Behavioral Finance

CFA Level III
#1

In the 2012 AM exam, Q4, there are 3 diagnostic questions given, asking the candidate to identify what bias will it likely reveal.

Biases could be : Anchoring, Hindsight, Regret Aversion, Representativeness and Status Quo

Here is the statement i am confused about:

Would you sell a recent equity investment following a management announcement of a significant decline in the expected growth rate of revenue?

I believe this could reveal a representativeness bias, since it would reveal that the client is disproportionately assigning more importance to the recent decline in prices.

Answer says, anchoring.

#2

If he does not sell it reveals anchoring i guess because he stays attached to the old forecast value ignoring the new one?

#3

Yeah, the justification from CFAI is similar, but doesn’t representativeness seem like the more appropriate choice?

#4

it can be both but the problem is representativeness bias has two forms.

#5

Representativeness might make sense if he does sell I could see your point. If he does not sell it wouldn’t make sense. I can’t quite tell from your original post as to whether he took action or not.

#6

In the question, these statements are framed as diagnostic questions, aimed at figuring out if the client exhibits any of these biases. So based on what the client answers, you will form your opinion about his bias. Makes sense?

#7

Edbert, i understand what you are saying. Do you think anchoring is a better answer?

#8

In my opinion, the most painful part this BF.

#9

Agree I thought representativeness as well… I think the answer would reveal either this or anchoring depending on client’s action.

#10

Flashback - i couldn’t agree more.

Moonborne - Thank you, i can only hope CFAI agrees with my reasoning in the paper.

#11

Representative bias is assigning things into categories and falsely putting weights on the things based on what you think about those categories. For example, X is a dividend stock, therefore I assign prob weight/return characteristics to X based on what I think of dividend stocks.

Anchoring is putting undue weight on some initial number. In the example: “Would you sell a recent equity investment following a management announcement of a significant decline in the expected growth rate of revenue?” It can’t be representative bias as there is nothing to assign into a group or category. It cannot be hindsight, status quo, regret aversion. It can only be anchoring as there is some initial number to anchor - the original expected growth rate of revenue.