The tendency to overweight what one knows and to read comfort as safety, producing concentration in an employer, an industry or a domestic market. Genuine expertise may improve selection within a category but removes none of the risk of holding only that category, which is the distinction the bias obscures.
Practice questions using Familiarity Bias
Original questions written against the published FINRA and NASAA exam content outlines — not actual exam questions. Every choice is explained.
A client inherited shares in a single company from her grandmother and tells her adviser that she would never buy them at the current price, but she will not sell them either. This best illustrates
A.the disposition effect.Wrong. That describes selling winners and holding losers, and nothing here turns on gain or loss.
B.familiarity bias.Wrong. She is not favouring a category she knows; she is attached to this particular holding because it is hers.
C.the illusion of control.Wrong. She claims no ability to influence how the shares perform.
D.the endowment effect.Correct. The stated gap between what she would sell for and what she would pay is the signature of the bias.
Why: The endowment effect is the tendency to value something more highly simply because one owns it, which shows up as a gap between the price at which a holder would sell and the price at which the same person would buy. The client has stated that gap explicitly, which is what identifies the bias, and the emotional provenance of the shares deepens it. The practical harm is a concentrated position that survives only because selling feels like a loss of something more than money. The test an adviser uses is exactly the one she has already failed, asking whether she would buy the position today at its current price.
An engineer holds most of her portfolio in her own employer and in two other firms in the same industry, explaining that these are the only businesses she genuinely understands. Her adviser should identify this as
A.familiarity bias, which has produced a concentration she has never priced as a risk.Correct. Comfort with what she knows has been substituted for an assessment of how much of it to own.
B.prudent use of a genuine informational advantage within her own professional field.Wrong. Knowing an industry improves selection within it and removes none of the risk of holding only it.
C.recency bias, since her sector has performed strongly across the span of her career.Wrong. Her stated reasoning turns on understanding rather than on any pattern of past returns.
D.an acceptable tilt, provided the three holdings are in genuinely different companies.Wrong. Three names drawn from one industry share the sector exposure that is doing the damage.
Why: Familiarity bias is the tendency to overweight what one knows and to read comfort as safety, and it is the mechanism behind concentration in an employer, an industry or a home market. Understanding an industry may improve the ability to analyse a company, but it does nothing to remove the unsystematic risk of owning only that industry, and the three holdings will fall together on any development affecting the sector. The client has priced her knowledge as a benefit without pricing the concentration as a cost. Diversifying away from what she knows best is uncomfortable precisely because the bias makes the unfamiliar feel riskier than it is.
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