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CFA Level I · CFA Level I Exam · The Behavioral Biases of Individuals

After a technology stock falls sharply, an investor who owns it says the drop was obvious from the start and that he sensed it all along, though he made no such record earlier. Which bias is he most likely displaying, and what is its main risk?

The investor is displaying hindsight bias. He believes the fall was obvious after it happened, which inflates his view of his forecasting ability. The main risk is overconfidence and excessive risk-taking in later decisions, rather than the control or base-rate issues in the other choices.

  1. AIllusion of control; trading too little after losses
  2. BHindsight bias; overestimating his forecasting ability and taking excess riskCorrect
  3. CRepresentativeness; ignoring base rates when assessing new stocks

Explanation

Hindsight bias is the tendency to see past events as having been predictable. It leads investors to overrate their forecasting skill and to take on too much risk later. Illusion of control concerns believing one can influence outcomes, and representativeness concerns classifying by superficial resemblance.

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