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Review of Behavioral Finance

Factors influencing investor’s decision making in Pakistan: moderating the role of locus of control
Muhammad Haroon Rasheed, Amir Rafique, Tayyaba Zahid, Muhammad Waqar Akhtar,
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Factors influencing investor’s decision making in Pakistan: moderating the role of locus of


1. Introduction

The stock market is a place where the sale and purchase of stocks occur. For any economy, the

stock market acts as a source of financing the investments of business organizations (Samuel,

1996). Stock markets are also considered to be the yardsticks for the economic strength and

development of a country. Therefore, the movements of the stock market or the trend of the
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market represents the economic health of a country. A rise in share prices is said to be a positive

sign for an economy (Jaswani, 2008). Pakistan is an emerging economy and, according to

Bloomberg, the stock market in Pakistan is the best performing market in Asia in 2016 and the

fifth best performing market globally. The stock exchange in Pakistan has recently announced to

regain its emerging market status from the MSCI's All Country World Index (ACWI) (Faseeh

Mangi, 2016). Investors worldwide are looking for stock markets that are less affected by the

interest rate cycle in the U.S. and the economic slowdown in China. For them, Pakistan is an

outstanding place in which to invest (Faseeh Mangi, 2016), with investors across the globe

eyeing Pakistan for future ventures, it is of vital significance to study and understand the

behavior of investors operating in the Pakistan stock market and the factors influencing their

investment behavior.

According to conventional theories of finance, investors are perfectly rational and act as

wealth maximizers in financial decisions (Markowitz, 1952). However, when we observe the

decision making of investors in real life, we see that, in fact, investors do behave irrationally.
Behavioral finance, by using theories of psychology and finance, helps us to identify the reasons

for such deviations from standard finance theories.

The aim of any investor is to gain maximum benefit, and in order to achieve that, investors

analyze the capital market situation and have a vigilant eye on market determinants and


Nonetheless, investors’ emotions, feelings, and intuition influence their decisions and can result

in irrational behavior (Kahneman and Tversky, 1979). The investor’s psyche also has a strong
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effect on investment decision making, which is why they can behave irrationally (Zaidi and

Tauni, 2012). Emotions and psyche are major factors that cause biases in investment decision

making. Biases are defined as predispositions towards error (Shefrin, 2007) and investors are

prone to a number of biases, errors, and illusions while making decisions due to lack of

capability in processing the complete information (Shefrin, 2009). Those errors and biases can

also be caused by investor’s use of some mental shortcuts, also known as heuristics (Slugoski et

al., 1993).

“A heuristic is a strategy that ignores part of the information with the goal of making

decision more quickly, frugally and/or accurately than more complex methods” (Gigerenzer and

Gaissmaier, 2011). Heuristic principles are rules of thumbs, or mental shortcuts, which help

investors to make a decision without doing a complex probability assessment and then predicting

values affiliated with a certain decision. These heuristics lead an investor towards severe and

systematic errors in their decisions (Tversky and Kahneman, 1974), hence causing them to

behave irrationally. In this study, our main focus is on the two most commonly used heuristics in

decision making, namely representativeness and the availability heuristic (Tversky and
Kahneman, 1974). Another reason for selecting these two heuristics for our research is that the

effects of these heuristics are not limited to the layman only, but also apply to experienced

investor (Tversky and Kahneman, 1974). It is not surprising that investors use these heuristics in

their decision making; what is, however, odd is that investors with knowledge and lifelong

experience in their field fail to utilize that knowledge and experience in application of

fundamental statistical principles for rational decision making and instead use these heuristics for

forming their decisions. Their mindset is such that they are not willing to accept rational analysis

and instead use heuristics, leading to irrationality (Moser, 1989).

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In this study, we will also see the moderating effect of the locus of control on the relationships

between investment decision making and both representative and availability biases. It is human

nature to think that one’s own personal involvement may change the results but, in reality,

human memory is not reliable and the chance of error always exists (MacLeod and Daniels,

2000). Another factor is that people think that an outcome happens due to their own personal

effort and that is why they tend to rely on their own intuition (Coleman and DeLeire, 2000),

hence causing them to rely more on heuristics.

