CFA Level IPortfolio ManagementHard
An equity analyst initially values a stock at $50 per share based on outdated financial statements. After receiving substantially improved updated earnings guidance, objective valuation models suggest a fair value closer to $70. However, the analyst revises the estimate only slightly, to $53, remaining heavily influenced by the original figure. This behavior best illustrates:
- AAnchoring and adjustment bias
- BSelf-attribution bias
- CIllusion of control bias
- DHindsight bias
Show answer & explanationAnswer & explanation
Correct answer: A. Anchoring and adjustment bias
Anchoring and adjustment bias occurs when an individual's estimate is unduly influenced by an initial reference point (the anchor), leading to insufficient adjustment even when new, materially different information becomes available. Here, the analyst's minimal revision from $50 to $53, despite strong evidence supporting $70, reflects an anchor to the original outdated estimate.
Why the other options are wrong
- B. Self-attribution bias involves crediting success to skill and failure to external factors, not anchoring valuations.
- C. Illusion of control involves overestimating one's ability to control outcomes, unrelated to anchoring on a prior estimate.
- D. Hindsight bias involves believing past events were predictable after the fact, not under-adjusting estimates.
Anchoring and Adjustment Bias
A cognitive bias in which individuals rely too heavily on an initial reference point (anchor) and fail to adjust sufficiently when new information arrives.
- Common in valuation and forecasting revisions
- Leads to under-reaction to new, materially different information
- Distinct from representativeness, which involves overreacting to patterns
Memory trick: The first number drops anchor — new facts can't pull it far.