Reading 12: The Folly of Forecasting: Ignore All Economists control, knowledge

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CFA Institute Area 3-5, 7, 12, 14-18: Portfolio Management
Session 3: Behavioral Finance
Reading 12: The Folly of Forecasting: Ignore All Economists, Strategists, and Analysts
LOS a: Explain how the illusions of knowledge and control lead expert forecasters to be overconfident in their forecasting skills.

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Which of the following best characterizes overconfidence in expert forecasters, according to behavioral finance? Expert forecasters are overconfident in their forecasting ability because:

A) of the positive reinforcement they receive from the media.

B) they feel their knowledge allows them to make more accurate forecasts.

C) they think market inefficiencies persist through time.

D) they have access to information others do not.

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Answer and Explanation

According to behavioral finance, expert forecasters are overconfident in their forecasting ability because they feel their knowledge allows them to make more accurate forecasts. Because they believe their forecasts are based on skill, they blame some external factor when the forecasts turn out incorrect. Although the other responses may have some real world validity, they are not given as a reason for overconfidence, according to behavioral finance.

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Which of the following concepts can explain overconfidence in expert forecasters, according to behavioral finance?

A) Emotional detachment.

B) Information disassimilation.

C) Asymmetric beliefs.

D) Cognitive dissonance.

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Answer and Explanation

According to behavioral finance, expert forecasters are overconfident in their forecasting ability due to cognitive dissonance. Cognitive dissonance states that individuals will avoid information (reflecting what has been actually experienced) that is in disagreement (dissonance) with the individuals perceived ability of himself or herself. As a result, experts will have limited recollection of their failures.

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Which of the following best characterizes overconfidence in expert and non-expert forecasters, according to behavioral finance? Expert forecasters are:

A) less overconfident than non-experts because their training has informed them of the difficulties in forecasting.

B) more overconfident than non-experts because they believe their knowledge and skill allows them to make better forecasts.

C) less overconfident than non-experts because they keep more accurate records of the outcome of their forecasts.

D) more overconfident than non-experts because they believe their access to company officers allows them to make better forecasts.

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Answer and Explanation

According to behavioral finance, expert forecasters are more overconfident in their forecasting ability than non-experts because they believe their knowledge and skill allows them to make better forecasts. Although it is true that they often have unique access to company officers, this is not mentioned as a factor for overconfidence by behavioral finance theory.

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