IFoA CB2 key terms

A field that studies how psychological, social and emotional factors cause people to deviate from the perfectly rational, self-interested decision-making assumed in standard economic models.

The idea that people intend to act rationally but are limited by cognitive capacity, time and available information, so they satisfice rather than optimise.

A descriptive model of choice under risk in which outcomes are judged as gains or losses relative to a reference point, with losses weighted more heavily than equivalent gains.

The tendency for the pain of losing a given amount to feel larger than the pleasure of gaining the same amount, so people take risk to avoid losses.

The finding that people place a higher value on an object simply because they own it, demanding more to give it up than they would pay to acquire it.

An irrational preference for the current state of affairs, so that defaults strongly influence choices even when switching would be easy and beneficial.

A change in preference caused by how a choice is described, such as presenting a survival rate rather than a mortality rate, despite identical underlying information.

A cognitive bias in which an initial number or piece of information disproportionately influences subsequent estimates, even when the anchor is arbitrary or irrelevant.

A quick mental shortcut or rule of thumb that simplifies judgement, often efficient but prone to predictable systematic errors in particular circumstances.

Judging the frequency or probability of an event by how easily examples come to mind, so vivid or recent events are overestimated relative to duller ones.

Assessing likelihood by how closely something resembles a typical case, which can ignore base rates and lead to errors such as the conjunction fallacy.

A low-cost change to the way choices are presented that predictably alters behaviour without banning options or materially changing economic incentives.

The deliberate design of the environment in which people make decisions, including ordering, framing and defaults, to influence the option selected.

The outcome that applies if an individual takes no active action, which has a powerful effect on behaviour because of inertia and status quo bias.

A preference pattern where a person's ranking of future options changes as the moment of decision approaches, causing plans made now to be broken later.

Discounting future rewards more steeply in the near term than over longer horizons, producing declining discount rates rather than the constant rate of exponential discounting.

The tendency to give disproportionate weight to rewards available immediately relative to those arriving later, even when waiting would be more valuable overall.

A voluntary arrangement that restricts future choices or imposes a penalty, helping a person with present bias stick to a plan they currently prefer.

Copying the actions of a larger group rather than relying on one's own information, often because others are assumed to know more.

A tendency to treat the behaviour or approval of others as evidence of the correct action, especially under uncertainty or similarity to those others.

A process where people ignore their own private signals and follow the observed choices of predecessors, so information stops aggregating into decisions.

A systematic tendency to overestimate one's own ability, knowledge or the precision of one's forecasts, leading to excessive trading and inadequate risk provision.

Treating money differently depending on its source or intended use, such as holding low-return savings while carrying expensive debt, rather than viewing wealth as one portfolio.

The statistical tendency for extreme observations to be followed by less extreme ones, which can be mistaken for a causal effect of an intervention.

Seeking, interpreting and recalling information in ways that support existing beliefs while discounting contradictory evidence, which impedes updating of views.

Revising a prior probability in the light of new evidence using Bayes' theorem, producing a posterior probability proportional to prior times likelihood.

The probability distribution expressing belief about an unknown quantity before any new data are observed, which is then combined with the likelihood.

The updated probability distribution for an unknown quantity after combining the prior distribution with the likelihood of the observed data.

A Bayesian interval within which an unknown parameter lies with a stated posterior probability, given the prior and the observed data.

A prior distribution that, combined with a particular likelihood, yields a posterior in the same distributional family, keeping calculations tractable.

A stochastic process in which the future state depends only on the present state and not on the sequence of states that preceded it.

The memoryless condition that, conditional on the current state, the past and future of a process are independent, which defines a Markov chain.

A square matrix whose entries give the probabilities of moving from each state to each other state in one step, with rows summing to one.

A probability distribution over states that is unchanged after applying the transition matrix, describing long-run behaviour of an ergodic Markov chain.

A counting process in which events occur singly, independently and at a constant average rate, so counts in fixed intervals follow a Poisson distribution.

A continuous distribution for the waiting time until the next event in a Poisson process, characterised by a constant hazard rate and the memoryless property.

Estimating the distribution of an output by repeatedly drawing random inputs from assumed distributions and running the model many times.

A value produced by a deterministic algorithm that mimics the properties of independent uniform random draws, used to drive simulations.

Generating a random variate by applying the inverse cumulative distribution function to a uniform random number on the unit interval.