Social Psychology of Financial Markets
Final Exam Review
Questions & Solutions
2025
©2025
,1. A case study observed that investors repeatedly followed prevailing
market trends despite contradictory fundamental data. Which theory
best explains this behavior?
A) Rational Expectations Theory
B) Herd Behavior
C) Efficient Market Hypothesis
D) Loss Aversion Theory
Correct ANS: B
Rationale: Herd behavior describes how individuals mimic the actions
of a larger group rather than relying on independent analysis, a
phenomenon well documented in financial market studies.
2. In an analysis of investor sentiment, which psychological bias leads
investors to overestimate their ability to predict market movements?
A) Anchoring Bias
B) Overconfidence Bias
C) Confirmation Bias
D) Recency Bias
Correct ANS: B
Rationale: Overconfidence bias causes investors to believe they have
superior predictive abilities, often resulting in excessive trading and
overestimating risk control.
3. A case study describes how a small group of influential traders sets a
trend that many others follow. Which psychological effect best explains
this phenomenon?
A) Social Proof
B) Cognitive Dissonance
C) Endowment Effect
D) Status Quo Bias
Correct ANS: A
Rationale: Social proof is the process by which individuals follow the
actions of others, especially in uncertain situations, leading to imitative
©2025
, decision making.
4. When market data is limited, investors might use a heuristic that
relies on prominent examples that readily come to mind. Which heuristic
is being demonstrated?
A) Representativeness
B) Anchoring
C) Availability
D) Framing
Correct ANS: C
Rationale: The availability heuristic causes decision makers to rely on
immediately available information, which in turbulent markets, may lead
to overreactions.
5. A study finds that after a market downturn, many investors become
notably risk-averse. Which of the following best explains the observed
behavior?
A) Prospect Theory
B) Cognitive Dissonance
C) Loss Aversion
D) Herd Behavior
Correct ANS: C
Rationale: Loss aversion—a central component of Prospect Theory—
describes how the pain of losses outweighs the pleasure of gains, leading
investors to shy away from risk post-loss.
6. In an instance where investors update their market forecasts
primarily based on recent price swings, which bias is most prominent?
A) Recency Bias
B) Confirmation Bias
C) Anchoring
D) Hindsight Bias
Correct ANS: A
Rationale: Recency bias causes decision makers to overweight fresh
experiences, thus skewing forecasts according to the latest data rather
©2025
Final Exam Review
Questions & Solutions
2025
©2025
,1. A case study observed that investors repeatedly followed prevailing
market trends despite contradictory fundamental data. Which theory
best explains this behavior?
A) Rational Expectations Theory
B) Herd Behavior
C) Efficient Market Hypothesis
D) Loss Aversion Theory
Correct ANS: B
Rationale: Herd behavior describes how individuals mimic the actions
of a larger group rather than relying on independent analysis, a
phenomenon well documented in financial market studies.
2. In an analysis of investor sentiment, which psychological bias leads
investors to overestimate their ability to predict market movements?
A) Anchoring Bias
B) Overconfidence Bias
C) Confirmation Bias
D) Recency Bias
Correct ANS: B
Rationale: Overconfidence bias causes investors to believe they have
superior predictive abilities, often resulting in excessive trading and
overestimating risk control.
3. A case study describes how a small group of influential traders sets a
trend that many others follow. Which psychological effect best explains
this phenomenon?
A) Social Proof
B) Cognitive Dissonance
C) Endowment Effect
D) Status Quo Bias
Correct ANS: A
Rationale: Social proof is the process by which individuals follow the
actions of others, especially in uncertain situations, leading to imitative
©2025
, decision making.
4. When market data is limited, investors might use a heuristic that
relies on prominent examples that readily come to mind. Which heuristic
is being demonstrated?
A) Representativeness
B) Anchoring
C) Availability
D) Framing
Correct ANS: C
Rationale: The availability heuristic causes decision makers to rely on
immediately available information, which in turbulent markets, may lead
to overreactions.
5. A study finds that after a market downturn, many investors become
notably risk-averse. Which of the following best explains the observed
behavior?
A) Prospect Theory
B) Cognitive Dissonance
C) Loss Aversion
D) Herd Behavior
Correct ANS: C
Rationale: Loss aversion—a central component of Prospect Theory—
describes how the pain of losses outweighs the pleasure of gains, leading
investors to shy away from risk post-loss.
6. In an instance where investors update their market forecasts
primarily based on recent price swings, which bias is most prominent?
A) Recency Bias
B) Confirmation Bias
C) Anchoring
D) Hindsight Bias
Correct ANS: A
Rationale: Recency bias causes decision makers to overweight fresh
experiences, thus skewing forecasts according to the latest data rather
©2025