The purpose of the present study is to theoretically and empirically explore the effect of

representative and availability biases on investment decision making and to test the interaction

effect of the internal locus of control with the said relationships using data collected from

investors operating in the Pakistan stock market (PSX). Our research is a pioneering study in

Pakistan in this context.

2. Literature Review

This section comprises the theoretical background upon which the proposed model is based.
2.1 Investment Decision Making

Investment is the action or process of investing money with the hope of future benefit. Investing

through research and by keeping a clear mind can lead to success. Every investor wants to get

maximum return from their investment. Sharpe (1964) explained the maximum level of risk for a

specific level of return to compare decisions from a benchmark position. In the past few decades,

some research has indicated that optimal and rational decision making is dependent on

knowledge of finance; the more a person has knowledge of finance, the more rational a decision
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will he make (Merton, 1987). However, research over the past two decades has highlighted the

behavioral phenomenon of the investors psyche through “cognitive unconsciousness,” which

relates to having perceptions, memories, and thoughts without awareness, and has used this to

describe the reason why sane investors make errors in investment decisions (Hilton, 2001).

Investors thoughts and feelings can change the decision making process from rational to

irrational (Baker and Nofsinger, 2002).

According to conventional theories of finance, investors are perfectly rational, but in the

actual world, they are affected by many factors, including psychological and behavioral, that

hinder the process of rational decision making. Behavioral finance attempts to explore the

reasons for this by linking different aspects of human nature with financial models (Barber and


1999), and some results indicate that, at times, investors do not display informational efficiency

(Ritter, 2003). Due to these factors, investors are not always rational and their decisions are

affected by behavioral preconception; therefore, in order to gain a better understanding of

investors in the real world, it is of vital importance to study investment decision making under

the theories of behavioral finance.

2.2 Representative Bias and Investment Decision Making

Representativeness can be explained as the degree of similarity that an event has with its parent

population (DeBondt and Thaler, 1995). This heuristic can be observed when a person is willing

to generalize about another person or phenomenon, including stocks, based on only a few

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(Bazerman and Moore, 2012; Nisbett and Ross, 1980). This is because investors use mental

shortcuts and rules of thumb to make investment decisions and may invest in a company only on

the basis of its characteristics, such as type of management, historical returns, or popularity, etc.

However, such pattern recognition can be weak due to the neglect of any supporting evidence.

Investors prone to representativeness may make biased decisions: for example, they may place

too much weight on recent experience and ignore the average long-term rate (Ritter, 2003).

Representativeness can also cause investors to wrongly infer the long-term growth rate of the

company by focusing on recent increases (Waweru et al., 2008). Representativeness also leads

investors towards irrational decisions by making them overreact, which occurs when investors

tries to buy “hot” stock instead of that which is poorly performing (DeBondt and Thaler, 1995).

Since the mid-20th century, with the emergence of behavioral finance, research has provided

ways to make investment decisions based on facts rather than probability. Ideally, investors

should calculate financial ratios to calculate future expected returns from the investment,

although they, in fact, consider the probability of a particular outcome using their previous

experience (Gold and Kraus, 1964), hence wrongly inferring that large firms with previous high
levels of returns will also generate high returns into the future (Jacobson, 1994). Complex

decision making in high uncertainty environments is often based on intuition, and the role of

intuition is crucial in most financial decisions (Kahneman and Riepe, 1998). However, decisions

based on intuition are often irrational and biased because they are not based on a complete

analysis of all of the available information but rather on gut feelings and heuristics (Simon,


Investors believe that their previous experiences and decisions were mostly correct, and on
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the basis of their prior experience they will make rational decisions in the future also (Rosman et

al. O’Neill, 1994), causing investors to become stuck in the same patterns of investment over and

over again, as a result of which they do not have a vigilant eye on the current scenario (Prechter

Jr, 2001). Rational investors know that a rigorous analysis is required before investment decision

making but nonetheless have a tendency to rely on past experience, which is alarming in

financial markets (Shimizu, 2007). Investors in the capital market do not act as they should,

which is to act rationally and without considering their previous experience (Filbeck et al., 2005).

