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NISM Certifications · NISM-Series-X-B: Investment Adviser (Level 2) · Basics of Behavioural Finance

Caselet: Mr. Rao, 45, bought shares of a company at Rs 800. They now trade at Rs 500. Fundamentals have deteriorated and the adviser expects further decline. Mr. Rao refuses to sell, saying 'I will exit only at Rs 800', and also refuses to consider a better alternative fund because it would mean 'admitting the mistake'. Which pair of influences best explains his stance, and what is the most suitable adviser response?

Anchoring on the Rs 800 purchase price combined with loss aversion explains his refusal. The suitable response is to reframe the choice around future prospects and alternatives, treating the original cost as sunk, rather than encouraging averaging down or frequent trading.

  1. AAnchoring on purchase price and loss aversion; reframe the decision as evaluating future prospects, treating the cost as sunkCorrect
  2. BOverconfidence and hindsight bias; ask him to trade more frequently to recover losses
  3. CAvailability bias and recency; advise doubling the position to average the cost regardless of fundamentals
  4. DFraming effect and herding; suggest he follow the majority view of other holders

Explanation

The Rs 800 reference point is an anchor, and reluctance to realise the loss reflects loss aversion. The rational approach treats past cost as sunk and compares expected future returns of alternatives. Averaging down regardless of fundamentals or trading more worsens the bias.

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