The brain takes shortcuts in an attempt to understand everything even before it grasps all the information. The two categories it sorts them into are representativeness and familiarity. Representativeness is led by sterotypes to trying to understand a situation. When people are too optimistic about future company earnings and the share price falls, it is called overreaction. Good companies does not necessarily mean it has a good stock. High growth stocks are also called "glamour"stocks compared to low growth stock known as "value" stocks. In a study, in a one year and five year return, the value stock outperformed the glamour stock in both categories. The price to earnings ratio (p/e) is also another tool to measure the glamour of a company and the higher the ratio translates to higher growth. The extrapolation bias is the belief that past returns should be continued causing investors to invest in stocks that had excellent pass returns in hope for the same performance. With that bias, people will chase stocks and
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This note was uploaded on 09/13/2011 for the course FIN 250 taught by Professor Johansen during the Fall '10 term at Boise State.