Question

Describe briefly the following terms found in research on behavioural finance:

(i) mental accounting

(ii) Recency effect

(iii) myopic loss aversion

(iv) framing

(v) confirmation bias

Answer 1

(i) Mental accounting - This is a bias considered in behavioral finance where the investor categorizes the money into different buckets ( ie different mental accounts). There can be different criteria for making the buckets or categorization. For eg. If a person keeps aside $ 5 for renting movies for every weekend. But he loses the money. So in this canrio most of the people would consider renting movie as they will mental account this as loss from total budget and not renting movie budget.

(ii) Recency effect - Recency effect refers to bias where recent information is given more weightage due to time of event rather than earlier happened event. This will have a impact on the judgement taken on the basis of time of events.

(iii) Myopic loss aversion - Myopic loss avaersion is a bias where loss averse investor have double the  pain in loosing money rather than the happiness they would have gained with gain of same amount. The investors takes a very short term view of the investment.

(iv) Framing - Framing baias means people behave on the basis of how information is presented rather than the information themselves. This is an example of cognitive bias.

(v) Confirmation bias - In this bias people tend to find information or facts which support their decision or belief rather than seeing the whole scenario. Hence the decision will be alwasy beased on selective data which the decsiion maker choses. Only those information which is confirming his beliefs will taken rest all be disregarded.