Over the past few years, researchers have been trying to highlight some of the factors of

investors’ representativeness behavior and how this causes irrationally. Investors of the modern

era are greatly tempted by reputation and the celebrity effect of a firm (Pfarrer et al., 2010). A

commonly repeated phenomenon is that of looking backwards instead of looking forwards, but

investors fail to realize that future outcomes can vary from their past experiences (Arrfelt et al.,

2013) and also the reputation of firms in which investors are going to invest sometime leads

investors to make decisions on the basis of the prior performance of the firm (Petkova et al.,
2014). All of these phenomena are caused by representativeness and often lead investors to select

a suboptimal alternative. Hence it is proposed that:

H1: Representative bias is significantly and positively associated with the degree of

irrationality in investment decisions.

2.3 Availability Bias and Investment Decision Making

Availability bias is a bias in which the decision maker relies on knowledge that is readily

available rather than examining other alternatives and procedures. That is why it causes decisions
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to be irrational (Folkes, 1988). It can be observed in investors when they prefer to invest in local

companies with which the investor is more familiar or where information about them can be

easily obtained (Waweru et al., 2008). Decision makers in the capital market are also influenced

by the information and they give more weight to people-oriented information (Haley and Stumpf,


Another effect of availability bias is that it can cause an investor to wrongly believe that a stock

perceived to have a good return will have a low risk and that securities perceived as bad will be

judged to be of high risk and low return (Ganzach, 2000), leading to suboptimal decisions.

From the later 20th century onwards, researchers have investigated important factors that

may cause availability bias, due to which, based only on partial information, investors change

their investment decisions. Information such as a change of executives and management of firms,

or the appointment of new CEO of the company, can cause their investment decisions to change

(Lubatkin et al., 1989). Investors sometimes make decisions without taking into consideration the

correct and relevant information (Scharfstein and Stein, 1990). Furthermore, in the case of
financial crises, investors have to suffer more than the market due to their reactions based on

availability bias (Marcus and Goodman, 1991). This is because investors overreact in a negative

manner when they hear announcements about securities and layoffs (Worrell et al., 1991),

leading to irrational decisions.

Investors are found to choose only those stocks that have recently caught their attention

from the news or those trading abnormally or offering extreme returns (Barber and Odean,

2008). Sometime investors’ decisions change through keen observation of just the actions and
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news leaked by representatives of the stock exchange (Stearns and Mizruchi, 1993), resulting in

overweighting or underweighting of such information.

Information about stock exchange gains/losses and the macro economy influence the

decisions of investors (Bulmash, 2001).The way in which information is reported in the financial

market and the role of intermediaries also play vital roles in altering investment decisions and

have a great influence on investors’ mindset (Healy and Palepu, 2001). Investors’ preferences

change according to the available information (Harris and Raviv, 2005), leading to a particular

pattern of investment, and sometimes even irrelevant information also influences investment

decisions (Kirchler et al., 2005). On the basis of recently available information, the risk taking

behavior of investors about particular security also changes (Grable et al., 2004), as do their


Investors compare the performance of a given firm with the performance of a peer, and

they react based on the information about the performance of securities (Brauer and Wiersema,

2012). This information can change the portfolio selection of investors towards liabilities instead

of assets that are beneficial for the investor (Wang et al., 2014), as instead of accessing and
evaluating all the information, investors use only the most recent or available information.

Competition among investors compels investors to react quickly to available information

(Bowers et al., 2014) and instead of making rational judgments, they depend on shortcuts like the

availability heuristic that will lead towards irrational decisions. Hence it is proposed that:

H2: Availability bias is significantly and positively associated with the degree of

irrationality in investment decisions.

2.4 Moderating role of internal locus of control

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When a person believes that the desired outcome occurs due to his/her own abilities, this is called

the internal locus of control. In contrast, if a person thinks the positive result is due to external

factors, such as luck, chance, fate and, powerful others, than this is called an external locus of

control (Selart, 2005). In our study, we incorporated the internal locus of control as a moderator.

A variable acting as a moderator is said to be one that can alter the form or strength of the

relationship between the predictor and criterion variable (Sharma et al., 1981). As per the rules

set by Baron and Kenny (1986) for moderation, we will analyze the effect of the interaction term

on the relation between heuristics biases and decision making. The role of the locus of control in

investment decision making relates to the extent to which the locus of control impacts on

investors decisions (Szilagyi et al., 1976).

