prashantsahni

Which of the following best exemplifies the structure of a committee that effectively makes decisions?

A) The committee members get along well and there is little animosity or in-fighting between the committee members.

B) The committee members are encouraged to speak out so different opinions are heard.

C) The committee is comprised of individuals from different backgrounds and where the committee chair encourages people to voice their opinions even if it is contrary to the group’s view.

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Effectively functioning groups would have the following features:

• Be comprised of individuals with diverse backgrounds.
• Have members who are not afraid to express their opinions even if it differs from others.
• Have a committee chair that encourages members to speak out even if the member’s views are contrary to the group’s views.
• A mutual respect for all members of the group.

prashantsahni

Which of the following would least likely be viewed as rational behavior during a market bubble?

A) Investors believe the price of a stock will continue to go up therefore they buy more.

B) The investor knows she is in a bubble but she doesn’t know where the peak is.

C) A real estate portfolio manager has no suitable alternative investments to switch to.

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Financial bubbles and subsequent crashes are periods of unusual positive or negative returns caused by panic buying and selling, neither of which is based on economic fundamentals. The buying (selling) is driven by investors believing the price of the asset will continue to go up (down).
In bubbles, investors sometimes exhibit rational behavior—they know they are in a bubble but don’t know where the peak of the bubble is. Or, there are no suitable alternative investments to get into, making it difficult to get out of the current investment. For investment managers, there could be performance or career incentives encouraging them to stay invested in the inflated asset class.

prashantsahni

When an investor extrapolates past data from a small sample size into a forecast this is most likely indicative of:

A) fear of regret.

B) the recency bias.

C) hindsight bias.

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Herding is when investors trade in the same direction or in the same securities, and possibly even trade contrary to the information they have available to them. Two behavioral biases associated with herding are the availability bias (a.k.a. the recency bias or recency effect) and fear of regret. In the availability bias, recent information is given more importance because it is most vividly remembered. It is also referred to as the availability bias because it is based on data that are readily available, including small data samples or data that do not provide a complete picture. In the context of herding, the recent data or trend is extrapolated by investors into a forecast.
Regret is the feeling that an opportunity has passed by and is a hindsight bias. The investor looks back thinking they should have bought or sold a particular investment (note that in the availability bias, the investor most easily recalls the recent positive performance). Regret can lead investors to buy investments they wish they had purchased, which in turn fuels a trend-chasing effect. Chasing trends can lead to excessive trading, which in turn creates short-term trends.

prashantsahni

Which of the following would least likely be considered a market anomaly?

A) Underperformance of stocks with relatively high PE ratios or low book-to-market values.

B) The stock market continues to climb as investors are trading according to economic expectations.

C) Bubbles and crashes.

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Typically, in a bubble, the initial behavior is thought to be rational as investors trade according to economic changes or expectations. Later, investors start to doubt the fundamental value of the underlying asset, at which point the behavior becomes irrational.
Two anomalies discussed by Fama and French are associated with value and growth stocks. Value stocks have low price-to-earnings ratios, high book-to-market values, and low price-to-dividend ratios, with growth stocks having the opposite characteristics of high PE ratios, low book-to-market values, and high price to dividend ratios.
Financial bubbles and subsequent crashes are periods of unusual positive or negative returns caused by panic buying and selling, neither of which is based on economic fundamentals. The buying (selling) is driven by investors believing the price of the asset will continue to go up (down). A bubble or crash is defined as an extended period of prices that are two standard deviations from the mean. A crash can also be characterized as a fall in asset prices of 30% or more over a period of several months, whereas bubbles usually take much longer to form.

prashantsahni

After Polly Shrum sells a stock, she avoids following it in the media. She is afraid that it may subsequently increase in price. What behavioral characteristic does Shrum have as the basis for her decision making?

A) Representativeness.

B) Fear of regret.

C) Anchoring.

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Shrum refuses to follow a stock after she sells it because she does not want to experience the regret of seeing it rise. The behavioral characteristic used for the basis for her decision making is the fear of regret.