87 The Behavioral Biases of Individuals

• Rex Newman exhibits mental accounting bias by treating wages and bonuses differently when making savings and investment decisions
• Mental accounting bias is viewing money from various sources differently when making investment decisions
• Framing bias is the impact on decisions based on how the data is presented
• Availability bias involves overemphasizing information that is readily available or easily recalled

Cognitive Errors

• Primarily due to faulty reasoning or irrationality

Emotional Biases

• Stem from feelings, impulses, or intuition
• Difficult to overcome and may need to be accommodated
• Cognitive errors are due primarily to faulty reasoning

Anchoring and Adjustment

• A cognitive error related to information processing

Emotional Biases vs. Cognitive Errors

• Loss aversion and status quo are emotional biases
• Anchoring and adjustment is a cognitive error related to information processing

Overconfidence Bias

• May lead to overtrading, underestimation of risk, and lack of diversification

Anchoring Bias

• May cause investors to believe recent highs are rational prices, even as they decline significantly

Fear of Regret

• May keep even skeptical investors in the market when analysis suggests assets are significantly overvalued

Belief Persistence Biases

• include conservatism, representativeness, confirmation, illusion of control, and hindsight biases

Information Processing Biases

• Mental accounting, framing, anchoring and adjustment, and availability

Conservatism Bias

• Refers to failing to change a view as new information becomes available

Confirmation Bias

• Involves seeking out information that supports beliefs while avoiding conflicting views

Hindsight Bias

• Involves selective memory of past events, leading individuals to believe these events were more predictable than they seemed

Cognitive Errors

• Are more likely to be mitigated by information compared to emotional biases

Loss-Aversion Bias

• Arises from feeling more pain from a loss than pleasure from an equal gain -A result is that investors may hold onto positions with the hope of getting even rather than selling the position at a loss

Self-Control Bias

• Occurs when individuals lack self-discipline and favor short-term satisfaction over long-term goals

Availability Bias

-Occurs when putting undue emphasis on information that is readily available, easy to recall, or based narrowly on personal experience or knowledge

Representativeness Bias

• Where investors classify information into the most appropriate subjective category based on "if-then" heuristics

Availability Bias

• Investors estimate future probabilities by how easily they recall a past event

Confirmation Bias

• Investors tend to notice only information that agrees with their perceptions or beliefs

Framing Bias

• Investors view information differently depending on how it is presented

Endowment Bias

• Involves considering an owned asset to be special and worth more than its actual market value

Overconfidence Bias

• Occurs when market participants overestimate their own reasoning

Status Quo and Endowment Biases

• Represent emotional biases

Conservatism, Hindsight, and Framing Biases

• Cognitive errors

Loss Aversion, Self-Control, and Regret-Aversion Biases

• Emotional Biases

Hindsight Bias

• May fuel overconfidence, potentially contributing to asset bubbles
• Behavioral finance has not supplied an overall explanation for the existence of market bubbles