Question

There are over 30 terms categorized into Behavioral Finance and Body of Knowledge:

1) cognitive biases,

2) emotional biases,

3) effects,

4) aversions and

5) other key terms.

In 500-1,000 words, discuss one to three of the terms above. For each term try to include a discussion about

1) how the problem becomes known or visible (manifestation),

2) why it can hurt investing or financial decisions, and

3) solutions to minimize its impact.

If you can provide citations, that would be great! Otherwise, don't worry about it

Answer 1

COGNITIVE BIAS

A cognitive bias is a systematic pattern of deviating from rationality.It causes us to be irrational in the way we search for , evaluate,interpret,judge,as well as in the way we make decisions.

Some common forms of cognitive bias are :-

i)overconfidence bias

ii)self serving bias

iii)Narrative fallacy-it is limited ability to look into facts without weaving an explanation into them.

iv)confirmation bias-tendency to recall information in a way that confirm one's prior beliefs or values

Biases distort and disrupt decision making process by introducing influences.Decison making is a cognitive activity that me rational or irrational.Decisions are often weighed against a set of needs and augmented by individual preferences.In finance cognitive bias can lead toignore evidence that indicate their strategies may lose causing them to behave overconfidently.

Cognitive bias may lead to take decisions based on past events and may also lead them to underestimate risks and have greater difficulty adjusting to negative events.

steos to reduce cognitive bias are:-

i)consider alternatives- always consider the various alternatives before taking the decision based on overconfidence or previous beliefs.

ii)Accepting errors- The best way to reduce bias is to accept the mistakes or error done and learn from them and use such experience in the future to benefit from it.

iii)Develop insight and awareness-Businesses are never immune to risk. we must invest time in reflecting the actual conditions

EMOTIONAL BIAS

Emotional bias occurs spontaneously based on personal feelings at the time of decision making.They may not always be errors,sometimes it may help them to make a more protective and better decision.

some common forms of emotional bias are :-

i)Reluctant to accept hard facts that are unpleasant and give mental suffering.

ii)o attribute negative judgements to neutral events.

iii)To attribute positive judgments to events that are contrary in nature.

Emotional bias may lead an investor to hang onto an investment that is nolonger beneficial.Anxiety about an investment increases the amount of perceived risk and reduces the amount of risk tolerance.Investors have a preference for particular or familiar investment despite the obvious gains from diversification.

Ways to reduce emotional bias are:-

Questioning others and oneself is the best way to look for answers for pertaining problems.

Challenge yourself at times of decision making rather than contunuing with the same old solutions.

Use empathy and intelligence to make decisions free from judgement.