Learning Module 5
The Behavioral Biases of Individuals
Key Outcomes Summary & Practice Problems
What you must be able to do
Curriculum Year: 2026
Compare and contrast cognitive errors and emotional biases.
Discuss commonly recognized behavioral biases and their implications for financial decision making.
Describe how behavioral biases of investors can lead to market characteristics that may not be explained by traditional finance.
1 · Behavioral Bias Categories
Cognitive Errors — Faulty reasoning stemming from statistical, information-processing, or memory errors. Can often be corrected or eliminated through better information, education, and advice.
Emotional Biases — Biases based on feelings or emotions, stemming from impulses and intuitions. Harder to correct; often only possible to recognize and adapt to them.
Category | Source | Correction | Examples |
|---|---|---|---|
Cognitive Errors | Faulty reasoning, statistical errors | Can be corrected with education and information | Conservatism, Confirmation, Representativeness, Anchoring, Mental Accounting, Framing, Availability |
Emotional Biases | Feelings, impulses, intuitions | Harder to correct; must recognize and adapt | Loss Aversion, Overconfidence, Self-Control, Status Quo, Endowment, Regret Aversion |
2 · Cognitive Errors
Belief Perseverance Biases — tendency to cling to previously held beliefs
Maintaining prior views by inadequately incorporating new information. Under-reaction to new data.
Looking for and noticing what confirms prior beliefs; ignoring contradictory information.
Classifying new information based on past experiences; includes base-rate neglect and sample-size neglect.
Believing one can control or influence outcomes when, in fact, one cannot.
Believing past events were predictable and reasonable to expect after they have occurred.
Processing Errors — flaws in how information is processed
Relying on an initial piece of information (anchor) and insufficiently adjusting from it.
Mentally dividing money into "accounts" that influence decisions, even though money is fungible.
Answering a question differently based on how it is framed (gain vs loss context).
Estimating probability based on how easily information is recalled; includes retrievability, categorization, narrow range of experience, and resonance.
3 · Emotional Biases
Strongly preferring to avoid losses than to achieve gains. Leads to holding losers and selling winners (disposition effect).
Unwarranted faith in one's own abilities. Includes prediction overconfidence and certainty overconfidence.
Failing to act in pursuit of long-term goals in favor of short-term satisfaction.
Choosing to do nothing instead of making a change, even when change is warranted.
Valuing an asset more when owning it than when not owning it.
Avoiding making decisions out of fear that the decision will turn out poorly.
4 · Behavioral Finance & Market Behavior
Momentum — Future price behavior correlates with recent past. Explained by availability (recency effect), hindsight, and regret aversion.
Bubbles and Crashes — Overconfidence, overtrading, underestimation of risks, confirmation bias, self-attribution, anchoring, and cognitive dissonance.
Value Effect — Value stocks (low P/E, high B/M) outperform growth stocks. Behavioral explanations: halo effect (representativeness), overconfidence, home bias, and emotional attachment to familiar companies.
Home Bias — Portfolios exhibit a strong bias in favor of domestic securities, reflecting perceived informational advantage or psychological comfort.