3.

Conclusion

The bounded rationality of the decision maker gives rise to the biasness in decision making. The
biases that arise are due to over confidence, bounded awareness, heuristics, etc. Human beings
have limited cognitive abilities and suffer information asymmetry. Hence, human decisions
cannot always be optimal of ideal one.
Case application

Case 1

Consider an amateur investor X. He wants to try investment in day trading. He has gained
knowledge on technical analysis as a method to make sound investment decisions. He identifies
the pattern in the stock price movement of the Apple. According to the pattern observed by him
the Apple’s stock price rises when the company releases earnings. He buys the stock of apple
just before it was supposed to release its reported earnings. The next day he sold the stocks by
gaining 15% profit. This event gave him the belief that he has the ability to judge the pattern of
stock price increase accompanied by the release of earnings by the companies.

X now invested in couple of companies prior to the release of their reported earnings in high
frequency. However to his dismay he loses significantly.

Overconfidence bias

In behavioral finance the tendency followed by investor X is termed as overconfidence bias.

Overconfidence stems when an individual feels his knowledge, skill, ability and judgment is
invincible. People mostly rate their abilities and judgment to be more than that of the average
people.

Investors with over confidence tend to focus hugely on favorable outcome and neglect the
probability of occurrence of unlikely scenario. This leads them to allocate large investment in
risky assets and huge investment in same kind of assets leading to the concentration risk.

The investor X was affected by the over precision where he was excessively sure about the
certainty and accuracy of his belief that the one can benefit by trading the stocks of the company
that are likely to forecast their earnings.