Behavioral Finance Finals

Ambiguity Aversion Bias

competence effect — Here, investors presented with an uncertain probability distribution might be expected to display caution. However, judging themselves competent in some pertinent realm (e.g., foreign stocks, small company stocks, etc.), these investors actually accept more risks than they should.

subjective utility theory vs expected utility theory

People do not like to gamble when probability distributions seem uncertain. In general, people hesitate in situations of ambiguity, a tendency referred to as ambiguity aversion.

may cause investors to demand higher compensation for the perceived risks of investing in certain assets. Thus, the investors may hold only conservative investments, which can cause the potential to outlive an asset base, purchasing power erosion, and other consequences.

may restrict investors to their own national indexes

Endowment bias

inconsistent with standard economic theory, which asserts that a person’s willingness to pay for a good or an object should always equal the person’s willingness to accept dispossession of the good or the object, when the dispossession is quantified in the form of compensation

value an asset more when they hold property rights to it than when they don’t

ex: investors to hold onto securities that they have inherited, regardless of whether retaining those securities is financially wise. This behavior is often the result of the heirs’ fear that selling will demonstrate disloyalty to prior generations or will trigger tax consequences.

Self Control Bias

human behavioral tendency that causes people to consume today at the expense of saving for tomorrow.

life-cycle hypothesis (Shefrin & Thaler)

wealth is assumed to be divided into three “mental” accounts: (1) current income, (2) current assets, and (3) future income. The temptation to spend is assumed to be greatest for current income and least for future income.

The propensity to consume is greatest from the current income account, while sums designated as future income are treated more conservatively.

optimism bias

inside view vs outside view

Daniel Kahneman and Daniel Lovallo note a tendency of investors to adopt an inside view, in lieu of the outside view that is often more appropriate when making financial decisions

inside view: focuses on a current situation and reflects personal involvement

outside view: dispassionately assesses a current situation in the context of results obtained in past, related situations

mental accounting bias

refers to the propensity for people to allocate money for specific purposes.

(1) current income, (2) current assets, and (3) future income

confirmation bias (under self-deception)

selective perception that emphasizes ideas that confirm our beliefs, while devaluing whatever contradicts our beliefs.

all-too-natural ability to convince ourselves of whatever it is that we want to believe

hindsight bias

“I knew it all along!” Once an event has elapsed, people afflicted with hindsight bias tend to perceive that the event was predictable—even if it wasn’t.

loss aversion bias

developed by Daniel Kahneman and Amos Tversky in 1979

In other words, the pain experienced from a loss of P5,000 is felt more sharply than the pleasure experienced from a gain of P 5,000.

the value function is steeper for losses than for gains

recency bias

primacy effect vs recency effect

causes people to more prominently recall and emphasize recent events and observations than those that occurred in the near or distant past.

primacy: The first items inscribed in a given session onto this hard drive are more precisely retained and are easier to access than items inscribed later on.

recency: subjects recall items appearing toward the end of the tobe-remembered list better than they remember items appearing in the middle.

subject heard most recently are more likely to persist in short-term memory than previous, “older” items that have been discarded

regret aversion bias

individuals avoid making decisions that they believe might lead to regret. This bias can result in indecision, risk aversion, and overly cautious behavior, as people often prioritize avoiding potential regret over making rational choices.

tendency to hold onto losing investments too long, while selling winners too soon.

framing bias

The decision frame refers to how a decision maker views a problem. The perception of a problem depends not only on the presentation but also on the characteristics of the decision maker.

people alter their perspectives on money and investments according to the surrounding circumstances that they face

status quo bias

familiarity = safe and lower risk

coined by William Samuelson and Richard Zeckhauser

operates in people who prefer for things to stay relatively the same.

reflexive

Going with your gut, which is effortless, automatic and, in fact, is our default option

reflective

Logical and methodical, but requires effort to engage in actively

strategies for individual investors

1. 1. understand bias

2. 2. be aware why u should save/invest

3. 3. quantify investment criteria

4. 4. diversify

5. 5. control one’s investment environemnt

6. 6. understand that underperformance shldnt be anathema

how to overcome behavioral bias

1. 1. manage emotions

2. seek contrary opinions

3. be a “renter” not owner

4. don’t chase yesterday’s winner

5. beware of crowded trades

6. pay more attention to detailed analysis than stories

padala/family-first culture

• utang na loob and collectivist culture

• role of family breadwinners

• emotional decision-making over financial planning

convervatism vs yolo

avoids risk entirely vs takes excessive risk

keeps money idle vs invests w/o research

fear driven vs excitement-driven

gap between financial literacy and financial behavior

knowing vs applying

emotional and social factors > logic

financial literacy alone does not guarantee good financial behavior

influence of subjective norms

decisions influenced by expectation of others

filipino tendency toward conformity and social acceptance

bahala na culture

present enjoyment > future security

delaying insurance, savings, and retirement planning

digital lending and instant gratification

rise of online lending apps; BNPL

convenience-driven borrowing behavior

scam mentality and easy money culture

attraction to unrealistic returns

trust based on relationships instead of due diligence

College Assurance Plan

• stardted in 1980

• pre-need educational plan

• “guaranteed” tuition fee

axie infinity

• play to earn crypto game

• massive popularity during pandemic

• many quit jobs to play full-time