Tutorial 8 - Topic 7 Emotional Foundations and Individual Investors

1*. Differentiate the following terms/concepts/individuals:

a. IQ and EQ

The intelligence quotient (IQ) measures a person’s intelligence, whereas the emotional quotient (EQ) measures a person’s ability to identify and manage emotional responses

b. Mood and emotion

• Mood is a general feeling that does not focus on anything in particular
• Emotion is a mental and physiological state

c. Human brain and the brain of other animals

• Cerebrum is what distinguishes the human brain from those of other verterate animals
• Gives the humnas the ability to plan which is a big advantages over other animals

d. Phineas Gage and Elliot

• Phineas - change in personality following an explosion that sent an iron bar through his head
• Elliot - change in personality following the removal of brain tumor in frontal lobe

2. You are considering managing your own money rather than trusting in an investment advisor. Some argue that emotional intelligence may be just as important as investment knowledge. Do you agree? Discuss.*

• IQ and EQ are both important for success - complementary
• EQ tests attempt to measure a person's ability to identify and manage their own emotional responses, as well as those of others
• Avoid panic sales (fire sales, etc) should also have high ability to control emotion
  • Manage own emotional responses

3. Imagine you just won a lottery with a $10 million prize. What primary emotions might you feel? (Note that the seven primary emotions generally include anger, contempt, disgust, fear, happiness, sadness, and surprise.) Describe their features, including the six used to define an emotion. Be sure to include observables.

4*. Your colleague argues that emotion and reasoning are completely separate influences on decision-making. Do you agree? Discuss.

• Emotion and reasoning are not separate influences on the choice we make
• emotions include cognitive, physiological and overt behavioral elements
• A person’s reasoning is the result of a complex interaction of the mind and body, and an understanding of the process must include all aspects of the person.

Part 2 - Individual investors and Force of Emotion

1*. Differentiate the following terms/concepts:

a. Regret and disappointment

• regret and disappointment are negative emotions
• regret - sorry about a decision that cannot be changes
• With regret the person is also sorry about a decision that cannot be changed, but regret is a stronger emotion than disappointment.

b. House money and break-even effects

• The house money effect is the willingness to take greater risk with money that was recently won, whereas the break-even effect refers to an increase in risk taking after a prior loss in order to try to break even.

c. Affect (noun) and affect (verb)

Affect (noun) refers to the quality of a stimulus and reflects a person’s impression or assessment, whereas affect (verb) means to have an effect on an outcome.

d. Bad mood and depression

• a mood is a general feeling that does not focus on anything in particular
• Depression has a biochemical basis and can occur with no cognitive appraisals

2. In housing markets, there is a positive correlation between prices and trading volume. When there is a housing boom, many houses sell at, or even above, the prices asked by sellers. In times of bust, homes sit on the market for a long time with asking prices that exceed the prices that can reasonably be expected. How can this be explained?

• The house money effect predicts that after a gain, the willingness to take greater risk increases so that investors and home owners will buy up houses.
• After losses are felt the snake-bit effect predicts an increase in risk aversion and people are less likely to buy

3*. Some investment banks engage in proprietary trading, which means that the firm’s traders actively trade financial securities using the bank’s money, in order to generate a profit. To offset a slowdown in one division, traders in a profitable division might more actively engage in proprietary trading. Do you think this practice is wise?

• Invest their stock directly
• Actively trade financial securities
• Breakeven effect refers to an increase in risk taking after a prior loss in order to try and break even
  • Might not make the same decisions as your normally would

4*. This morning I woke up in a sour mood because my favorite team lost its game yesterday. Then I had to wait an extra-long time in line for coffee. It started to rain, and I forgot my umbrella in the car. When I arrived at my office (finally) I found that a stock I held in my portfolio was falling in value, so I sold. Is this evidence that mood moves markets?

• Probably depends on the context and individual personality
• Don't really know that the bad mood caused me to sell. I might have sold because the market was falling, I decided to follow the herd
• I might have already been planning to sell

5*. What does research based on the game show Deal or No Deal tell us about path dependence and integration vs. segregation of gambles?

• Strongly influenced by what has happened before
• take greater risk taking after a prior loss in order to try and break even
• more risk in response to changes in wealth
• Evidence of path dependence was provided and suggests that gambles are integrated.

Part 3: CFA

1. Discuss how Gerber displayed overconfidence bias and cite one example to support this statement. Distinguish between the availability bias and the overconfidence bias.

• Having too much knowledge (superior knowledge) of the healthcare industry
  • Related illusion of knowledge bias
• Emotional biases result for reasoning influenced by bias
• Overconfidence is primarily an emotional bias and is different fro availability bias which is a processing bias and a cognitive error
• Knows ABC should be monitored closely because
• Difficulty interpreting the scientific results

1. Discuss how Gerber displayed conservatism bias. Cite three examples from the reading

• Cognitive error, maintain their pervious veiw or forecasts by inadequately incorporaing new information
• Has aspects of both statistical and information-processing errors
• Maintaining his prior views on ABC without adequately incorporating new information
• Several examples of new information that was either ignored or inadequately considered