Review of Behavioral Finance

Elucidating investors rationality and behavioural biases in Indian stock market

Venkata Narasimha Chary Mushinada, Venkata Subrahmanya Sarma Veluri,
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Venkata Narasimha Chary Mushinada, Venkata Subrahmanya Sarma Veluri, (2019) "Elucidating
investors rationality and behavioural biases in Indian stock market", Review of Behavioral Finance,
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Elucidating
Elucidating investors rationality investors
and behavioural biases in rationality

Indian stock market

Venkata Narasimha Chary Mushinada
Department of Finance and Accounting, ICFAI Business School,
Received 10 April 2018
IFHE Hyderabad, India, and Revised 3 August 2018
Venkata Subrahmanya Sarma Veluri Accepted 18 August 2018

Department of Commerce and Business Management,

Kakatiya University, Warangal, India
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Abstract
Purpose – The purpose of this paper is to empirically test the relationship between investors’ rationality and
behavioural biases like self-attribution, overconfidence.
Design/methodology/approach – The study applies structural equation modelling to understand whether
individual investors, besides being rational, are subjected to self-attribution bias and overconfidence bias.
Findings – The study shows the empirical evidence in the support of behavioural biases like self-attribution
and overconfidence existing besides investors’ rationality. Moreover, there is a statistically significant
positive covariance found between self-attribution and overconfidence, implying that an increase/decrease in
self-attribution results in the increase/decrease in overconfidence and vice versa. It is also observed that the
personal characteristics of an investor such as gender, age, occupation, annual income and their trading
experience have an impact on behavioural biases.
Research limitations/implications – The study focused on rational decision making, self-attribution and
overconfidence biases using primary data. Further studies can be encouraged to test the existence of
behavioural biases based on both market level and individual account data simultaneously.
Practical implications – Insights from the study suggest that the investors should perform a post-analysis of
each investment, so that they become aware of past behavioural mistakes and stop continuing the same. This might
help investors to minimise the negative impact of self-attribution and overconfidence on their expected utility.
Originality/value – To the best of the authors’ knowledge, this is the first study to examine the
relationship among investors’ rationality, self-attribution and overconfidence in the Indian context using a
comprehensive survey.
Keywords Structural equation modelling, Behavioural finance, Bounded rationality, Self-attribution bias,
Overconfidence bias
Paper type Research paper

1. Introduction
The decision makers generate various strategies and follow specific logical procedures to
resolve problems according to the nature of problem, timing and decision environment.
Rational decision theory asserts that an individual attempts to reach an optimum decision
by categorising decision making into three types based on the level of rationality. First, pure
rationality which allows decision makers to reach optimum decisions and achieve the
highest efficiency out of unlimited time, resources and knowledge in order to make
decisions. This type assumes the administration dichotomy, in which the former identifies
goals for the latter to achieve (Gianakis, 2004). Second, the incremental type which is a less
rational model in which goals are politically feasible and decisions are made by comparing
several immediately available alternatives (Lindblom, 2005). Third, the bounded rationality
type which is a mixture of the above two types that refers to the achievement of given goals
subject to subjective constraints (Simon, 1982, 1991). Review of Behavioral Finance
The bounded rationality framework asserts that individual investors are regarded as © Emerald Publishing Limited
1940-5979
attempting to make rational decision but they often lack important information on the DOI 10.1108/RBF-04-2018-0034
 RBF definition of the problem, the relevant criteria and so on. In general, the judgment of people is
bounded in their rationality, so they will forego the best solution in favour of acceptable or
reasonable one that is so-called the decision makers’ satisfice (March and Simon, 1958). Amos
Tversky and Kahneman (1974) provided critical information about specific systematic biases
that affect judgment. Thaler (2000) argued that investors have bounded willpower so they
give greater weight to current concerns than to future concerns that will lead to a variety of
ways in which their temporary motivations are inconsistent with long-term interests. It is
understood that despite the investment decisions complying with rational decision-making
process, the behavioural biases would still exist in the mind of investors.
The assumptions of traditional economists portray humans as rational beings who
always strive to maximise their utility. Thus, standard finance theory and economic
models draw heavily upon two basic assumptions, namely, rationality and market
efficiency. On the other hand, the proponents of behavioural finance continuously
challenge this assumption and believe that numerous factors, including both rational and
irrational thinking, drive investors’ behaviour. They believe that market price is not
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always a fair estimate of the underlying fundamental value of the firm, and that investor
psychology can drive market prices and fundamental value very far apart (Shefrin, 2000).
Empirical research and studies on investor behaviour have shown the existence of
irrational thinking in investor decision making.
The cognitive biases are important research mediators and moderators for investor
decision making. Such decision-making biases affect investor behaviour and decisions due
to repeated occurrence of a specific set of conditions. Specifically, the decision-making
biases discussed widely in the literature are self-attribution and overconfidence. In this
premise, the study focuses on the relationship between investors’ rationality and these two
proposed behavioural biases in the context of investment decision making. An attempt is
also made to understand the relationship between two proposed behavioural biases and
investor’s personal characteristics like gender, age, occupation, annual income, financial
education or certification and trading experience. The main objective of the study is to
examine the investor’s rationality in the context of behavioural biases and investors’
decision making.

