A client refuses to sell a stock she has held since 2018, insists her favorite tech pick will rebound, and panics out of equities the morning after a 4% drop. Three different biases, three different remedies, and the exam expects you to name each one.
Traditional finance assumes investors are rational, risk-averse utility maximizers with perfect information. Behavioral finance documents that real people are none of those things. These commonly recognized behavioral biases are ones the exam expects you to discuss by name, along with their implications for financial decision making. The exam tests two skills: classifying a described behavior into the correct named bias, and identifying which market anomaly a bias helps explain.
The split is the spine of this reading. Compare the two families and the contrast is sharp: cognitive errors trace to faulty reasoning, emotional biases to feelings. Memorize it.
KEY: Cognitive errors stem from faulty reasoning, memory limits, or statistical mistakes. Provide better data, better process, or formal decision rules and the bias shrinks.
Common mistakes
- Calling everything overconfidence. Overconfidence is specifically about forecast precision and judgment quality. Excessive trading from a belief that "I can predict short-term moves" is overconfidence. Excessive trading because "I feel like doing something" is closer to illusion of control. Trap: matching the bias to the symptom (trading) instead of the cause (forecast precision).
- Confusing loss aversion with risk aversion. Risk aversion is symmetric; you dislike variance. Loss aversion is asymmetric; you dislike losses about twice as much as you like equivalent gains. A loss-averse investor is risk-seeking in the loss domain (refuses to realize the loss and "doubles down"). Trap: labeling the disposition effect as "risk aversion."
- Calling anchoring "conservatism." Anchoring uses a numeric reference and adjusts insufficiently from it. Conservatism is about sticking with the prior worldview after new information arrives. Trap: an analyst whose price target tracks the last published target is anchored; an analyst who refuses to change a bullish thesis after a profit warning is conservative.
Bottom line
- Cognitive errors come from faulty reasoning and can be moderated with education, data, and written process. Emotional biases come from feelings and usually require accommodation, not correction.
- Cognitive errors split into belief perseverance (conservatism, confirmation, representativeness, illusion of control, hindsight) and information processing (anchoring, mental accounting, framing, availability).
- Six core emotional biases: loss aversion, overconfidence, self-control, status quo, endowment, regret aversion.
- Loss aversion: a loss feels roughly 2x as painful as an equal gain, driving the disposition effect (sell winners early, hold losers too long).
Exam shortcut
For the moderate-vs-accommodate question: cognitive equals moderate, emotional equals accommodate, always. For belief perseverance vs. processing: belief perseverance is about an existing view (conservatism, confirmation, representativeness, illusion of control, hindsight); processing is about handling a specific new input (anchoring, mental accounting, framing, availability). For anomaly matching: momentum tracks conservatism, bubbles track overconfidence plus herding, the value premium tracks representativeness, and home bias tracks availability.
The full lesson (about 3,013 words, 20 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- behavioral biases of individuals
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