Reading 14: Alpha Hunters and Beta Grazers －LOS a, (Part 2) behavioral, factors

cfaedu

CFA Institute Area 3-5, 7, 12, 14-18: Portfolio Management
Session 3: Behavioral Finance
Reading 14: Alpha Hunters and Beta Grazers
LOS a, (Part 2): Describe the behavioral factors (such as convoy behavior, Bayesian rigidity, price-target revisionism, and the ebullience cycle) that may give rise to chronic inefficiencies.

cfaedu

According to behavioral finance, investors have biases that result in chronic inefficiencies in the market. In this view, which of the following is the most likely scenario? When a stock rises in price above the investors original target price, the investor will:

A) revise the price target upwards, buy more shares, and incur more risk.

B) revise the price target upwards, subsequently sell shares, and reduce risk.

C) sell shares to reduce risk.

D) hold the price target steady and sell shares only if the stock drops in price.

---

Answer and Explanation

In the price target revision bias, when a stock rises in price above the investors original target price, the investor will revise the price target upwards, buy more shares, and incur more risk. The investor may do so because of overconfidence. If the stock price has declined, the investor may assume that the rest of the market is wrong instead of themselves, and not revise their target price.