2021年CFA三级 - Behavioral Finance

2021年CFA三级Behavioral Finance思维导图分享，供广大CFA三级备考同学参考，如有差错，请随时指正，谢谢。

Behavioral Finance Perspective

• Traditional VS Behavioral Finance
  • TOP 7
  • 4 Axioms
    • Completeness
    • Transitivity
    • Independence
    • Continuity
  • REM
    • Rational Economic Men - perfect rationality
  • Risk Aversion
    • risk aversion VS 3 types of risk appetites
  • Limitations
    • decision-making is flawed by lack of information or flaws
    • individuals not process all informtions availabe to them
    • conflict that prioritize short-term (spending) goals over long-run (saving) goals
    • lack of perfect knowledge
    • people not perfectly self-interest
    • wealth utility not always concave
• Utility Theory & Prospect Theory
  • Utility Theory
    • Indifference Curve
    • complex risk functions
  • Decision Theory
    • de: make ideal decision when the decision maker is fully informed, mathematically able and rational
    • Bound Rationality
      • knowledge capacity limit
      • remove assumption of perfect information
      • not fully rational decision-making
      • not consistent utility maximization
      • satisficing
  • Prospect Theory
    • prospect theory = people view loss and gains differently, thus make decision based on perceived gains -> loss aversion
    • release risk aversion + impose loss aversion
    • 2 stages
      • Editing Phase
        • Codification
          • assign probability to each possible outcomes
        • Combination
          • combine identical values
        • Segregation
          • segregate values into both risk-free and risky returns
        • Cancellation
          • remove outcomes common to 2 proposal
        • Similification
          • apply to very small differences in probability + highly unlikely outcomes
        • Detection of Dominance
          • proposal clearly dominant
        • Isolation Effect
          • focus on one outcome/factor but ignore others
      • Evaluation Stage
        • probability-weighted outcome to determine expected utility
        • S-shape value function -> disposition effect
• Traditional Finance Impact on Market
  • Efficient Market Hyphothesis
  • • technical analysis features, e.g. resistence level or floor level, are examples of weak-form efficient violation
• Behavioral Finance Perspective
  • Consumptions & Savings
    • mental accounting + framing bias
    • wealth = current income + current assets + NPV of future income
    • less to spend from current assets/future wages + more from current income
  • Behavioral Asset Pricing
    • sentiment premium
      • estimated by the dispersion between different analyst' forecast
        • 是用不同的analyst之间观点的差异程度进行衡量的，而不是预测与实际之间的差异。
  • Behavioral Portfolio Theory
    • construct portfolio in layers, with different risk and expectations
    • Five-factor process
      • 1. allocate each goal into layers based on importance
      • 2. allocate assets into layers
      • 3. number of assets reflect investor's risk aversion
      • 4. concentrated position for information advantage
      • 5. risk averser will hold large cash position
  • Adaptive Market Hypothesis
    • investor satisfice to survive in the market, rather than utility maximization
    • 5 conclusions
      • 1. relationship of risk and return is unstable
      • 2. active management can find opportunities to exploit
      • 3. no strategy can work all the time
      • 4. adaptive and innovation are essential to continue
      • 5. survivors change and adapts

