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Influence of Loss Aversion Bias on Investments at the Rwanda Stock Exchange

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http://www.ijssit.com Vol III Issue IV, June 2017 ISSN 2412-0294 INFLUENCE OF LOSS AVERSION BIAS ON INVESTMENTS AT THE RWANDA STOCK EXCHANGE 1* Jacob Niyoyita Mahina 2** Dr. Willy M. Muturi 3*** Dr. Florence S. Memba Jomo Kenyatta University of Jomo Kenyatta University of Jomo Kenyatta University of Agriculture and Technology Agriculture and Technology Agriculture and Technology [email protected] [email protected] [email protected] Abstract With the emergence of behavioural finance as an alternative to analysis of investor choice, Behavioural biases have been identified to affect the investor’s investment. It was therefore useful for investors to understand common emotional behaviours, from which they justify their reactions for better returns. The main objective of this study was to establish the effect of behavioural biases on investment in the Rwanda Stock Exchange. The specific objective was to establish the effects of loss aversion bias, on investment in the Rwanda stock exchange. The prospect theory, heuristics theory and herding theory formed the foundation of this study. The underlying epistemology of this research was positivist; focusing on examining earlier established theories under the assumption that reality is objectively given and can be described by measurable properties independent of the observer and the instruments. The study used cross- sectional descriptive survey research design to ascertain and establish the effect of behavioural biases on investment in the Rwanda stock exchange. A Linear regression model was used to predict the probability of different possibility outcomes of dependent variables, helping to predict the probability of an investor to invest in RSE. The results confirmed that there was a significant positive linear relationship between loss aversion bias, and Investment in Rwanda stock market. The study also concluded that most investors suffered from behavioural biases in investment in stock markets. The study further recommends that the individual investors to seek the advice of stock brokers/fund managers to advise them accordingly in terms of performance of a specific security in which an investor would wish to invest in. Keywords: behavioural biases, stock exchange © Niyoyita, Muturi, Memba ISSN 2412-0294 1917 INTRODUCTION faulty cognitive reasoning or emotions that Behavioural finance is the new field that seeks to affect individual financial outcomes has seen the combine behavioural (aspirations, cognition, emergence of research on behavioural finance as emotions) and cognitive psychological theory. It a concept. Singh (2010) stated that investors explains why investors makes a rational may be inclined toward various types of financial decisions on the stock market (Lodhi, behavioural biases, which lead them to make 2014). Behavioural finance attempt to better cognitive errors. People may make predictable, understand and explain how emotional and non-optimal choices when faced with difficult cognitive errors influence investment on the and uncertain decisions because of heuristic stock markets (Subrahmanyam, 2008). The stock simplification. Behavioural biases, abstractly, markets are able to positively influence the are defined in the same way as systematic errors economic growth through encouraging savings are, in judgment (Chen et al, 2007). amongst individuals and providing avenues for According to Shefrin (2007) bias is nothing else firm financing. Liquid stock markets may yet the inclination towards failure. Bias is improve the allocation of capital and enhance tendency to make decisions while the decision prospects for long-term growth ( Wasiu & maker is already being subjected to an Temitope, 2013). Investment is not an easy underlying credence or belief. There are so many process, since the assumption is that investors biases in human psychology (Shefrin, 2010). always expect to maximize the returns although These biases lay impact on individuals in such a not all investors are so rational (Sukanya & way that they frequently deed on an obviously Thimmarayappa, 2015). silly way, routinely disregard conventional ideas The traditional theory of finance assumes that of risk aversion, and make foreseeable lapses in people are guided by reason and logic and their conjectures and judgments (Sewell, 2007). therefore view investment through the Investment on Stock Markets in Africa transparent and objective lens of risk and return. African stock markets have historically offered a It argues that markets are efficient and therefore limited, narrow range of products with the security prices are an unbiased estimate of their principle role of financial sector being the intrinsic value. Behavioural finance