Role of Emotional Bias on Investment Decision from Behavioural Finance Perspective

INTERNATIONAL JOURNAL OF SCIENTIFIC & TECHNOLOGY RESEARCH VOLUME 9, ISSUE 03, MARCH 2020 ISSN 2277-8616

Role Of Emotional Bias On Investment Decision From Behavioural Finance Perspective

Ruchi Priya Khilar, Dr. Shikta Singh

Abstract—The human mind is capable of taking complicated decisions at very ease but sometimes they also do mistakes and fall prey to certain biases. Such biases lead them to take the wrong decisions which results in suffering losses. As emotion plays a very vital role in the human decision- making process, it sometimes leads them to wrong investment decisions. This is why it becomes very evident to study in detail the various emotional biases in investors’ decisions. Therefore the purpose of this present research paper is to address the role of different emotional biases in investors’ investment decision making in the Indian context. Maximum number of research papers has been reviewed in this regard and most relevant literatures have been quoted here in the paper. This paper has tried to explain some of the emotional biases such as overconfidence, loss-aversion, home bias and endowment effect which work as a guideline that can be considered by the decision makers while making invested related decisions. This paper would contribute to the extinct literature of behavioural finance and also helps the investors to identify their own bias and take corrective measures to reduce such bias in their investment decision.

Index Terms— Cognitive bias, Emotional bias, Endowment effect, Home bias, Investment decision, Loss- aversion, Overconfidence ——————————  —————————— 1 INTRODUCTION them fall prey to the various behavioural biases. Behavioural Investment is the allocations of available money to different bias is predominantly divided into two types such as cognitive prospective avenues which in turn give some future benefit to bias and emotional bias. Cognitive bias involves decision the investor or may make him incur loss. The very purpose of making based on some established concepts or rule of thumb making an investment is to get some good return out of such in the mind of investors which may or may not hold accurate or investment from an investor’s point of view. Investment can be factual in real sense [1]. An investment decision said to be done in many ways like investing in stock market, real estate, influenced by emotional bias when taken spontaneous based banks, post office, insurance company etc. Choosing a correct on the person’s intuition and his personal feelings associated avenue for investing which can meet the investor’s objective is with it [1]. The purpose of the current paper is to explore the a crucial task on part of an investor. It takes lot of time to various emotional biases influencing the investment decision analyze and decide “where to invest”. Proper analysis of in Indian context by reviewing various literatures pertaining to different avenues available is very much vital before making the objective of the present paper. an investment. For instance, if an investor wants to invest in share market then he needs to properly analyze the 2 REVIEW OF LITERATURE performance of the shares of the companies trading in stock In this part, the most significant literatures relevant to the market, their values, the market trend and every nitty- gritty objective of the present paper have been discussed. Three related to it. Investing without proper analysis is a disaster so it authors named Thaler, Kahneman and Tversky are regarded has to be done very carefully and mindfully. Still it has been as the father of “Behavioural Finance”. These authors have seen that after putting so much of effort in analyzing the laid down the foundation stone on which the present theories stocks, people suffer losses from their investment. This of behavioural finance stands. Thaler being a finance theorist happens due to the misinterpretation of the information was of the opinion that investors do not behave rationally available by an investor. This misinterpretation can be caused hence they tend to make mistakes while taking investment because of the lack of information available, several decision [2]. Kahneman and Tversky came up with “prospect behavioural biases such as cognitive and emotional biases etc theory”. Prospect theory can be treated as an alternative to expected utility theory, rational expectations theory and the 1.1 Behavioural Biases: Cognitive and Emotional Bias EMH (Efficient Market Hypothesis) [3]. A significant amount of In standard finance theory, it is assumed that the investors previous studies suggests that various behavioural anomalies always take rational decisions i.e. they always make lead to poor judgement and mispricing of securities in financial investment decision correctly and logically. If this would have market. been the case then none of the investors would have to suffer losses but in reality we see investors suffer losses too which 2.1 Emotional Biases Influencing Investment Decision means that this assumption doesn’t hold true in real sense. Previous literature suggests that investor’s personal feelings, This has led to the emergence of a new paradigm in the world spontaneous emotions, their intuition affect their investment of finance known as “Behavioural Finance” which deals with decision. This part of the paper tries to identify the different the irrational beliefs of the investors that may influence the prominent emotional biases which have an impact on investment decision making process of an investor and make investors’ decision basing upon the prior literature done in the ———————————————— given context.  Ms. Ruchi Priya Khilar is currently pursuing her doctoral programme in management in KIIT School of Management, KIIT deemed A. Overconfidence: Investors are said to be influenced by University, India. E-mail: [email protected] overconfidence bias when they try to rely more on their  Dr. Shikta Singh is currently working as an associate professor in the area of finance and economics in KIIT School of Management, own belief, knowledge and intellect. In short, it is a kind of KIIT deemed University,India . E-mail: [email protected] egoistical belief that I am better than actually I really is. Such kind of beliefs lead to overestimation of one’s own skill and talent and overestimation leads to

