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Market Psychology & Behavioural Finance

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Market Psychology & Behavioural Finance

Hindsight Bias

The tendency to believe, after an event, that it was more predictable than it actually was.

Test: recalled prior probability estimates shift toward the outcome that actually occurred qualitative Market Psychology & Behavioural Finance

Home Bias

The tendency to hold a far larger proportion of domestic assets than global market weights would suggest.

Test: domestic allocation substantially exceeds the home market's share of global market capitalisation % Market Psychology & Behavioural Finance

Hot-Hand Fallacy

The belief that a run of successes will continue because the performer is on a streak.

Test: the predicted probability of continued success rises with the length of a prior run of successes qualitative Market Psychology & Behavioural Finance

House Money Effect

Taking greater risks with money regarded as winnings than with money regarded as one's own.

Test: risk tolerance rises after gains, treating profits as a separate account with lower value qualitative Market Psychology & Behavioural Finance

Hyperbolic Discounting

Discounting future rewards at a rate that falls as the delay increases, producing inconsistent preferences over time.

Test: preference between two future rewards reverses as both move closer in time, though the interval between them is unchanged qualitative Market Psychology & Behavioural Finance

Illusion of Control

The belief that one can influence outcomes that are largely determined by chance.

Test: confidence in a favourable outcome rises with involvement or effort, without any change in the actual probability qualitative Market Psychology & Behavioural Finance

Loss Aversion

The tendency to feel the pain of a loss more strongly than the pleasure of an equivalent gain.

Test: the compensation demanded to accept a possible loss exceeds the loss's size, typically by a factor near two ratio (x, times) Market Psychology & Behavioural Finance

Market Sentiment

The prevailing attitude of investors toward a market or security, independent of its fundamentals.

Test: measured by proxies such as put-call ratios, volatility indices, survey data, fund flows and new issue activity qualitative Market Psychology & Behavioural Finance

Mental Accounting

Treating money differently depending on its source or intended use, rather than as fungible.

Test: identical amounts are treated differently according to which mental category they occupy qualitative Market Psychology & Behavioural Finance

Myopic Loss Aversion

The tendency to evaluate a long-term portfolio too frequently, magnifying the felt pain of short-term losses.

Test: the probability of observing a loss rises sharply as the evaluation interval shortens, while the underlying investment is unchanged qualitative Market Psychology & Behavioural Finance

Narrative Fallacy

The tendency to construct coherent stories that explain past events, giving false confidence about their predictability.

Test: a causal story is accepted because it is coherent, without testing whether the same story would have predicted the outcome in advance qualitative Market Psychology & Behavioural Finance

Noise Trading

Trading on information that carries no genuine signal about value.

Test: the trade is prompted by rumour, pattern or sentiment rather than by information that changes the asset's expected cash flows qualitative Market Psychology & Behavioural Finance

Omission Bias

Judging harmful actions as worse than equally harmful failures to act.

Test: an identical outcome is judged more acceptable when it results from inaction than from action qualitative Market Psychology & Behavioural Finance

Optimism Bias

The tendency to expect better outcomes for oneself than the base rate justifies.

Test: personal probability estimates for favourable outcomes exceed the observed frequency in the relevant population qualitative Market Psychology & Behavioural Finance

Outcome Bias

Judging the quality of a decision by how it turned out rather than by the information available when it was made.

Test: two identical decision processes are evaluated differently solely because their outcomes differed qualitative Market Psychology & Behavioural Finance

Overconfidence Bias

The tendency to overestimate one's own knowledge, judgement or ability to predict outcomes.

Test: stated confidence intervals are too narrow, so outcomes fall outside them far more often than the stated confidence implies qualitative Market Psychology & Behavioural Finance

Panic Selling

Selling driven by fear during a sharp decline, without reference to value.

Test: the sale is triggered by the size or speed of the price fall rather than by new information about the asset qualitative Market Psychology & Behavioural Finance

Present Bias

The tendency to overvalue immediate rewards relative to larger rewards available later.

Test: a smaller immediate reward is preferred to a larger delayed one, at a discount rate far above the market rate qualitative Market Psychology & Behavioural Finance

Probability Neglect

Focusing on the magnitude of a possible outcome while disregarding how likely it is.

Test: the decision responds to the size of a payoff or loss but is insensitive to changes in its probability qualitative Market Psychology & Behavioural Finance

Prospect Theory

A model of decision-making under risk in which outcomes are valued as gains and losses from a reference point, with losses weighted more…

Value function: concave for gains, convex for losses, and steeper for losses than for gains by a factor of roughly two qualitative Market Psychology & Behavioural Finance

Recency Bias

The tendency to weight recent events more heavily than older ones when forming expectations.

Test: expectations track the most recent period's outcomes rather than the full available history qualitative Market Psychology & Behavioural Finance

Regret Aversion

Avoiding decisions because of the anticipated pain of regret if they turn out badly.

Test: the choice minimises anticipated regret rather than maximising expected outcome qualitative Market Psychology & Behavioural Finance

Representativeness Heuristic

Judging probability by how closely something resembles a mental prototype, rather than by statistical likelihood.

Test: the judgement follows similarity to a stereotype and ignores how common that category actually is qualitative Market Psychology & Behavioural Finance

Risk Aversion

The preference for a certain outcome over an uncertain one with the same expected value.

Test: the certainty equivalent accepted is less than the gamble's expected value qualitative