What is Representativeness Heuristic? Representativeness heuristic bias occurs when the similarity of objects or events confuses people’s thinking regarding the probability of an outcome. People frequently make the mistake of believing that two similar things or events are more closely correlated than they actually are. This representativeness heuristic is a common information processing error in…
What is Hindsight Bias? Hindsight bias is the misconception, after the fact, that one “always knew” that they were right. Someone may also mistakenly assume that they possessed special insight or talent in predicting an outcome. This bias is an important concept in behavioral finance theory. Hindsight Bias Example Consider the 2008 financial crisis or…
What is Confirmation Bias? Confirmation bias is the tendency of people to pay close attention to information that confirms their belief and ignore information that contradicts it. This is a type of bias explored in behavioral finance. Our biases tend to limit our ability to make purely rational investment decisions. Confirmation Bias Example Let’s look…
What is Anchoring Bias? Anchoring bias occurs when people rely too much on pre-existing information or the first information they find when making decisions. For example, if you first see a T-shirt that costs $1,200 – then see a second one that costs $100 – you’re prone to see the second shirt as cheap. Whereas,…
What is the Narrative Fallacy? One of the limits to our ability to evaluate information objectively is what’s called the narrative fallacy. We love stories and we let our preference for a good story cloud the facts and our ability to make rational decisions. This means that we may be drawn towards a less desirable…
What is Cognitive Bias? A cognitive bias is an error in cognition that arises in a person’s line of reasoning when making a decision is flawed by personal beliefs. Cognitive errors play a major role in behavioral finance theory and are studied by investors and academics alike. This guide will cover the top 10 most…
What is Behavioral Finance? Behavioral finance is the study of the influence of psychology on the behavior of investors or financial analysts. It also includes the subsequent effects on the markets. It focuses on the fact that investors are not always rational, have limits to their self-control, and are influenced by their own biases. Traditional…
What is Durability Bias? Durability bias is the subconscious inclination to forecast past events or occurrences forward to the future. In other words, durability is a type of cognitive bias with the assumption that past trends will continue into the future. The term durability bias is commonly used in behavioral finance and forecasting. Implications of…
What is Arbitrage? Arbitrage is the strategy of taking advantage of price differences in different markets for the same asset. For it to take place, there must be a situation of at least two equivalent assets with differing prices. In essence, arbitrage is a situation where a trader can profit from the imbalance of asset…
