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

Mr. Rajesh Iyer, 45, invested in a small-cap fund after it returned 45% in each of the last two years. He says, 'This fund manager clearly cannot go wrong, so I will put my entire bonus here.' Which pair of biases best explains his decision?

Recency bias and overconfidence best explain it. He projects the last two strong years into the future and assumes the manager's skill is certain, ignoring that high returns can reflect market conditions and may not repeat. The other pairs do not match his reasoning.

  1. ARecency bias and overconfidence in the manager's skillCorrect
  2. BMental accounting and status quo bias
  3. CEndowment effect and regret aversion
  4. DHindsight bias and conservatism

Explanation

Extrapolating two years of high returns is recency bias, and believing the manager cannot fail reflects overconfidence or illusion of skill. Mental accounting and status quo bias involve categorising money or inertia. Endowment and regret aversion concern attachment to holdings and fear of regret. Hindsight and conservatism involve past explanations and slow belief updating.

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