overconfidence [4], [17], [18]. An overconfident investor 5 CONCEPTUAL FRAMEWORK relies more on the information gathered by him than to the market generated information [5]. Overconfident investors overreact to the market information and it leads to the stock market’s excessive trading phenomenon [6]. Behavioural Overconfidence bias is often triggered by self-attribution Biases bias which ultimately leads to over optimism that affect the rational decision making process of an investor [7], [15], [17]. B. Loss aversion Bias: Another more interesting bias which has been widely studied in different context is loss aversion bias. This bias leads the investors to irrational decision-making [3]. In this bias, investors become frightened towards incurring losses so much that they stop Emotional Biases: investing in portfolios which could entail them gain. Here, Investors Overconfidence Investment pain of loss is way more than the gain in an investment. Loss aversion Investors are very sensitive to loss which they always Decision Home bias want to avoid it and thus their decision gets influenced [8]. Endowment Loss aversion is associated with the feelings of guilt, fear, effect anguish [9]. It was also found during the review that

female investors are more loss averse than the male investors [23], [24]. 6 METHODOLOGY C. Home Bias: According to this bias, investors are more inclined towards their domestic companies than to the The methodology followed for the present article is a review of Endowment foreign companies. This bias better describes “the sense literature. It involves reviewing the previously published effect of belongingness” in the minds of the investors [10]. They research work pertaining to the topic of the current research. tend to invest more in domestic companies even if the Due to certain limitations all the extensive amount of literatures returns are lower. They do so because of the higher could not be reviewed but a considerable amount of relevant transaction cost involves in trading in foreign securities literatures related to the topic has been reviewed and findings [25]. has been drawn basing upon it. For this study, research D. Endowment effect: It is yet another type of emotional articles have been downloaded from peer- reviewed journals. bias which influences the investors’ decision making. The research articles are being gathered from Emerald According to this bias, investors’ tends to value the assets Insight, Elsevier, JStor, EBSCOhost, Google Scholar and more which are currently being held by them than its SSRN. The keywords provided in this study have been used to actual market value [10]. This bias exists widely with the search for the relevant research articles pertaining to the topic. investors who have attached some emotional feeling Those search result helped us in finding the various articles towards certain asset or stock. For instance, shares gifted describing the relationship between different behavioural by a father to his son and the son develops an emotional biases and investment decision-making of investors. This feeling towards the stock which compel him to retain it particular paper includes those research articles which had with him even if the stocks aren’t doing well in current studied various emotional biases in their study and had drawn market scenario.Panel data analysis is an increasingly conclusions accordingly. The literatures reviewed for the popular form of longitudinal data analysis among social current paper includes both on individual investors and and behavioral science researchers. A panel is a cross- institutional investors. This study includes the articles on the section or group of people who are surveyed periodically pertaining topic from the evolution stage of the concept of over a given time span. Panel methods will be behavioural finance [2] till the most recent study on emotional summarized along with their related disadvantages and bias affecting the decision making of the investors. The advantages. present research paper has followed certain criteria for selecting the articles for the current study. The research articles selected for the purpose of reviewing are as follows: 3 RESEARCH QUESTIONS  Does emotional biases such as overconfidence, loss- aversion bias, home bias and endowment effect has any  The article should have been published in a peer- impact on investers’ investment decision-making ? reviewed journal,  What is the impact of above said emotional biases on  The research article must have been published in