2. Review of literature
2.1 Investors’ rationality
A rational decision maker generally makes a decision based on certain logic and systematic
decision procedures (Robbins, 2002). With respect to the rational decision-making process,
there are some well-established models with different decision stages. For example,
Mintzberg et al. (1976) described three elementary stages of rational decision-making
process, i.e., problem identification, seeking relevant information and evaluating alternative
solutions. Similarly, Keeney (1998) and Hammond et al. (2002) outlined six procedure criteria
to evaluate an effective rational decision. Daft (2003), Osland et al. (2006) and Robbins (2002)
suggested eight steps on it. Although decision makers vary with respect to their beliefs,
opinions and preferences, rationality deals with the notion that these factors should be
coherent (Shafir and LeBoeuf, 2002).
Robbins and Judge (2007) argued that a rational decision ultimately involves a robust
and systematic decision-making process and then focuses on maximising anticipated
profits. The efficient market hypothesis included in conventional financial theory is also
established based on the assumption of rational behaviours among investors. Fama (1965)
suggested that no one can continuously defeat the market to earn the excess profits in an
efficient financial market, where the information has been exposed completely. Additionally,
most rational investors can immediately and independently reflect the market information
to maximise profits.
 The individual investors who are involved in choosing financial products always Elucidating
undergo a deliberative evaluation that appears similar to rational investment decision investors
making. Simon (1957, 1982) pioneered the concept of bounded rationality, which asserts rationality
that managers make imperfect decisions due to lack of information, inadequate time and
cognitive limitations. Therefore, managers could make better decisions if they could
access essential resources. Instead, managers are often forced to make decisions without
sufficient information to ensure successful decision making so that the decision is
suboptimal yet satisfactory.
Kahneman and Tversky (1979) proposed the prospect theory to explain decision-making
behaviour under uncertain circumstances. According to the prospect theory, psychological
factors of investors will drive their actual decision-making process to deviate from rationality,
which is continued to Simon’s (1957) argument of bounded rationality. Investors thus often
simplify their decision processes and are prone to behavioural heuristics that might make
systematic errors and lead to satisfactory investment choices, but do not maximise decisions.
Asymmetries of risk perception are inherent in the investors’ value function that may cause
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investors to make investment decisions based on their intuitions and previous investment
experiences rather than rational analysis with objective reasons.
Lin (2011) conferred with a similar argument of Simon (1982, 1991), who suggested that the
existence of psychological anticipation tendency is the foundation of the bounded rational
behaviour. Lin opined that although allocating and selecting financial assets are of priority
concern in financial activity, such activity frequently accompanies the psychological tendency
that generates psychological factors in the decision-making process, ultimately leading to an
irrational and uncertain financial decision.