Behavioural Finance 2 - The Behavioral Biases of Individuals

• Cognitive Bias
  • TOP 2
  • Features
    • Fault reasoning, statistical, information-processing or memory errors
    • Easy to correct
  • Categories
    • Belief perseverance - cling to previous belief irrationally/illogically
      • 1. Conservative Bias
        • Conserative Bias -> focus on relate new information to old one Anchoring and adjustment Bias -> stick on initial number
        • Definition
          • maintain prior forecast/view by inadequately incorporating new information
          • overweight previous belief + underweight new information
        • Consequences
          • maintain/slow to update view/forecast
          • opt to maintain prior belief due to difficult in processing new information
        • Mitigations
          • aware the bias
          • conduct careful analysis incorporate new information + respond properly
      • 2. Confirmation Bias
        • Definition
          • look for/notice what confirms belief + ignore/undervalue what contradicts
        • Consequences
          • consider positive information + ignore negative
          • develop screening criteria + ignore contradicts
          • under-diversify portfolios
          • hold disproportionate investment assets in employing company's stock
        • Mitigations
          • actively seek information challenges belief
          • corroborating support for investment decisions
      • 3. Representativeness Bias
        • Definition
          • tend to process new information based on past experiences and classification
        • Types
          • Base-Rate Neglect
            • base rate/probability of the categorization is not adequately considred
          • Sample-Size Neglate
            • believe small size is representative of populations
        • Consequences
          • adopt view/forecast exclusively based on new information/small samples
          • using simple classification, but not analyze complex data
        • Mitigations
          • aware statisical mistakes + check whether overlook reality
          • invest in diverisified portfolios + stick to it
          • check the probability + always ask questions
        • 备注
          • 此处representative bias和利用historical data做regression中的不同，此处更侧重于利用最近比较easy理解的信息用于判断
      • 4. Illusion of Control
        • Defintion
          • people believe they can control/influence outcomes when they actually cannot
        • Consequences
          • trade more than prudent
          • investment in inadequately diversfiied portfolios
            • e.g. invest in employer's company stock
        • Mitigations
          • aware investment cannot be controlled by them
          • seek contraditory viewpoints
          • keep records of transactions to remind yourself
          • keep rational
      • 5. Hindsight Bias
        • 回顾偏差-回顾的时候觉得已经发生的事情是高概率的
        • Definition
          • see past events predictable and reasonable to expect
        • Consequences
          • overestimate the degree to which they predict investment outcome + false sense of confidence
          • cause financial decision maker unfairly assess money manager/security performance
        • Mitigations
          • aware the bias + ask questions whether honest about self
          • record and examine investment decisions + avoid make repeated mistakes
          • remind to assess performance via benchmarks
    • Processing errors - use information irrationally/illogically in financial decision making
      • 1. Anchoring and Adjustment Bias
        • Definition
          • start with a initial default number (anchor) + inadequate adjustment on new information
        • Consequences
          • stick to original estimate when new information occurs
        • Mitigations
          • aware the bias + ask questions
            • e.g. whether based on rational analysis or just achor?
          • remeber past event/price cannot predict future
      • 2. Mental Accounting Bias
        • Definition
          • treat same amount of money differently
        • Consequences
          • strucutre portolios in layers + make investment in discrete bucket without consider asset correlation
          • neglect opportunities to reduce risk by combining assets with low correlation
          • irrationally distinguish return from income and capital appreciation
        • Migitations
          • aware the bias - correlation is not taken into account when construct the overall portfolio
          • go through all summary documents and investment assets to see the true asset allocation
          • treat income and capital appreciation differently + focus on overall returns
      • 3. Framing Bias
        • Definition
          • people answer questions differently based on the way it is asked
        • Consequences
          • willingness to accept risk is influenced by how situations are presented/framed
          • misidentify risk torelance
          • choose suboptimal investments
          • focus on short-term price fluctuation -> excessive trading
        • Mitigations
          • ask questions whether focus net gain or net loss
          • be neutral and open-minded when interpreting investment related situations
      • 4. Availability Bias
        • Definition
          • people take a rule of thumb/mental shortcut approach to estimate the probability of an outcome based on how easily the outcome comes to mind
        • Types
          • Retrievability
            • choose the first answer come to the mind as correct one
          • Categorization
            • people gather information from what they perceive as relevant search set, e.g. familiar category
          • Narrow Range of Experience
            • use too narrow a frame of reference based upon that experience when making an esitimate
          • Resonance
            • baised by how closely a situation parallels their own personal situtaions
        • Consequences
          • make choice based on advertising not analysis
          • limit investment opportunity set based on familar classfication schemes
          • fail to diversify -> based on narrow range of experience
          • fail to achieve an appropriate asset allocation
          • over-react to recent market conditions
        • Mitigations
          • develop appropriate investment policy strategy
          • carefully research and analyze investment decisions
          • focus on long-term result
• Bias Mitigation
  • Relative Wealth
    • the higher the level of wealth -> the more could adapt to client's bias
  • Standard Living Risk
    • the higer SLR -> the more client's bias should be moderated
  • Deviation from Goal-Based Model
• Emotional Bias
  • Features
    • Reasoning influenced by feelings, impulse, intuition
    • Recognize and adapt
  • Categories
    • 1. Loss-Aversion Bias
      • Definition
        • strongly prefer avoid loss than achieve gains
        • Myopic Loss Aversion 短视损失厌恶
      • Consequences
        • Disposition Effect
          • hold loss asset too long + gains asset too fast
        • limit the upside potential -> via disposition effect
        • trade excessively for gains + trade less for loss
        • hold riskier assests than objectives/returns
      • Mitigations
        • disciplined approach to investment based on fundamental analysis
        • consider probability of future losses and gains to make rational decisionss
    • 2. Overconfidence Bias
      • Definition
        • demo unwarranted faith in their own intuitive reasoning, judgements, objective ability
      • Types
        • Prediction Overconfidence
          • assign too narrow confidence interval to investment predictions
        • Certainty Overconfidence
          • assign too high probability to outcomes when make judgement
      • Casues
        • Illusion of Knowledge
        • Self-attribution
      • Consequences
        • underestimate risk + overestimate expected returns
        • hold poorly diversified portfolios
        • trade excessively
        • experience lower return than market
      • Mitigations
        • keep transaction record + analyze investment returns -> to acknowledge losers
        • be objective when make investments
        • conduct post-investment analysis on successful/unsuccessful investments
    • 3. Self-control Bias
      • Definition
        • people fail to act in pursuit of their long-term, overarching goals, due to lack of self-control
      • Consequences
        • save insufficiently
        • accept too much risk to pursue higher returns
        • imbalance asset allocation
      • Mitigations
        • proper investment plan
        • have personal budget
    • 4. Status Quo Bias
      • 安于现状
      • Definition
        • unwilling to change + do nothing
      • Consequences
        • unknowlingly maintain portfolios with inappropriate risk characteristices
        • fail to explore other opportunities
      • Mitigations
        • education
        • quantify benefits of diversificiation/proper asset allocation
    • 5. Endowment Bias
      • Definition
        • people value the asset more when they hold it
      • Consequences
        • fail to sell and replace certain assets
        • maintain inappropriate asset allocation
        • continue to hold familar assest
          • e.g. inherent assets
      • Mitigations
        • review other unfamiliar assets and accept them
        • ask self whether the same amount of money can achieve better return in other investment
    • 6. Regret-Aversion Bias
      • Definition
        • avoid to make decisions will result in action out of fear + decision will turn out to be poor
      • Types
        • Error of Commission
          • regret for taking action
        • Error of Omssion
          • regret for not taking action
      • Consequences
        • too conservative due to past poor returns on risky investment
        • herding behaviour
      • Mitigations
        • education
        • quantify benefits of diversificiation/proper asset allocation

