Using Behavioral Economics to Pass the CFA® Exam

I am passionate about behavioral economics (behavioral finance is behavioral economics applied to finance problems; it is thus a subset of behavioral economics). I teach it in my classes and have written a book about it. Behavioral economics has applications to investments, corporate finance, public policy, and beyond. Daniel Kahneman won the Nobel Prize in Economics* in 2002 for being the pioneer in this field, and just this year Richard Thaler won the Nobel Prize for his work in this area. If Kahneman is the grandfather of behavioral economics, Thaler is the father.

As you might know, behavioral economics is a blending of economics and psychology. It emphasizes the human-ness of people, their inability in real life to make perfectly rational calculations and decisions. This approach to thinking about human behavior differs from traditional economics, which assumes that people don’t suffer from the limitations that have been reliably documented in many psychology studies.

Because there are very fine readings on behavioral economics/finance in the CFA curriculum (at the moment, in Level III), this post is not about behavioral economics and investing. Instead, I’m going to identify a few of the cognitive errors and/or emotional biases that might affect your studying for the CFA exam. I will offer antidotes to those biases, although—spoiler alert—the typical antidote is “be aware of your human-ness.” Ready? Here goes.

I’d like to start with representativeness bias, which occurs when people use past experiences and classifications to organize or classify new information. For many years, I taught in a CFA review program similar to Bloomberg Exam Prep, and I saw this phenomenon a lot in the students. They organized the curriculum material (“new information”) to align with their professional experiences (“past experiences and classifications”). But one trick to passing the exam is to answer from the curriculum.

One particularly striking example stands out in my mind. I remember a student coming up to me after a presentation and saying something like the following about his previous year’s experience: “The curriculum readings said that the right way to do X is Y, but I’m in the business and I know that isn’t right. It is done another way. So I answered in terms of how the ‘real world’ works.” Paraphrasing Dr. Phil, I asked, “And how did that work for you?” His answer, you can guess: “I failed that part of the exam.”

Yes, this is an extreme example, but my point is simple: The curriculum stands on its own, no matter your experience or real-world knowledge. That’s the antidote to representativeness bias.

Confirmation bias occurs when we filter out information that is contrary to a currently held belief. Confirmation bias is blatantly obvious in today’s political climate. I’m not going to touch that topic; instead, I want to point out that confirmation bias can work in two ways as you approach your studying. If you feel pessimistic about passing the exam, it is quite easy to find confirming information (e.g., the pass rates are low, the smart person in the next cubicle didn’t pass Level I, and so forth).

Of course, it can work in the opposite direction if you are convinced you are going to pass the exam. You can imagine that the majority of people that will be taking the test with you are less prepared than you, less smart than you, or that some people show up to take the test just because their boss requires them to (actually, I’ve seen a number of those cases). Many test takers are not taking the exam in their first language—surely, they will all fail, right? In this case, confirmation bias can lead to overconfidence, another behavioral trait shared by many people. Consider, for example, the widely cited statistic that 80% of drivers believe that they are above-average drivers.

The antidote to confirmation bias is to recognize our natural attraction to information that feels comfortable to us. By its nature, it reinforces a view or opinion that we already have. But you might ask yourself, “What information tends not to support what I believe?” For example, you might believe that you are not good at option pricing. But perhaps there is evidence that you have that capability; you did it once in a college class, for example.

Finally, let me turn to hindsight bias. As the name suggests, hindsight bias involves a selective, often incorrect, view of past events, which are often seen (in retrospect) as being more predictable than they actually were at the time. I think hindsight bias is important as you review the results of taking, say, the Level I exam.

If you do not pass, you might say something like, “I knew I wasn’t strong in corporate finance,” or words to that effect. But was that true? Did you feel that way at the time? If so, why didn’t you concentrate more study time on corporate finance? Similarly, if you do pass, you might look back and say, “Yeah, I figured I’d ace economics.” But did you really figure that at the time?


The danger of hindsight bias is that it will get in the way of an impartial view of your performance on the exam. In turn, you will have a distorted view of your strengths and weaknesses. The antidote is, as always, awareness that you didn’t actually know at the time of the exam what you now know. An appreciation of your mindset prior to the exam will make your preparation for the next exam more efficient.



*It is not actually the Nobel Prize in Economics, but rather The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel. But don’t be a cocktail party snob.


About the Author

John Howe, PhD, CFA, is chair of the Department of Finance at the University of Missouri, where he has taught finance for more than two decades and has received awards for excellence in teaching. His writings on banking, corporate finance, corporate governance, and behavioral finance have been published extensively in major finance and accounting journals. Howe has also taught at the University of Cambridge and has trained investment professionals in Zurich at one of Switzerland’s largest banks. He is a longstanding member of the editorial board of the CFA Digest, the primary publication of CFA Institute.


John Howe