2.2 Self-attribution bias

Self-attribution bias is the tendency of individuals to attribute good outcomes to their own
qualities and bad outcomes to bad luck or other factors. Individuals would take credit for
successes and blame external factors for failures. In general, in ambiguous situations,
attributions are influenced by a person’s needs and wishes. Technically, self-attribution bias
consists of self-enhancing bias referring to the tendency of people to claim an irrational
degree of credit for their success; and self-protecting bias referring to the irrational denial of
responsibility for failure. Self-attribution bias is formally introduced into standard learning
models by some behavioural models that made an attempt to provide a theoretical
framework for the empirical return anomalies documented in the finance literature (Daniel
et al., 1998; Gervais and Odean, 2001; Chuang and Lee, 2006). Studies have also shown
strong association between self-attribution and overconfidence. According to Hirshleifer
(2001), overconfidence and self-attribution are static and dynamic counterparts.
Self-attribution causes individuals to learn to be overconfident rather than converge on
an accurate self-assessment. Feng Li (2010) studied the relationship between self-attribution
bias and overconfidence, and found that managers have self-serving attribution bias which
leads to overconfidence.
Mishra and Metilda (2015) studied the impact of investment experience, gender and
level of education on two specific biases – overconfidence and self-attribution from a
sample of mutual fund investors in India. They explored the relationship between the two
biases and found that there is significant level of correlation between them. It is also
observed that self-attribution bias increases with the level of education and is a significant
predictor of the overconfidence bias. Mushinada and Veluri (2018a, b) provided an
empirical evaluation of self-attribution bias and overconfidence bias in Indian stock
market. The results showed that there is self-attribution bias existing among investors,
which make them trade more subsequent to past good results, leading to overconfidence
in the long run.
 RBF 2.3 Overconfidence bias
Overconfidence bias suggests that the investors systematically misprocess publicly available
information and overweight their private information (Daniel et al., 1998). Considerable
research suggests that people are overconfident and the individual investors, in particular.
Odean (1998) argued that investors are overconfident of their abilities, knowledge and future
expectations. This makes them trade more aggressively leaving a cost on their level of
expected utility. The empirical evidence supports this argument (Odean, 1998, 1999; Benos,
1998; Barber and Odean, 2000, 2001; Grinblatt and Keloharju, 2009; Trinugroho and Sembel,
2011). However, overconfidence differs from one culture to another (Lee et al., 1995; Whitcomb
et al., 1995; Yates et al., 1997, 1998; Chuang and Lee, 2006).
De et al. (2011) studied the relative effects of disposition effect and investor
overconfidence across investor categories in the Indian context. Their findings, in general,
suggest that overconfidence results in more wealth loss than disposition effect.
Mishra and Metilda (2015) explored the relationship between the overconfidence and
self-attribution showing a significant level of correlation between them. The major
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findings are that the level of overconfidence increases as the investor’s level of education
and investment experience increases, and men are more overconfident than women.
Garg and Varshney (2015) revealed the existence of a momentum effect in the Indian stock
market supporting the behavioural explanation that momentum profit is a result
of initial underreaction of the traders followed by eventual overreaction to firm-specific
news and investors’ overconfidence about their own abilities. Prosad et al. (2015)
investigated the presence of optimism (pessimism) bias in the Indian equity market. Apart
from self-attribution bias, optimism is an important variable for overconfidence bias.
The study depicts that past volatility plays as an important precursor to optimism
(pessimism). It is observed that when investors are biased, their perceived risk return
relationship is negative. They stressed the need to understand the role of the factors such
as age, experience, sophistication and professionalism in explaining the disparity in
investor behaviour.
Prosad et al. (2017) investigated the presence of the disposition effect and
overconfidence in the Indian equity market using NSE Nifty 50 index and found the
presence of overconfidence bias and the disposition effect. They observed that the
overconfidence bias is found to be predominant of two biases. Mushinada and Veluri
(2018a) empirically tested the overconfidence hypothesis at Bombay Stock Exchange
(BSE) and showed the empirical evidence in support by arriving at three key findings.
First, the overconfident investors overreact to private information and underreact to the
public information. Second, it is observed that self-attribution bias, conditioned by right
forecasts, increases investors’ overconfidence and the trading volume. Third, the
excessive trading of overconfident investors makes a contribution to the observed
excessive volatility. Mushinada and Veluri (2018b) provided an empirical evaluation of
self-attribution bias, overconfidence bias and dynamic market volatility at BSE across
various market capitalizations. A unique observation of this study is that these biases do
exist in various market capitalisation stocks, unlike the argument of previous studies that
these biases are more prevalent in small stocks.