Indian investor’s investment decision- making ? English language with full-text access,  Only those articles have been taken into consideration which have studied one or more 4 RESEARCH OBJECTIVE emotional biases in their study The objective of the present research article is to address the various emotional biases such as overconfidence, loss-  Research articles having the above said keywords in aversion, home bias and endowment effect that have influence their studies have been taken into consideration for on investors’ decision making by reviewing various literatures this study available in the above context. This research will review only those papers which have studied one, two or multiple biases. We have taken only those articles for this study which have fulfilled the above laid criteria. Articles with the help of above 3458 IJSTR©2020 www.ijstr.org INTERNATIONAL JOURNAL OF SCIENTIFIC & TECHNOLOGY RESEARCH VOLUME 9, ISSUE 03, MARCH 2020 ISSN 2277-8616 keywords had been searched thoroughly throughout the different context. internet and had been included in this study. Around 125 articles have been reviewed and out of those only 22 articles 9 CONCLUSION have been found relevant within the said context. Most of the Behavioural finance can be proved beneficial in many ways. articles reviewed have been found to be based on secondary This would not only help the individual investors in their data analysis. investment decision but also the financial advisors, issuing companies and financial intermediaries could be able to 7 RESULT AND ANALYSIS understand the movement of the market performing in a Most of the research papers found in the area of behavioural certain way. They would be able to clear out their doubts by finance have pointed out towards the existence of various properly understanding this phenomenon and be able to take behavioural biases in their studies. They have concluded that better financing and investment decision. A thorough most of the times investor’s investment decisions are understanding of these emotions, sentiments, moods involves influenced by behavioural biases. Investors do fall prey in the human behaviour would make investors understand the trap of emotional biases and take wrong investment decisions market behaviour better. This would also help them to detect which make them suffer losses too. Past literature shows that the mispricing of securities and help them to take their overconfidence, home bias does influence the investors’ investment decision accordingly. Thus it has become very decision [10]. Overconfidence leads investors to take necessary to study these biases thoroughly to make the excessive risk which in turn makes them less cost efficient decisions correctly which would entail a maximum benefit to [11], [20]. Among investors, overconfidence bias seems to be the investors. The outcome of this research work provides a dominant, and hence, investors may tend to be more clear insight to the future researchers about the types of overconfident rather than more loss-averse [12], [13], [19], researches happening on this area and the need of research [22]. Basing upon the past literatures, it has also been seen to be done on other different dimensions of the same area. that investors are also get influenced by home bias and there More researches are required on the unpopular biases such exist a strong association between the cultural factor and as home bias, endowment effect bias in order to know the true home bias [13], [14], [15], [16]. From the literatures reviewed impact of such biases on the investors’ decision-making. for this present paper, following table has been prepared to see the frequency of the studies done on a particular 10 RESEARCH IMPLICATION emotional bias in the given context. The present paper offers direct implications to the individual investors as well as institutional investors as the various Table 1 emotional biases discussed above have a direct impact on STUDIES ON EMOTIONAL BIASES their investment decisions. This also offers an indirect implication to the policy makers and economic advisors as Sl. Emotional biases No. of time these biases could affect wherever decision-making is no. studied 1. Overconfidence 10 involved. This paper helps in making them aware of such 2. Loss -aversion 07 biases so that decision can be taken without any bias or with 3. Home bias 03 minimum influence of bias in it. 4. Endowment effect 02 Total 22 REFERENCES [1] Parker, T. (2019, November 18). 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