recognizes provision of the source of domestic funding to that emotions, herd instincts and social offset government budgetary deficits. Common influences play an important role in influencing factors still inhibiting stock market development investment leading to discrepancies between include the lack of legal protection for investors market price and fundamental value. Investor and creditors (Odera, 2012). Prices in the behaviour looks at how behaviour impacts the African stock markets tend to be highly volatile investment performance (Nyamute, Lishenga & and enable profits within short periods. Critics Oloko, 2015). point out that the actual operation of the pricing Pompian (2012) defines behavioural biases as and takeover mechanism in well-functioning the tendency of decision making that result in stock markets lead to short term and lower rates irrational financial decisions caused by faulty of long term investment (Mbaru, 2003). This is cognitive reasoning and /or reasoning influenced because prices react very quickly to a variety of by emotions. The interest in biases caused by © Niyoyita, Muturi, Memba ISSN 2412-0294 1919 information influencing expectations on in 2008. It is the principal stock exchange financial markets (Mahonye, 2014). operating under the jurisdiction These problems are further magnified in of Rwanda's Capital Market developing countries especially sub-Saharan Authority (CMA), previously known as Capital African economies like Rwanda, with their Markets Advisory Council (CMAC), which in weaker regulatory institutions and greater turn reports to the (MINECOFIN) Ministry of macroeconomic volatility (Bizimana, 2010). The Finance and Economic Planning (Babarinde, higher degree of price volatility on stock 2012). markets in developing countries reduces the Currently RSE has only three Initial Public efficiency of the price signals in allocating Offering (IPO), Bralirwa, Bank of Kigali and investment resources. These serious limitations Crystal Ventures as primarily listed in Rwanda of the stock market have led many analysts to and four IPO as secondarily listed in Rwanda question the importance of the system in includes: Kenya Commercial Bank promoting economic growth in African countries Group and Nation Media Group, which are (Dailami & Atkin, 1990). primarily listed in Nairobi Stock Exchange and Some of the common mistakes made by cross listed on the Rwanda Stock Exchange investors in designing their investment are (Kidd, 2012). Uchumi Supermarkets and identified as follows: investors fail to design Equity are primarily listed on the Nairobi Stock their investment avenues systematically; Exchange and are cross listed on the Rwanda investors fail to diversify their investment choice Stock Exchange starting from 2014. Equity (Sukanya & Thimmarayappa, 2015); Group Holdings Limited is primarily listed on Behavioural motivations have been advocated as the Nairobi Stock Exchange (2006) and cross a main driving force in investment choice in listed on the Rwanda Stock Exchange starting Africa and the world at large. Nielsen & Riddle from 2015. The RSE operates in close (2009) shows that irrational behaviours among association with the Nairobi Stock Exchange in investors do exist and collectively this Kenya, the Dares Salaam Stock irrationality can affect the movement of the Exchange in Tanzania and the Uganda Securities stock market. According to Kumar & Goyal, Exchange in Uganda since regional integration is (2015), markets and market agents are efficient only one aspect of the financial policy agenda and systematic. Investors have to choose a for Africa (ADB, 2012). course of action among various alternatives in Statement of the Problem the world of uncertainty. The government of Rwanda has a goal to Rwanda is one of the youngest stock market in develop the economy by 2020 therefore it has to East Africa compared to the other markets in encourage participation and growth of the stock EAC, like Nairobi Security Exchange (NSE), market, thereby facilitating the growth, flow, with a small number of listed companies and low and regulation of the stock market (Mauwa, market capitalization, an indicator of low Stock 2016). The government has ensured that Market development (Bizimana, 2010). investors in the Rwanda Stocks Exchange are The Rwanda Stock Exchange Limited (RSE) protected, by advising and guiding companies was incorporated in 2005 and launched officially seeking investment through provision of © Niyoyita, Muturi, Memba ISSN 2412-0294 1920 important infrastructures and conducive Minh Stock Exchange. The variables studied environment for business development (Mauwa, were herding, market, prospect, overconfidence- 2016). gamble’s fallacy, and anchoring-ability bias. No Despite these efforts, investment in the Rwanda study on effects behavioural biases
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