3. Research objectives and rationale

It is understood from the literature that behavioural biases exist alongside the rationality.
Particularly, the decision-making biases such as self-attribution and overconfidence have a
tendency to influence investors’ behaviour by making them trade more in subsequent
periods by applying aggressive trading strategies. This leads to illogical or irrational decision
making. In that, the presence of self-attribution bias among investors put them to varied
levels of overconfidence. Hence, it is understood that despite investment decisions complying
 with rational decision-making process, behavioural biases such as self-attribution and Elucidating
overconfidence would still exist in the mind of investors. In this premise, the main objective of investors
the study is to examine the investor’s rationality in the context of behavioural biases and rationality
investor’s decision making by way of a comprehensive survey.
Such an empirical analysis will examine whether self-attribution bias and overconfidence
bias exist in the Indian stock market and also study their implications on the concerned
stakeholders. Particularly, the results of this study can help investors to minimise the
negative impact of these behavioural biases on their expected utility. It can also help the
practitioners to identify the biased trends in the market beforehand and develop their
investing strategies accordingly.

4. Research methodology
The study makes an attempt to verify that the individual investors may simultaneously
possess complex rational and irrational thinking logics in their investment behaviour. In
contrast with previous studies, which focus on detecting behavioural biases and the impacts
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of behavioural biases, this study performs a cross-section analysis via structural equation
modelling (SEM) that constructs a comprehensive path to link the investors’ rationality with
two proposed behavioural biases. The causal processes are represented by a series of
structural equations that can be modelled graphically to facilitate the conceptualization of a
theoretical framework (Byrne, 2010). SEM allows to evaluate simultaneously the factor
loadings and error variance of the measurements and to test the significance of the
relationships between the latent variables of interest.

4.1 Sample
The primary data are collected by administering structured questionnaires on the “active
investors”, i.e., investors who have a track record of at least five years in stock trading. This
is to capture the data about the behavioural biases that exist in the minds of investors
though they attempt to make rational decisions. The total sample size of 384 respondents is
selected from five identified cities, 77 respondents each from Hyderabad, Bengaluru,
Mumbai, New Delhi and 76 respondents from Kolkata.
The rationale of selecting five cities for collecting primary data is based on the study
“How Households Save and Invest: Evidence from the National Council of Applied
Economic Research (NCAER) Household Survey, Main Report” sponsored by Securities and
Exchange Board of India and conducted by the NCAER. The survey report clearly shows
that the city-wise percentage share of investors in India is relatively very high in Kolkata
(eastern region), Mumbai (western region), New Delhi (northern region), Bengaluru and
Hyderabad (southern region). A structured questionnaire is administered on the “active
investors” from the selected five cities to elicit their responses based on a six-point
Likert-type scale: strongly disagree (1) to strongly agree (6). The SEM is used to develop
measurement and structural models in order to understand the relationship between
investors’ rationality and the behavioural biases.