Investors will be greatly motivated towards certain decisions if they think the situation is in

their own control. The locus of control is an important behavioral factor and is incorporated in

studies of the factors influencing ethical decision making (Özbek et al., 2013) and in consumers’

purchasing decisions. Consumer decision making is similar to investment decision making as an

investment is also a purchase decision, but of capital assets ( Kazemi et al., 2015); however, there
has been no significant research in the field of Investment decision making. Hence, there is a

need to explore its effect in the field of finance as it can provide a significant understanding of

the differences in the behavior of investors. Modern researchers have found that the locus of

control provides a strong explanation for future outcomes (Hiller and Hambrick, 2005) and can

explain difference in investors’ behavior as there are differences in the level of the locus of

control among investors of collectivist and individualist societies (Spector et al., 2002). An

investor’s interpretation of their personal abilities to control the outcome is also affected by the

nature of the investment and the time horizon (Lam and Schaubroeck, 2000). The effect of the
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locus of control is not limited to individual investors only: decision makers at the executive level,

such as managers and executives, also indulge in this phenomenon of believing that the outcomes

of all actions are under their control (Boone et al., 1996).

Some investors do not know their abilities (Gervais and Odean, 2001) and become overly

risk averse, whereas some investors overestimate their abilities and believe that they can control

or change market conditions (Allen and Evans, 2005). Such investors believe they are better than

average (Kaustia and Perttula, 2012), which will lead them to an increased degree of irrationality

in their investment decisions.

Investors with an internal locus of control do not perform well as they do not consider helpful

information in making their decisions (Boone and Van Witteloostuijn, 2005). An Investor will be

said to have an internal locus of control if they attribute the cause and control of an investment

outcome to be within their power, and this certainty about controlling the outcome will lead an

investor to act upon their intuition or gut feeling instead of relying on rational analysis. Investors

with an internal locus of control will consider their decision outcomes to be within their control
(Selart, 2005) and will be more self-centered towards their decision making; hence, an absence of

willingness in investors to accept their errors of judgement will lead such investors to biased and

irrational decision making (Davis and Bobko, 1986). Based on the discussion above, it can be

inferred that the greater the degree of internal locus of control an investor has, the more he will

rely on decisions based on heuristics; hence, the present study is of the view that the presence of

an internal locus of control will lead investors towards more biased and irrational investment

decisions. Therefore, it is proposed:

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H3: Internal locus of control moderates the relationship between representative bias and

investment decision making.

H4: Internal locus of control moderates the relationship between availability bias and

investment decision making.

2.5 Theoretical framework

Figure 1. Theoretical Framework

3. Research methodology

In this study, a framework is proposed as shown in figure 1 to explore the factors influencing

investment decision making. First, this study examines the relative explanatory power of

availability bias and representative bias for the degree of irrationality in financial decision

making, and second, it will examine the interaction effect of the locus of control.

3.1 Questionnaire Design

The questionnaire consists of two parts. The first part comprises descriptive questions, including
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gender, marital status, age, and investment experience. The second part consists of adapted

measures to identify availability and representative heuristics along with the locus of control and

decision making method. In this part, a 5-point Likert scale is used, which is the most widely

used scale. Given below are the details of the items used in the instrument.

3.1.1 Availability Heuristics. This measure consists of five items, the first two of which

are adopted from a 10-item scale to measure heuristics and biases by Kudryavtsev et al. (2013).

The third and fourth items of the measure are from Luong and Thu Ha (2011), whereas the fifth

item is from Waweru et al. (2008).

3.1.2 Representative Heuristics. This measure consist of six items, of which the first three

questions identify the degree of representativeness in investors using a 27-item instrument from

Sarwar et al. (2014). The fourth and fifth items are from Waweru et al. (2008), whereas the last

item for measuring the representative heuristic in investors is from Luong and Thu Ha (2011).

3.1.3 Locus of Control. The items to measure the internal locus of control in investors are

adapted from an instrument developed by Furnham (1986). For our research, we have adapted

eight items that deal with the internal locus of control.

3.1.4 Decision Making. The measure we used for measuring decision making is by Scott

and Bruce (1995), from which we only incorporated intuitiveness in our questionnaire as a proxy

for the degree of irrational behavior in decision making.

