Reading 12: The Folly of Forecasting: Ignore All Economists continue, previous

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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 c: Explain why forecasts may continue to be used when previous forecasts have been inaccurate.

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According to behavioral finance, investors continue to depend on forecasts even when previous forecasts have been inaccurate. Which of the following best explains this, from a behavioral finance viewpoint?

A) Investors recognize that some imperfections exist in forecasts, but that they still provide some value.

B) Investors feel a need to justify their decision.

C) Although forecasts can sometimes be inaccurate, they are still unbiased.

D) The forecasts are validated by the media.

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Answer and Explanation

According to behavioral finance, investors continue to depend on forecasts even when they have been inaccurate because they need an expert to justify a decision they have made. Although there is an element of truth in some of the other responses, they are not the best explanation in this case, according to behavioral finance.

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Paula Goodyear has been investing her own funds for the past three years. As part of her strategy, she listens to economic and market experts every morning on her favorite financial news show. Lately however, the forecasts provided by the experts have been incorrect. According to behavioral finance, which of the following is her most likely future behavior? Goodyear will:

A) change investment strategies.

B) keep using the experts forecasts.

C) switch to print media for advice.

D) reallocate to safer assets to avoid uncertainty.

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Answer and Explanation

According to behavioral finance, investors will continue to depend on forecasts even when they have been inaccurate because they need an expert to justify a decision they have made. So Goodyear will continue to depend on the experts forecasts. Although there is an element of truth in some of the other responses, they are not the best description of her future behavior, according to behavioral finance.

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According to behavioral finance, investors continue to depend on forecasts even when previous forecasts have been inaccurate. Which of the following behavioral finance concepts is most closely related to this behavior?

A) Overconfidence.

B) Anchoring.

C) Cognitive dissonance.

D) Representativeness.

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Answer and Explanation

According to behavioral finance, investors will continue to depend on forecasts even when the forecasts have been inaccurate because they need an expert to justify a decision they have made. This is related to anchoring because when faced with uncertainty, investors will grab hold of something for security.

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