4.2 Questionnaire
A structured questionnaire is used to collect primary information from individual investors.
The items are developed for the rational decision making and two proposed behavioural
biases to be studied. The questionnaire consisting of 26 items is designed keeping in view
the objectives and focus of the study. The first part involves determining rational decision
making by developing items based on the existing literature. The investors’ rationality is
regarded as a latent variable measured by 13 observed items of questionnaire. The second
part involves evaluating the two behavioural biases, i.e., self-attribution and overconfidence.
 RBF Each behavioural bias is treated as a latent variable measured by 6–7 observed items and
totally developed 13 items of questionnaire. The 26 items in the two parts adopt a six-point
Likert-type scale to measure the psychological agreement of respondents based on the
following observed variables:
(1) Investors’ rationality:
• need fulfilment;
• buy and sell stocks frequently;
• acquiring and exercising voting rights in a company;
• increase wealth;
• family, relatives and friends;
• newspapers, magazines or published documents;
• brokers, analysts or investment consultants;
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• past experience;
• economy and market trend;
• future growth of the industry;
• financial performance of the company;
• stock’s price movement; and
• transaction costs.
(2) Self-attribution:
• success due to investment information seeking skills;
• success due to stock selection skills;
• success due to investment analysis and evaluation skills;
• failure due to incorrect recommendations or advice from family, relatives
or friends;
• failure due to incorrect recommendations or advice from brokers, analysts or
investment consultants; and
• failure due to bad luck and related factors.
(3) Overconfidence:
• certainty of making correct investment decision;
• mastering the future trend for investment;
• consistency of market trend with views and opinions;
• controllability and responsibility for results from investment;
• profit due to sense of care and caution;
• profit from successful investment strategy; and
• successful expectations triggering investment.
The third part of the questionnaire deals with demographic factors such as the gender, age,
occupation, annual income, education/certification in financial markets and experience in
trading (no. of years).
 4.3 Reliability and validity Elucidating
To ensure the content-related validity of items and language clarity, the questionnaire has investors
been reviewed and tested by two academic experts, a broker, financial experts, language rationality
experts and five active investors. Their opinions and suggestions were incorporated as far
as possible without affecting the nature of questions. Both the construct validity and
convergent validity were ensured by using confirmatory factor analysis (CFA). The
self-report questionnaire designed by this study is utilised to collect subjective information
from individual investors which might lead to common method variance (CMV ). To detect
whether the data have been affected by CMV, Harman’s one-factor test is adopted to
examine the value of CMV by incorporating all observed variables to conduct an un-rotated
factor analysis (Podsakoff and Organ, 1986). Using maximum likelihood estimation (MLE),
five factors with eigen value greater than 1 are extracted from 26 items of observed
variables. The percentage of cumulative explained variance is 51.53 per cent and the
explained variance of the first component is only 8.40 per cent. The explained variance is
29.02 per cent when a single factor is extracted. This means that a lot of variance is left to be
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explained by other factors. It implies that the CMV has little effect on the survey data.
A pre-test is also executed by using 116 convenience samples collected from the individual
investors to test the internal consistent reliability (Nunnally, 1967) shown as the
Cronbach’s α values. All of the values were well above 0.50 indicating that the instrument is
fit for further analysis.