3.2 Sample

In our study, we distributed 300 hundred questionnaires among the investors. This sample size is

large enough to fulfil all the statistical requirements and this was also confirmed by reviewing
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various studies conducted on similar topics in different environments, such as those of Waweru

et al. (2008), Kudryavtsev et al. (2013) and several others, in which the sample size ranged from

170 to 230.

The convenience sampling technique was used to select the respondents, as it can give the

highest rate of response. It also saves time and resources (Bryman and Bell, 2015), and in the

given circumstances and constraints of our research, this method is best suited due to the

unknown population. The sample was selected by identifying brokers at the stock market and,

after gaining their consent, approaching their clients to complete the questionnaires.

The survey was conducted among investors operating in the cities of Islamabad, Lahore,

and Sargodha. The questionnaires were distributed among the investors at different brokerage

offices in these cities. Of the 300 questionnaires distributed, 271 were returned, of which 227

were considered for the final analysis; the remaining 44 were discarded due to missing values

and unclear or dual selection among the given options. The demographic distribution of the

sample is shown in Table I.

Table I. Demographic Distribution

Characteristics Frequency Percent

Marital Status
Married 111 48.9
116 51.1
Gender Male
201 88.5
Female 26 11.5

18 to 25 24 10.6
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26 to 33 85 37.4
34 to 41 60 26.4
42 to 49 42 18.5
50 & Above 16 7.0

Investment Experience 0-5

Years 94 41.4
6-20 Years 107 47.1
21 Years & Above 26 11.5

Intermediate 7 3.1
Bachelors 96 42.3
Masters 110 48.5
M.Phil. 7 3.1
Others 7 3.1

3.3 Reliability and Validity

To ensure the content-related validity of the items, as per the context of our study of the adapted

instrument compiled, our method has been reviewed and tested by a two academic experts. To

ensure that the language of the questionnaire was clear for the investors, the instrument was

reviewed by a broker, an investment banker, and an expert in English language, together with a
three investors. Their opinions and suggestions were incorporated as far as possible without

affecting the nature of the questions, after the review by the academic experts. To examine the

construct validity, explanatory and confirmatory factor analyses were used. The convergent and

discriminant validity of the instrument were ensured, pursuant to the criteria of Campbell and

Fiske (1998), by using confirmatory factors analysis. The results of the analysis showed that all

the correlations are greater than zero and may be considered convergent valid. According to

Campbell and Fiske (1998), discriminant validity is established by counting the number of times

an item correlates higher with items from other factors than with items from its own factor,
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which should be above 50 percent; this was also fulfilled, showing our instrument to be both

convergent and discriminant valid.

A pilot study was also conducted to analyze reliability, using data from 30 investors. The

reliability was assessed using Cronbach’s alpha. All of the values were well above 0.70, enabling

us to conclude that the instrument is fit for further analysis. Cronbach’s alpha is a measure of

internal consistency (Nunnally et al., 1967) and its value should be greater than 0.70, which in

our case was also achieved for the overall sample, as shown in Table II below. The criterion

validity of the instrument used is also considered satisfactory as the item to total correlation is

above 0.60 (Kerlinger and Lee, 1999).

Table II. Reliability Analysis

Variable/Items Cronbach’s Alpha

Availability Bias 0.708

Representative Bias 0.710
Locus of Control 0.757
Investment Decision Making 0.701
4. Empirical Analysis and Results
The data collected through the survey was tested using the SPSS and AMOS software after

removing any questionnaires with missing values. The structural equation modeling technique

was used for testing the proposed relationship: this is a multivariate statistical technique for

testing structural theory (Tan, 2001), incorporating both observed and latent variables.

4.1 Correlation Analysis

The data were gathered using convenience sampling, a type of non-probability sampling that
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causes the data to be non-normal, which is confirmed through the test of normality in SPSS.

Spearman’s correlation analysis was conducted to analyze the direction and strength of the

relations among the variables, the results of which are reported in Table III.

Table III. Correlation Analysis

Availability Bias Representative Bias Locus of Control Decision Making
Availability Bias 1.000
Representative Bias .106 1.000
Locus of Control .141* .444** 1.000
Decision Making .433** .192** .462** 1.000
*. Correlation is significant at the 0.05 level (1-tailed).
**. Correlation is significant at the 0.01 level (1-tailed).

