Reading 7: Heuristic-Driven Bias: The First Theme －LOS a making, impact, including, investment

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CFA Institute Area 3-5, 7, 12, 14-18: Portfolio Management
Session 3: Behavioral Finance
Reading 7: Heuristic-Driven Bias: The First Theme
LOS a: Evaluate the impact of heuristic-driven biases on investment decision making including representativeness, overconfidence, anchoring-and-adjustment, and aversion to ambiguity.

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Which of the following is least likely a heuristic learning process?

A) Research.

B) Trial and error.

C) Experimentation.

D) Experience.

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Answer and Explanation

Trial and error, experimentation, and personal experience are heuristic learning processes. Heuristic learners pick up information simply, through their own efforts or from sources simple to access. They don't do research.

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Which of the following steps is least likely to be included in the process of developing heuristic-driven bias?

A) Making mistakes.

B) Receiving bad advice.

C) Reliance on rules of thumb for investment decisions.

D) Developing investment principles through personal experience.

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Answer and Explanation

The process of developing heuristic-driven bias starts with developing investment principals through experience, followed by reliance on heuristics (rules of thumb) to make decisions. At this point, imperfect heuristics start to sway investment decisions, and investors make errors. Bad advice can contribute to all of these steps, but it is not a part of the development of heuristic-driven bias.

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Martina Blackwood has not been doing well with her investments. She consults Ben Haifen, CFA, for some advice. Which of Haifen's following statements indicates that Blackwood has a heuristic-driven bias?

A) Blackwood tends to hold onto her losers too long.

B) Blackwood's most valuable lessons were learned through her own mistakes.

C) A lack of accounting knowledge makes it difficult for Blackwood to effectively evaluate stocks.

D) Blackwood doesn't like fixed-income investments because she doesn't understand them.

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Answer and Explanation

Blackwood developed her investment style through trial and error, learning from her own mistakes. This is a sign of heuristic-driven bias. The other statements could be true of many types of investors who are not bound by heuristic-driven bias.

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