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CFA Level III Updated
What are Pompian's four behavioral investor types?
Michael Pompian's four Behavioral Investor Types: (1) Passive Preserver — low risk, emotional (loss aversion); (2) Friendly Follower — moderate risk, cognitive (availability, recency); (3) Independent Individualist — moderate-high risk, cognitive (overconfidence); (4) Active Accumulator — high risk, emotional (overconfidence, regret aversion)...
How does the availability heuristic distort investor decisions?
Availability inflates the perceived probability of vivid or recent events, driving home bias, post-crash selling, and megacap overweighting. Remedies are quantitative frameworks and decision journals.
How do I build an active risk budget at the fund level?
Active risk budgeting allocates a total tracking error target across strategies, controlling both total active risk and contribution per sleeve...
How do I calculate the liquidity constraint in an IPS?
Liquidity = ongoing distributions (typically 1 year) plus one-time near-term outflows plus emergency reserve. Separate ongoing from one-time when writing the IPS.
How is the Kalman filter used in finance through state-space models?
A state-space model has two equations. The measurement equation y_t = Z_t alpha_t + epsilon_t links observables to the unobserved state alpha_t...
How do I immunize a portfolio against multiple future liabilities with different dates?
Match PV, duration, AND convexity/dispersion with cash flows bracketing each liability. Refine with key rate duration for non-parallel shifts.
How should referral fees be handled under CFA Institute standards?
Under CFA Institute Standard VI(C), referral fees are permitted but require full disclosure to clients, prospective clients, and the employer. Disclosure must include the nature, amount, and conditions of the fee, and must occur before the referred engagement.
What is vintage year risk and how do LPs manage it?
Vintage year drives entry and exit valuations; LPs diversify by committing steadily across years and strategies.
How does lifecycle asset allocation work for individual investors?
Lifecycle asset allocation adjusts the equity/fixed-income mix across the investor's life based on the changing ratio of human capital to financial capital.
What is MCMC and when do I need it?
Markov Chain Monte Carlo generates samples from a probability distribution by constructing a Markov chain whose stationary distribution is the target...
What techniques do CFA-level advisors use to manage client behavioral biases?
Three high-leverage techniques: (1) Moderate, adapt, or educate based on Pompian's framework — wealthy emotional clients get moderated, cognitive clients get educated, middle ground adapts; (2) Written IPS with behavioral guardrails; (3) Nudges and framing...
How often should strategic asset allocation be reviewed?
Review SAA every 3-5 years on schedule, plus event triggers: objective change, liability shift, funded status, structural market change, governance change.
Walk me through the five belief perseverance biases with concrete investor examples.
Conservatism underreacts; confirmation cherry-picks; representativeness judges by stereotype; illusion of control overestimates influence; hindsight rewrites past accuracy.
How do I assess a client's risk tolerance for the IPS?
Risk tolerance splits into ability (objective: horizon, wealth, liquidity) and willingness (subjective: psychometric, experience). Reconcile with the lower unless explicit client acceptance.
What is a Hidden Markov Model and how is it used to detect market regimes?
A Hidden Markov Model (HMM) is a doubly stochastic process: an unobserved state sequence S_t evolving by a Markov chain, and an observed emission y_t drawn from a state-specific distribution...
How do I optimize Social Security claiming for a married couple?
Optimal strategy usually has lower earner claim early while higher earner delays to 70, maximizing survivor benefit protection...
What is horizon matching and how does it blend cash flow matching with immunization?
CFM bucket for years 1-5, immunization for years 6+. Cheaper than pure CFM, safer than pure immunization. Rebalance long bucket annually.
How does overconfidence bias lead to excessive trading and worse portfolio returns?
Overconfidence is arguably the most damaging behavioral bias for portfolio performance because it directly increases activity costs while reducing diversification benefits. It comes in two forms relevant to investing: prediction overconfidence and certainty overconfidence.
How does risk budgeting work in practice for asset allocation?
Risk budgeting allocates risk rather than capital across asset classes. Each asset's Absolute Contribution to Total Risk (ACTR) depends on its weight, beta to the portfolio, and portfolio volatility. In a typical 60/40 portfolio, equities often consume 85–90% of the risk budget.
What's the difference between committed, called, and paid-in capital?
Committed is max promised; called = paid-in = actually contributed; DPI/RVPI/TVPI track realized, unrealized, and total multiples.
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