Behavioral biases are briefly defined as systematic errors in judgment. Researchers have identified and presented a long list of types of behavioral biases. Recent studies have identified more than fifty known behavioral biases toward investors, while many behavioral tendencies have not yet been clearly identified.
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Some research is looking for a meaningful framework for classifying behavioral biases. Some authors refer to behavioral tendencies as “unreasonable,” while others refer to them as “beliefs,” “judgments,” or “preferences.” Some scholars classify these biases into two categories: cognitive and emotional; this classification seems useful. So far, no coherent theory of why behavioral biases has been proposed, but instead of a universal theory, behavioral financial research relies on a vast body of evidence to support the inadequacy of individuals’ decisions in various economic decision-making situations.
Although the classification of behavioral biases is useful, it does not matter as much as the practical applications of biased behavior in real investor situations. Therefore, this book will not emphasize the separation and classification of different behavioral tendencies. But the two main categories of cognitive and emotional biases will be considered where needed. Because, as stated in Chapter 3, the distinction between cognitive and behavioral biases will be used in investor case studies to make adjustments to asset allocation.
Our main focus will be on estimating the presence or absence – not the extent – of the behavioral biases under consideration. For example, we are not talking about how much a person is overconfident, we just want to know if the person is overconfident or not. In addition, we will not deal with the possibility of linking a certain behavioral bias to other behavioral biases, unless a practical application is intended. Finally, it is important to note that the study of behavioral finance is still in its infancy. So our expectations of it must be realistic.
In the following articles, one by one, we will give a complete and detailed introduction to all behavioral biases.
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