4.4 Methodology
The general SEM model can be decomposed into two sub-models, i.e., a measurement model
and a structural model. The measurement model defines relations between the observed and
unobserved variables. In other words, it provides the link between scores on a measuring
instrument (i.e. the observed indicator variables) and the underlying constructs they are
designed to measure (i.e. the unobserved latent variables). The measurement model, then,
represents the CFA model in that it specifies the pattern by which each measure loads on a
particular factor. In contrast, the structural model defines relations among the unobserved
variables. Accordingly, it specifies the manner by which particular latent variables directly
or indirectly influence (i.e. cause) changes in the values of certain other latent variables in
the model. Since the study focuses on the causal relationship between rational decision
making and two behavioural biases, it is proposed to develop full latent variable model
comprising both measurement and structural models.
The task involved in developing the measurement model of a full SEM is twofold, i.e., to
determine the number of indicators to use in measuring each construct, and to identify
which items to use in formulating each indicator. Based on the literature, it is understood
that there should be at least two observed items for each latent variable. As for which
items to use in the model, the Cronbach’s α value and squared multiple correlations (SMCs)
of each item are tested. Cronbach’s α is the reliability coefficient that assesses the
consistency of the entire scale and it is the most widely used measure. The items with
Cronbach’s α of 0.5 or higher are retained for the study. SMCs represent the extent to
which a measured variable’s variance is explained by a latent factor. From the
measurement perspective, it represents how well an item measures a construct. SMCs are
sometimes referred to as item reliability. The items with SMCs less than 0.3 are eliminated
from the model. The absolute values of skewness and kurtosis for each latent variable are
lower than 3 and 10, respectively. It means that all of these measurements could be
regarded as approximate normal distribution (Kline, 2010) and the MLE method is
suitable to be used to estimate the parameters in the model.
The study conducted CFA using 384 samples to evaluate the construct validity.
Construct reliability is an indicator of convergent validity and it should be 0.7 or higher to
 RBF indicate adequate convergence or internal consistency. Average percentage of variance
extracted (VE) among a set of construct items is a summary indicator of convergence. It
should be 0.5 or greater to suggest adequate convergent validity. The size of the factor
loading is another important consideration. The standardized factor loading estimates
should be 0.5 or higher (Hair et al., 2010).
First, the study uses SEM to estimate and test how latent variables and their
measurements are related by using the following equations:
X i ¼ lxij xj þdi ; (1)

Y i ¼ lyij Zj þei ; (2)

where λxij denotes the regression coefficient of Xi on ξj; λyij denotes the regression coefficient
of Yi on ηj; δi, εi denote the measurement errors of exogenous (ξj) and endogenous (ηj)
latent variables, respectively. In the measurement model, the investors’ rationality is an
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exogenous latent variable, whereas biased self-attribution and overconfidence are

endogenous latent variables.
Second, the structural models are developed depicting the structural links between the
latent variables to be accurately estimated by using the following equation:
Zi ¼ bij Zj þgij xj þBi ; where i; j ¼ 1; 2; 3; . . .; (3)

where ξj denotes exogenous latent variable, i.e., investors’ rationality; ηj denotes the
endogenous latent variables, i.e., biased self-attribution and overconfidence; gij denotes the
regression coefficient of ξj on ηi; βij denotes the regression coefficient of ηj on ηi; and ςi
denotes the error variance of structure equation.
Finally, the study proceeds to examine how the demographic variables (i.e. gender, age,
occupation, annual income, financial education/certification and trading experience) of
investors differ in two proposed behavioural biases (i.e. biased self-attribution and
overconfidence). Since the measurement model is only for endogenous variables in this
context, Equation (2) is used and the structural model is developed by using Equation (3).

5. Empirical analysis and results

The results for the first measurement and structural models aimed at studying the
relationship between investors’ rationality and two proposed behavioural biases
(i.e. self-attribution and overconfidence) are presented along with the discussion.
Subsequently, the results for second measurement and structural models are presented
which aimed at studying the relationship between two proposed behavioural biases and
investor’s personal characteristics such as gender, age, occupation, annual income, financial
education or certification and trading experience.

5.1 Measurement Model 1

In the first measurement model, the investors’ rationality is exogenous latent variable,
whereas overconfidence and biased self-attribution are endogenous latent variables. A CFA
is conducted using 384 samples to evaluate the construct validity. Figure 1 shows the
estimations of parameters for the first measurement model.
The results of first measurement model relating to Cronbach’s α, SMCs, CR, average
percentage of VE and standardized factor loading estimates are shown in Table I.
It is understood from Table I that all the validity measures for the hypothesised model
are significant showing adequate convergent validity. On the other hand, the estimation of
measurement model resulted in statistically significant probability value indicating that
 e13
0.58
X1 Elucidating
0.52
0.76
investors
e12 X2
0.48 0.72
rationality
e11 X3
0.69
0.51
e10 X4
0.74
0.30 0.58
0.17 e9 X5 0.76

