Behavioral Bias in Investing

A

Based on the provided information, the investor initially purchased 100 shares of a stock two years ago for $50 per share, considering it a good value investment. However, the stock price has since fallen to $35 per share due to the cancellation of contracts by some of the company's major customers. The investor has now decided to purchase another 50 shares at the lower price. The question asks which behavioral bias best characterizes the investor's actions. Let's analyze the given options:

A. Escalation bias: Escalation bias refers to the tendency of individuals to increase their commitment to a failing investment in the hope of recovering their losses. In this case, the investor is not increasing their stake in the stock that has fallen in price. They are merely purchasing additional shares at the lower price, without any indication of trying to recover losses from the initial investment. Therefore, escalation bias does not best characterize the investor's actions.

B. Momentum bias: Momentum bias occurs when investors chase past performance and make investment decisions based on recent price movements. However, in this scenario, the investor is not making a decision based on the stock's recent price movements or any perceived momentum. They are purchasing additional shares at the lower price because they believe it represents a good value investment. Therefore, momentum bias does not best characterize the investor's actions.

C. Overconfidence bias: Overconfidence bias refers to the tendency of individuals to have excessive confidence in their own abilities or judgments. In this case, the investor initially believed the stock was a good value investment, despite the subsequent decline in its price. By purchasing additional shares at the lower price, the investor may be displaying overconfidence in their ability to identify undervalued investments. They may believe that the stock's price decline was unjustified and that it will eventually recover. Therefore, overconfidence bias best characterizes the investor's actions.

In conclusion, the best behavioral bias that characterizes the investor's actions in this scenario is overconfidence bias (Option C).