4.2 Impact of Availability and Representative Bias on Investment Decision Making

To analyze the effect of availability bias and representative bias on decision making, we

employed structural equation modeling (SEM), which uses the maximum likelihood method to

estimate the regression weights of the independent variables on the dependent variable. The

results calculated using AMOS are shown in the figure 2 below.

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Figure 2. Structural Equation Modeling

The findings shown in Figure 2 demonstrate that there is a positive relationship between

representative bias and decision making and also between availability bias and the decision

making of investors.

Table IV. Structural Equation Modeling

Relationships: (Unstandardized) Estimates S.E. C.R. P-Value

1- Decision Making <--- Availability Bias .767 .179 4.279 0.000

2- Decision Making <--- Representative Bias .253 .128 1.975 0.048

Relationships: (Standardized) Estimates S.E. C.R. P-Value

1- Decision Making <--- Availability Bias .558

2- Decision Making <--- Representative Bias .190

Table IV shows that the effect of availability bias on investors irrational or intuitive

decision making is significant, such that a one-unit increase in the level of availability bias will

result in an increase in irrationality of β=0.767 (p<0.01). This means that the more an investor

has availability bias, the more irrational they are in decision making, hence proving Hypothesis
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The relationship between representative bias and irrational decision making is also

significant and has a positive effect: as can be observed in the table IV, a one-unit increase in the

level of representative bias will lead to an increase of irrationality of β=0.253 (p<0.05), hence

also proving Hypothesis 1.

Goodness of fit of the SEM was verified using different finesses as calculated by AMOS. The

goodness of fit index (GFI) = 0.926 and the comparative fit index (CFI) = 0.920, of a maximum

value of 1 for the indices: the values should be as close to 1 as possible, and values above 0.90

are considered as good, while those above 0.80 are acceptable (Tsai and Ghoshal, 1998), The

value of CMIN/DF=1.491: this is a ratio of the chi-square and degrees of freedom, which should

be below

2 and is also acceptable at a value below 3 (Koufaris and Hampton-Sosa, 2002). The value of the

root mean square of the error of approximation (RMSEA) value is also below 0.5; hence, all the

criteria fulfil the prerequisites of a statistically fit model.

4.3 Moderation of Locus of Control
To test, through regression, the proposed moderation of the internal locus of control according to

the rules set out by Baron and Kenny (1986), two new variables were created in the data set, first,

by taking the product of the availability bias and the locus of control (A.BxLOC) and, second, by

multiplying the representative bias with the locus of control (R.BxLOC). These newly created

variables are also known as interaction variables.

4.3.1 Moderation of Locus of Control with Availability Bias. The Table V below show

moderation regression results that the effects of availability bias (β=-0.078, p=0.900) and locus
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of control (β=0.171, p=0.793) are insignificant. The interaction term of these variables is also

insignificant (β=0.091, p=0.543), negating any moderating relationship of the locus of control

between availability bias and investment decision making, as proposed by Hypothesis 3.

Table V. Moderation of Locus of Control with Availability Bias

Independent Variables Model 1 Model 2

Beta S.E T P Beta S.E T P

Availability Bias .300 .049 6.116 .000 -.078 .623 -.125 .900

LOC .567 .069 8.219 .000 .171 .653 .262 .793

A.BxLOC .091 .149 .609 .543

0.001063 .543
R Square Change
a. Dependent Variable: Decision Making
b. LOC=Locus of Control
c. A.B=Availability Bias

It can also be seen that, in Model 2, there is no significant change in the R square value, which

change is very low and thus insignificant.

4.3.2 Moderation of Locus of Control with Representativeness Bias. The table VI below

show moderation regression results that the representative bias (β=-0.480, p=0.383) and locus of

control (β=-0.185, p=0.711) are not significantly associated with investors’ decision making. The

interaction term of both variables is also insignificant (β=0.118, p=0.363), showing that the

relationship between representative bias and decision making is not being moderated by the locus

of control; hence, Hypothesis 4 is rejected. The value of the change in R square is also very low.

