the absence of a critical variable or the inclusion of an irrelevant variable will c 602766
The models we construct on how the world works influence our assessment of risk. Models represent how the world works and incorporate our assumptions and yet, we know that these assumptions can be biased based on our education, upbringing, or current professional position. This is particularly true in the field of investing.
a. The absence of a critical variable or the inclusion of an irrelevant variable will create a misrepresentation of the outlook for investment returns.
How might a currency trader miss the downdraft and then recovery of the euro in 2010 if the Greek sovereign debt situation had been overlooked?
b. Framing an investment in terms of risk/reward is the essence of the investment decision. Where one investor sees risk another investor will see rewards. Where some saw economic recovery, others saw continued recession in mid-2009.
How might this framing set the investment strategy for an investor for 2010?
c. The anchoring bias is the tendency to build a model based on the present situation that overweights the present and fails to allow for change over time. Yet we always experience change.
How might an investor with a model that suggested a traditional V-shaped recovery have been misled by events in the 2009 to 2010 recovery? Why might an investor overweight historical trends in developing her view of the future?
d. Investors have a tendency to focus on a concept that often has very little staying power over time. This tendency to jump at an illusory correlation tends to lead many investors astray. What are your thoughts on the focus on commodity prices, particularly gold, copper, or oil, as a signal of both growth and inflation over time? How well do these three indicators actually work over the entire economic cycle?