Behavioural Biases

CFA Level III Portfolio Management
#1

Roger Wong is a financial advisor at SCI. Wong has been assigned the responsibility to

work with Jasmine Arcus, a 35-year old successful entrepreneur who owns a fashion

boutique in Chicago, USA. Arcus has an investment portfolio worth $5,000,000 that is

invested 55% is stocks, and 45% in bonds. She manages to make an annual profit from

her boutique that comfortably covers her living expenses and also contributes to her

savings. Arcus is convinced about the future prospects of the U.S. automobile sector and

has invested 25% of her equity allocation in automobile stocks. When Wong suggested

diversifying part of the holding due to a deterioration of the industry’s fundamentals,

Arcus disagreed, and stated that his predictive model validated the industry’s positive

outlook. Arcus also mentioned that most of the companies within the auto industry had

high P/E multiples which confirmed that her investment in the industry is of good value.

When Wong asked her how she gathered the information about the P/E multiples, Arcus

mentioned that she read in most of the best selling financial journals about how high P/E

multiples for companies within the industry prove that their stocks have growth potential

and can yield high returns for investors.

C. Determine whether to adapt to, moderate, or adapt to and moderate Arcus’s biases and justify your response

#2

moderate and adapt due to : Low standard of living risks + dominant cognitive biases

#3

Thats the correct answer, but I do not understand why it is necessary to adapt given the fact that the bias is cognitive and therefore can be addressed and the standard of living risk is low. What I am missing?

#4

to moderate : means to recognise the bias and seek to reduce/eliminate it.

to adapt : means to recognise the bias and accept it without moderation.

…perhaps,the richer you are the more you can afford to NOT moderate your biases because you can accept the bias without much negative consequence to your standard of living…if you are poor (like me :P) and you have loads of biases, you can’t afford to just adapt&accept,you would want to moderate it to prevent negative consequences…

don’t know if this is true though!

#5

ya, if you were rich enough, you dont need to give a sht about what your adviser says!

lol

#6

yes, Aracus is showing cognitive errors mainly conservatism (When Wong suggested diversifying part of the holding due to a deterioration of the industry’s fundamentals,Arcus disagreed, and stated that his predictive model validated the industry’s positive outlook.) & confirmation ( Arcus also mentioned that most of the companies within the auto industry had high P/E multiples which confirmed that her investment in the industry is of good value.) . Also framing i guess (When Wong asked her how she gathered the information about the P/E multiples, Arcus mentioned that she read in most of the best selling financial journals about how high P/E multiples for companies within the industry prove that their stocks have growth potential and can yield high returns for investors.)

His level of wealth is high & standard of living risk is low. As per four axes given in book he lies in North-West. So moderate & adapt in the range of plus minus 5-10%.

#7

rahuls, i would have pegged it to anchoring&adjustment rather than conservatism though because we are talking abt estimates rather than beliefs…?

#8

Anchoring & adjustment is a information processing bias where you process the information around your anchor & adjust your estimates numbers little down/upward. In conservatism you may underreact or fail to incorporate new info. May be coz cognitive cost is high Here Arcus has fully disregarded the new info. I could be wrong though…

#9

ok