Behavioral Finance and Investment Processes

• understand impact and implication of BF on all aspects of investment
• Behavioral Models
  • TOP 1
  • Barnewall two-way behavioral model
    • passive investor
      • de: not risk own capital to gain wealth
      • risk averse + need more security
    • active investor
      • de: risk own capital to gain wealth + take active role in investment
      • less risk averse
      • gather large amount of information to obtain control -> easy lead to overconfidence
  • BB&K five-way model
    • confidence
    • methods of action
  • Pompain model
    • 4-step process to go through investors' BIT
    • BIT - Behavioral Investment Types
      • closer efficient frontier -> other common sense benefits
    • limitations
      • inappropriate to classify investors via emotional/cognitive -> as they are the same
      • traits of more than one behavioral investment types
      • behavioral may change
      • same BIT should be treated as the same, due to unique personal circumstance
      • investor act irrationally at unpredicatable times
• Advisor-Client Relationship
  • Goal
    • to construct a portfolio for client comfortable to stay in the long run
  • Measurement of successful relationship
    • advisor understand long-term financial goals of client
    • advisor maintain a consistent approach with client
    • advisor acts as client expects
    • both advisor and client benefit from relationship
  • Limitations of Risk Tolerance Questionnair
    • answer may vary from times due to current circumstance
    • questions are not structured to measure behavioral biases
    • affected by framing of the questions
    • need to update annually/regularly
    • advisor interpret too literally, should act as an indicator of client's risk attitude and required returns
• Portfolio Construction
  • Biases
    • Status Que Bias
      • Target Date Fund
        • auto change asset allocation on target day - glide path
    • Naive Diversification (conditional)
      • e.g. concentration in employer stock
        • familirity + overconfidence + loyalty effect
    • Excessive Trading
      • disposition effect
    • Home Bias
  • Behavioral Portfolio Theory
    • Pyramid Structure
• Analyst Forecast
  • Overconfidence
    • 主要是总结overconfidence如何影响analyst作出错误的forecast判断，结合chapter 2的课本后练习题
    • Self-Calibration
    • prompt, well-structured, systematic feedback
    • develop explicit and unambiguous conclusions
    • document decision/forecast for reasoning
    • systematic review process
    • apprasial by colleagues and supervisors
    • only include comparable data in reasearch to reduce overconfidence
  • Influence by company management
    • Framing
    • Anchoring and Adjustment
      • interprete infomation in systematice and disciplined approach
    • Avalibility
  • Biased Research
    • Causes
      • Confirmation Bias
      • Gamblers' Fallacy
        • 认为一件事情在之前down了之后，之后up的概率会比理论上的概率高
    • Mitigations
      • focus on objective data
      • collect informaiton in systematic way
      • structured research process + clear way of incorporate evidence
      • seek contrary facts and opinions
      • prompt feedback
      • timely document for review
• Investment Committees
  • Social Proof Bias
  • Mitigations
    • diverse background and culture
    • people not afraid to speak up
    • committe chair to encourage others to speak up
    • mutual respect for all members of group
    • collect views before meeting discussion
• Market Behaviors
  • Momentum Effect
    • herding + trend-chasing effect + disposition effect
  • Financial Bubbles and Crashes
    • overconfidence + irrational
  • Value VS Growth
    • halo effect -> representative bias
  • Home Bias