I read a paper regarding investor psychology today. And here are some notes:
Some psychological biases that affect investors:
1. Overconfidence. Investors are overconfident about their predictions or judgments.
2. Optimism. Investors underestimate the likelihood of bad outcomes over which they have no control. Investors underestimate the role of chance in human affairs and misperceive games of chance as games of skill.
3. Hindsight. Events people did not anticipate appear almost inevitable after they occur. Hindsight promotes overconfidence, by creating the illusion that the world is more predictable than it is.
4. Over-Reaction to Chance Events. Investors often perceive trends where none exist.
5. Non-Linear Weighting of Probabilities. Investors overweight low probabilities and underweight high probabilities, which is why lottery and insurance work.
6. People value changes, not states. Investors would prefer gains over losses even if they lead to the same outcome. Loss aversion is prevalent in the pricing of risky assets.
7. Purchase price is a reference point. An increase of loss is much more significant than a reduction of gain of the same amount.
8. Narrow Frame. Investors keep mental accounts and adopt different risk attitudes towards each.
9. Irrational Risk Policy. Investors usually have too little tolerance for risk with small gambles and too much risk taking with large ones.