CFA Refresher Readings

 

Behavioral Finance: Study Session 3

Learning Outcome Statements

 

“Heuristic-Driven Bias: The First Theme”

The practitioner should be able to evaluate the impact of heuristic-driven biases on investment decision making including representativeness, overconfidence, anchoring-and-adjustment, and aversion to ambiguity.

 

“Frame Dependence: The Second Theme”

The practitioner should be able to:

• Explain how loss aversion can result in investors’ willingness to hold on to deteriorating investment positions
• Evaluate the impacts that the emotional frames of self-control, regret minimization, and money illusion have on investor behavior

 

“Inefficient Markets: The Third Theme”

The practitioner should be able to evaluate the impact that representativeness, conservatism (anchoring-and-adjustment), frame dependence, and overconfidence may have on security pricing and discuss the implications for market efficiency.

 

“Portfolios, Pyramids, Emotions, and Biases”

The practitioner should be able to:

• Discuss the influence of hope and fear on investors’ desire for security and investment potential
• Explain how portfolios can be structured as layered pyramids and how such structures address needs associated with security, potential, and aspiration
• Evaluate the effects of regret and self-attribution bias on the relationship that investors form with their financial advisers
• Evaluate the impact of excessive optimism and overconfidence on investors’ decisions regarding portfolio construction

 

"Investment Decision Making in Defined Contribution Pension Plans”

The practitioner should be able to:

• Explain how limited participant knowledge and bounds to rationality, self-control, and self-interest may lead DC plan participants to construct inefficient investment portfolios
• Evaluate the impacts of status quo bias, myopic loss aversion, 1/n diversification, and the endorsement effect on DC plan participants’ investment decisions and the risk profile of their investment plans
• Discuss the factors that may contribute to DC plan participants holding “excess” amounts of their own company’s stock in their plan

 

"The Folly of Forecasting: Ignore All Economists, Strategists, and Analysts"

The practitioner should be able to:

• Explain how the illusions of knowledge and control lead expert forecasters to be overconfident in their forecasting skills
• Explain the ego defense mechanisms that forecasters rely on as justification for inaccurate forecasts
• Explain why forecasts may continue to be used when previous forecasts have been inaccurate

 

“A Survey of Behavioral Finance”

The practitioner should be able to:

• Critique the classic objection to behavioral finance that rational agents will quickly undo any dislocations caused by irrational traders
• Explain how the statement “there is no free lunch” can be valid in both efficient and inefficient markets, and discuss its relationship to the statement “prices are right”
• Evaluate the implementation costs and risks, including fundamental risk and noise trader risk, associated with trades designed to profit from asset mispricings

 

“Alpha Hunters and Beta Grazers”

The practitioner should be able to:

• Contrast chronic market inefficiencies with acute inefficiencies and describe the behavioral factors (such as convoy behavior, Bayesian rigidity, price-target revisionism, and the ebullience cycle) that may give rise to chronic inefficiencies
• Explain the portfolio rebalancing behavior of holders, rebalancers, valuators, and shifters and evaluate the impact these rebalancing behaviors have on market efficiency