Table VI. Moderation of Locus of Control with Representative Bias

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Independent Variables Model 1 Model 2

Beta S.E T P Beta S.E T P

Representative Bias .016 .060 .266 .790 -.480 .548 -.876 .382

LOC .634 .077 8.191 .000 .185 .499 .370 .711

R.BxLOC .118 .129 .911 .363

R Square Change 0.002766 .363

a. Dependent Variable: Decision Making
b. LOC=Locus of Control
c. R.B=Representative Bias

The summary of testing the hypotheses of the study is given in Table VII. There was a

significant relationship found between decision making and both availability bias and

representative bias. These results are in line with the studies of Waweru et al. (2008) and Bashir

et al. (2013). These results also affirm that investors in Pakistan are also affected by different

behavioral factors; hence, study of these factors can provide great insight into understanding the

behavior of investors in Pakistan.

These results imply that investors’ decisions in Pakistan are driven by the most current or

easily available information and that they rely on information from friends and family without

any verification

Investors also use similar or stereotyped information in making their investment decisions and

they prefer to buy local stocks. Investors in Pakistan, also due to the effects of these heuristics,

wrongly believe that stocks of good companies will lead to a higher return. These two heuristics

lead investors to fail to diversify their portfolios. It is recommended for investors to evaluate the
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degree of bias they themselves have and then to make financial decisions by keeping that in

mind. They should, after investigating the information from the market, dually verify the facts

and figures.

Table VII. Hypothesis Results

No. Hypothesis Results

1 Supported
Representative bias is significantly and positively associated
with degree of irrationality in investment decision making.
2 Availability bias is significantly and positively associated Supported
with degree of irrationality in investment decision making.

3 Internal locus of control moderates the relationship between Rejected

representative bias and investment decision making.

4 Internal locus of control moderates the relationship between Rejected

availability bias and investment decision making.
Thus, Hypotheses 3 and 4 were not supported. One explanation for this insignificant

moderation of locus of control could be that the traits of the sample used in each study, such as

personal characteristics, vary from culture to culture. In prior studies, investors in the Asia region
have been found to be more overconfident as compared to western investors (Chuang et al.,


Lin and Ding, 2003; Özbek et al., 2013).

Another possible explanation for these results could be that the relationship between

heuristic biases, including availability bias and representative bias, and investment decision

making is not personality specific (Lin and Ding, 2003), as in a bias caused by heuristics,

investors rely on the mental shortcuts developed through knowledge and experience (Gigerenzer

and Gaissmaier, 2011).

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5. Conclusion and Discussion

The main focus of this study was the effects of availability and representative bias on investment

decision making, which are caused by the reliance of investors on their heuristics (Tversky and

Kahneman, 1974). These heuristics cause decisions to be irrational or suboptimal, even though

investors have basic knowledge of standard finance and know the reward value associated with

rational decisions. Still, as discussed earlier, the effects of these biases are not limited to the

layman only but also apply to experienced and highly educated investors. These two heuristics

are the most commonly used in decision making, but their use leads to errors in prediction and

estimation during decision making.

The results suggest that investors at the Pakistan stock exchange (PSX) are influenced by

both representativeness and availability bias. The investors prefer to buy only those stocks for

which more information is available to them instead of doing a complete analysis of all the

available and relevant information, and they invest in stocks only on the basis of the similarity of

their characteristics with their expected performance. Investors also depend for their decisions on
readily available information that can sometimes lead to poor market performance, especially

when investors are misled by false information. Hence, this study provides an explanation for the

behaviors of investors that cause stock markets to deviate from stock market efficiency.

The purpose of this study was not to prove that the theories of standard finance are

outdated but rather to better understand the actual, real life behavior of investors and to link this

behavior to that expected by theories of standard finance, aiming to provide a better explanation

for deviations from standard and rational behavior through empirical evidence.
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5.1 Implications

This study explains and affirms the reasons for the deviation of the stock market from standard

rational behavior as explained by existing financial models, endorsing Shefrin's claim (2007) that

investors are influenced by biases that cause them to deviate from rational behavior. This study

can help to explain the various phenomena that traditional finance has failed to explain, such as

overpricing, underpricing, herding behavior, focus only on popular stocks, and many others,

hence giving a much deeper understanding of the investors’ real life behavior.

