston's historically large Irish population.[12]

The Celtics' rise to dominance began in the late 1950s, after acquiring center Bill Russell in a draft day trade in 1956, who would become the cornerstone of the Celtics dynasty. Led by Russell and superstar point guard Bob Cousy, the Celtics won their first NBA championship in 1957. Russell, along with a talented supporting cast of future Hall of Famers including John Havlicek, Tom Heinsohn, K. C. Jones, Sam Jones, Satch Sanders, and Bill Sharman, would usher the Celtics into the greatest period in franchise history, winning eight consecutive NBA championships throughout the 1960s. After the retirement of Russell in 1969, the Celtics entered a period of rebuilding. Led by center Dave Cowens and point guard JoJo White, the Celtics returned to championship caliber, winning two NBA titles in 1974 and 1976. The Celtics again returned to dominance in the 1980s. Led by the "Big Three" that featured Larry Bird, Kevin McHale, and Robert Parish, the Celtics won the 1981, 1984, and 1986 championships. After winning 16 championships throughout the 20th century, the Celtics, after struggling through the 1990s, rose again to win a championship in 2008 with the help of Kevin Garnett, Paul Pierce, and Ray Allen in what was known as the new "Big Three" era. The Celtics returned to the NBA Finals in 2010, only to lose to the Lakers in a seven-game series.

By the start of the 2013 season none of the "Big Three" were still signed - Ray Allen having already left a season prior - ushering in a new era for the team. With the help of newly hired head coach Brad Stevens, the team began rebuilding. In his second season, Stevens led the Celtics on a return to the playoffs in 2015. During the following season, the Celtics clinched the top seed in the Eastern Conference, but were eliminated in the Conference Finals. This prompted an aggressive rebuild in 2017, where the team acquired All-Stars Kyrie Irving and Gordon Hayward.[13] However, the pair struggled with injuries throughout the 2017–18 season, and the team was again defeated in the Eastern Conference Finals, despite pushing the Cleveland Cavaliers to seven games.

Why do you think we do mental accounting?

Mental accounts are believed to act as a self-control strategy. People are presumed to make mental accounts as a way to manage and keep track of their spending and resources. People also are assumed to make mental accounts to facilitate savings for larger purposes

Explain the House Money effect that comes from mental accounting

What Is the House Money Effect? ... This effect presumes that some investors will increase their risk in a given trade by the use of mental accounting when they perceive they are risking money they didn't have previously, but have gained through their interaction with the market.

How does this impact financial decision making in the stock market?

The impact of behavioural factors on decision-making is often ignored by individual investors, and this hampers the performance of their investment in stock market. ... Investors fall prey to their own and sometimes others' mistakes due to the use of emotions in financial decision-making