0.57 0.75 Investors

0.21 e8 X6
0.67 Rationality
0.45
e7 X7 0.72
0.51
e6 X8 0.76
0.30 0.57
e5 X9 0.59
0.75
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–0.18 0.35
e4 X10 0.62
0.56
e3 X11

0.42
0.61
e16 Y12 0.78
0.80 0.90 Biased
e15 Y11
0.87 Self-Attribution
0.76
e14 Y10

0.81

0.56
e19 Y15 0.75

0.61 0.78
e18 Y14 Overconfidence
–0.29
0.78 Figure 1.
0.61
Measurement Model 1
e17 Y13

the model was successful in estimating all parameters, thereby resulting in a convergent
solution. The study proceeds to look at alternative goodness-of-fit statistics which are
helpful to understand whether the model is fit for establishing causal relationship between
latent variables or not. It is observed that AGFI is more than 0.8, PNFI is more than
0.5, RMSEA is 0.079, most of the fit indices (NFI, IFI and TLI) are above 0.90 and CFI is
0.934 which is close to 1. This is an indication that the study can proceed to develop
structural model.

5.2 Structural Model 1

The first structural model is developed based on Equation (3). In this model, the investors’
rationality is an exogenous latent variable, whereas biased self-attribution and
overconfidence are endogenous latent variables. The latent variables in the model are
represented by ovals. The observed items associated with the questionnaire are used for
evaluating the latent variables which are represented by rectangles. They are labelled as X1,
X2, …, Xn and Y1,Y2, …, Yn. This model makes an attempt to study the relationship between
investors’ rationality and two proposed behavioural biases. Figure 2 shows the structural
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RBF

Table I.

variables in the
measures for latent

measurement Model 1
The internal quality of
Squared
Standard multiple Construct Variance
factor correlation reliability extracted
Latent variable Notation Item loading (SMC) Cronbach’s α (ρc) (VE)

Investors’ X1 Investing in stock markets allows me to buy and sell stocks often 0.760*** 0.578 0.924 0.913 0.513
rationality X2 Investing in stocks is a better way to increase my wealth 0.722*** 0.521
X3 In order to understand a variety of stocks available for investing, I
exchange information with family, relatives or friends 0.692*** 0.479
X4 For the investment information on stocks, I refer to the relevant public
resources like newspapers, magazines or published documents 0.713*** 0.509
X5 For the investment information on stocks, I seek advice from brokers,
analysts or investment consultants 0.762*** 0.580
X6 My past investing experience provides me with important information
useful for current and future investment in stocks 0.754*** 0.569
X7 Before investing in the stock market, I analyse the country’s economy and
the market’s trend 0.673*** 0.453
X8 Before choosing the stocks for investment, I consider future growth of the
related industry 0.717*** 0.514
X9 I analyse the financial performance of a company for investing in its stocks 0.757*** 0.573
X10 I analyse the stock’s price movement for investing in it 0.594*** 0.352
X11 When I invest, I pay much attention to transaction costs like Broker’s
commission, STT, etc. 0.751*** 0.564
Biased self- Y10 My past investment failures were, usually, due to the incorrect
attribution recommendations or advice from family, relatives or friends 0.871*** 0.759 0.882 0.887 0.723
Y11 My past investment failures were, usually, due to the incorrect
recommendations or advice from brokers, analysts or investment
consultants 0.896*** 0.803
Y12 My past investment failures were, usually, due to bad luck and
related factors 0.780*** 0.609
Overconfidence Y13 I believe I can predict the future trend for my investment in stocks with a
bias fair degree of accuracy 0.780*** 0.609 0.785 0.813 0.592
Y14 I control and am fully responsible for the results of my investment decisions 0.781*** 0.610
Y15 Past success in the investments make me invest more in stocks 0.747*** 0.558
Note: ***p o0.001
 e20 Elucidating
e13
0.58
X1 0.76
investors
e12
0.52
X2 0.76 Biased
0.38 0.87
0.90
Y10
0.80
e14
rationality
Y11 e15
0.48 0.72 Self-Attribution 0.78
e11 X3 0.61
0.69 Y12 e16
0.51
e10 X4 0.62
0.71
0.30 0.58 0.77
0.17 e9 X5 0.76
0.57 0.75 Investors
0.21 e8 X6
0.67 Rationality
0.45
0.26 e7 X7
0.72 e21
0.51 0.42
0.30
e6 X8 0.76
0.61
0.57 0.18 Y13 e17 –0.29
e5 X9 0.59 0.78
–0.18 0.75 0.78 0.61
0.35 Overconfidence Y14 e18
e4 X10 0.75 Figure 2.
0.56
0.56 Y15 e19 Structural Model 1
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e3 X11

