Chapters 15

Optimism Bias
Prepared By : DR. Wael Shams EL-Din
Behavioral Biases
❑ Most of the Behavioral finance researchers pointed out in their
studies that investors can harm their wealth when they allow
psychological biases and emotions affect any investment
decisions.
❑ To clarify their point of view, these biases make the investors take
risks that they did not anticipate and make them liable to
unjustified trading, and end up blaming themselves or others
when outcomes are bad.
❑ Behavioral Bias that influence investment decisions could be
grouped into two categories:-
❑ Emotional Biases
❑ Cognitive Biases
Emotional Biases
Emotional Biases
1. Loss Aversion
2. Optimism
3. Self Control
4. Endowment Effect
5. Regret Aversion
6. Status Quo

LOSERS
Optimism
❑ Most people have heard of “rose-colored glasses” and know
that those who wear them tend to view the world with
extreme optimism
❑ Optimism is a behavioral bias that could cause investor to
feel that he is really significantly less inclined to any
damaging incidents in the market than other investors.
❑ Many overly optimistic
investors believe that bad
investments will not happen to
them according to their choice.
other factors might affect them
Such as oversights can damage
their portfolios.
Implications for Investors
❑ Optimism Bias may also lead individual investors to
overestimate their own investment results.
❑ They subconsciously choose results from their portfolios
that match their optimistic self-perception as investors, and
fail to measure the results of their entire portfolio.
❑ To control this bias, investors need ideas because the
insider’s view is usually to adopt an outsider’s view when
evaluating investment overly optimistic.
❑ It can also lead to Poor decision-making, which can
sometimes have disaster results.
Optimism Bias & Investment Mistakes

2. Investor aren't
cautious about the 3. Investors read too
1. Investing in the
factors that eat up his much into “Rosy”
Employer Stocks
return (Inflation, Fees Forecasts
and Taxes )

4. Investors believe 5. Investors to invest

that they are above near to their
average geographic Region
Investment Mistake(1)& Mitigation
Investing in the Employer Mitigation
Stocks
❑ Optimism bias can cause ❑ Advisors must emphasize that
investors to potentially overload Asset allocation is the key to
themselves with their own successful portfolio.
company stocks, because ❑ Optimism bias can cause
optimism bias can make them investors to excessively favor
think that other companies are Employer Stocks , while
more possible to declines than neglecting others. Advisors
their own. should encourage clients to
❑ Employee feel a greater comfort build balanced asset
and optimism with the stock of allocations and to stick with
their employer, feeling that them.
investment in his company is
less risky than an investment
elsewhere.
Investment Mistake (2) &Mitigation
2. Investor aren't cautious Mitigation
about the factors that eat
up his return e.g. (Inflation, ❑ Advisors must inform the
Fees and Taxes ) investor that he/she have to
❑ Optimism bias can cause save and invest regularly. This
investors to believe they are piece of advice is essential as
getting market like returns, Saving and investment are the
when in fact they need to be keys to sustain the value of
cautious of things like inflation, money over long-term period.
fees, and taxes that eat up these So investor who inclined to
returns and eliminate the long- such bias should try to save
term benefits of compounding correctly and to invest wisely
returns. at every opportunity in order
to maintain their living
standard at same level.
Investment Mistake(3) &Mitigation
3. Investors Read Too Much Mitigation
into “Rosy” Forecasts
❑ Optimism bias can cause investors ❑ We have to encourage such
to read too much into “Rosy” investor to deal with financial
forecasts such as earnings advisor.” It goes without saying
estimates of analysts or their own that nothing can replace the
research done by reading company benefit of objective advice.
reports that show rosy outlooks. ❑ Using the services of financial
❑ Additionally, investors prefer to advisor can partially correct the
get good news about the markets way of thinking that investors
or their investments and so may be sometimes lack.
disposed to optimism versus ❑ By utilizing an advisory
pessimism. service, clients can gain the
benefits of regular, rational
investing behavior.
Investment Mistake(4) &Mitigation
4. Investors believe that they Mitigation
are above average
❑ Optimism bias can cause investors ❑ We have to encourage such
to think they are above average investor to deal with financial
investors, simply because they are advisor.” It goes without saying
optimistic people in general, or to that nothing can replace the
believe that they are above benefit of objective advice.
average in other areas of their life,
such as energetic ability or social
skills.
Investment Mistake(5) &Mitigation
5. Investors to invest Near to Mitigation
Their geographic Region
❑ Optimism bias can cause investors ❑ Advisors should encourage
to invest near to their geographic clients to build balanced asset
region (home bias) because they allocations and to stick with
may be overly optimistic about the them regardless geographic
prospect of their local geographic region.
area.
Optimism Bias Test
Question 1
Relative to other drivers on the road, how good a driver is you?
A. below average
B. average
C. above average
Question 2
How optimistic are you about the investing opportunities close to home
versus those overseas?
A. I am much more optimistic about investment opportunities close to home.
B. I am optimistic about investment opportunities in foreign locations.
Question 3
Relative to other investors, how good investors are you?
A. Below average.
B. Average.
C. Above average
Optimism Bias Test
Question 4
Look at the five rates of return, and choose the one that you believe you
have earned in the past five years.
Rates of Return
1. below 0 %
2. between 0 % and 3.90%
3. between 4 % and 7.90 %
4. between 8 % and 10.00 %
5. Over 10 %
If you picked numbers 2, 3, or 4, answer this question:
How confident are you that you earned this as a “real” return (after
taxes, fees, etc.)?
A. I am optimistic that I earned a good "real return“
B. I am NOT optimistic that I earned a good “real return”
Test Results Analysis
Questions 1 and 3:
An answer of “B” or “C” tends to indicate exposure to
optimism bias

Questions 2 and 4:
An answer of “A” tends to indicate exposure to optimism bias
What is Pessimism Bias?
❑ The tendency for some people to overestimate the
probability of negative things will happen to them
(especially person who suffer from depression).
❑ Pessimism bias is the opposite of optimism bias.
Example of Pessimism Bias
❑ During bearish markets several stocks where available at
lower prices. The wiser investor would seize this
opportunity and getting a great deal. however, a person with
pessimism bias may think that stock market’s declining
performance would continue and as a result miss out on this
opportunity.
How to avoid Pessimism Bias?
❑Evaluate Best and Worst Case Scenarios: Don’t avoid the
hard work. By analyzing the worst thing that can happen,
you can also work on ways to avoid it. And by analyzing the
best case scenario you can work on what it would take to
make it happen.
❑Talk to Others Partner: Getting opinions from others
really can help, to offset your own biases as bias creates
blind spots, and the blind spots bring failure.
❑Keep Yourself Well: While your personal self may not seem
like it has a lot to do with this, keeping yourself in optimal
mental and physical health is very important for the mental
and emotional control needed for entrepreneurship.
Additionally, avoid comparisons to others and keep track of
your goals.
Thank You