This study will also help investors, including investment managers, to better understand

their own behavior by keeping in view the factors causing their decisions to deviate from wealth

maximizing decisions. It will help them to consider and analyze all the available information

much more effectively before making an investment decision. According to Nikiforow (2010),

providing training and awareness on behavioral factors will result in significant improvement in

decision making and avoidance of the effects of biases.

This research also has implications for investment organizations seeking to analyze and

understand market trends in a more rigorous way and provides more reliable consultancy
information based on real life behavior to such investors. This study will also help policy makers

to better understand investors and devise policies that keep in view these psychological factors in

order to ensure the smooth running of the market. According to Spindler (2011), investor

protection is a prime concern for policy makers, along with stronger regulation, after the global

financial crisis. Prior to which policymakers considered investors to be rational, but the global

financial crisis posed some serious questions regarding this approach and revealed a strong need

for the incorporation of behavioral factors into policy making considerations.

5.2 Limitations
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The main limitation of this study is that it is limited to the effects of just two, albeit the most

commonly used, heuristics on decision making. There is a need to enhance the scope of this

research by incorporating all relevant heuristics in the model. The representation of female

investors is also very low. Only 26 out of 227 of the respondents were females; hence, it is

suggested for future research to have a more representative and adequate representation of

women, as Gumus and Dayioglu (2015) concluded that demography affects investors.


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Section 1:

Married Single Gender: Male Female

Marital Status:
18 to 25 26 to 33 34 to 41 42 to 49 50 & above

Investment Experience: 00-05 Years 06-20 Years 21 Years & Above

Qualification: Matric Inter Bachelors Masters M.Phil. PhD Other

Section 2.

Listed next are series of statements that represent possible ways individual might behave while
investing in the stock market along with some statements stating the way you feel about yourself.
With respect to your own behavior please indicate the level of agreement or disagreement with
the statements by mentioning 1 of 5 levels of agreement indicated below.
Strongly Slightly Neutral Slightly Agree Strongly Agree
Disagree Disagree
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1 2 3 4 5

Availability Bias:
A.B1 I prefer to sell stocks on the days when the value of the stock 1 2 3 4 5
market index decreases.
A.B2 I prefer to buy stocks on the days when the value of the stock 1 2 3 4 5
market index increases.

A.B3 I prefer to invest in local stocks than international stocks because 1 2 3 4 5

the information of local stocks is more available.
A.B4 I consider the information from my close friends and relatives as 1 2 3 4 5
the reliable reference for my investment decisions.
A.B5 I prefer to buy local stocks than trade in international ones. 1 2 3 4 5
Representative Bias:
R.B1 I consider the past performance of the stocks before investing in 1 2 3 4 5
R.B2 I believe that through detailed analysis of past performance future 1 2 3 4 5
value of a contract in stock market can be determined
R.B3 I avoid investments in stocks that have a history of poor earnings. 1 2 3 4 5
R.B4 I buy ‘hot’ stocks which provided most return recently and avoid 1 2 3 4 5
stocks that have performed poorly in the recent past
R.B5 I use trend analysis to make investment decisions 1 2 3 4 5
R.B6 Before investing I use trend analysis of some representative 1 2 3 4 5
stocks to make investment decisions for all stocks.

Locus of Control:
L.C1 Careful investing is the key factor to becoming rich. 1 2 3 4 5
L.C2 People’s suffer investment losses due to their own idleness 1 2 3 4 5
L.C3 Whether or not I have desired returns from my investment 1 2 3 4 5
depends upon my abilities.
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L.C4 In the long run, people who take care of their investments stay 1 2 3 4 5
L.C5 When I make my investment plans, I am almost certain to make 1 2 3 4 5
them work.
L.C6 I can pretty much determine what will happen in my investments. 1 2 3 4 5
L.C7 I am usually able to protect my investment interests. 1 2 3 4 5
L.C8 When I get what I want, it is usually because I worked hard for it. 1 2 3 4 5
Decision Making
D.M1 When making an investment, I trust my inner feelings and 1 2 3 4 5
D.M2 I generally make investments that feel right to me 1 2 3 4 5
D.M3 When making investments, I rely upon my instincts 1 2 3 4 5
D.M4 When I make an investment, it is more important for me to feel 1 2 3 4 5
the investment is right than have a rational reason for it.
D.M5 When I make Investment, I tend to rely on my intuition 1 2 3 4 5