paths and estimations of parameters for first structural model. Table II presents the
structural relations and related statistics for the structural Model 1. It is observed from the
alternative goodness-of-fit statistics that AGFI is more than 0.8, PNFI is more than 0.5,
RMSEA is 0.079, most of the fit indices (NFI, IFI and TLI) are above 0.90 and CFI is 0.934
which is close to 1. Hence, the first structural model is a good fit model and acceptable for
further analysis.
The analysis of all the observed variables shows that around less than 50 per cent of the
variance is explained by latent variables for most of the items. This implies that the
investors’ belief that investing in stocks is a better way to increase their wealth and their
behaviour of analysing country’s economy, market trend and the stock’s price movement for
investing in it is explained to a larger extent by the factor “investors’ rationality”.

Regression Standardized
Structural relation weights SE CR P regression weights

Biased self-attribution ← investors’ rationality 0.880 0.081 10.932 *** 0.619

Overconfidence ← investors’ rationality 0.387 0.055 7.032 *** 0.419
X1 ← investors’ rationality 0.893 0.059 15.096 *** 0.760
X2 ← investors’ rationality 0.958 0.067 14.199 *** 0.722
X3 ← investors’ rationality 0.857 0.063 13.615 *** 0.692
X4 ← investors’ rationality 0.943 0.067 14.071 *** 0.713
X5 ← investors’ rationality 0.921 0.061 15.130 *** 0.762
X6 ← investors’ rationality 0.891 0.060 14.964 *** 0.754
X7 ← investors’ rationality 0.780 0.059 13.142 *** 0.673
X8 ← investors’ rationality 0.848 0.065 13.036 *** 0.717
X9 ← investors’ rationality 0.816 0.054 15.028 *** 0.757
X10 ← investors’ rationality 0.655 0.057 11.514 *** 0.594
X11 ← investors’ rationality 1.000 0.751
Y10 ← biased self-attribution 1.000 0.871
Y11 ← biased self-attribution 0.973 0.042 23.066 *** 0.896
Y12 ← biased self-attribution 0.883 0.048 18.557 *** 0.780
Y13 ← overconfidence 1.000 0.780 Table II.
Y14 ← overconfidence 0.844 0.065 12.980 *** 0.781 Structural relations
Y15 ← overconfidence 0.854 0.066 12.866 *** 0.747 and related statistics
Notes: CR, critical ratio; P, probability (***p o 0.001) for structural Model 1
 RBF As seen from Figure 2, all factor loadings, i.e., λij for the observed variables are greater than
0.4 which is meaningful. However, the structural component is represented by the path
between latent variables. The relationship between investors’ rationality and behavioural
biases is statistically significant. According to the estimates of the structure parameters
(i.e. standardized path coefficients gij ¼ 0.619, ρo0.001; gij ¼ 0.419, ρo0.001), if the
investors’ rationality increases by one standard deviation, the biased self-attribution and
overconfidence behaviour increases by a standard deviation of 0.619 and 0.419, respectively.
This implies that the investors’ rationality can accurately predict the degree of biased
self-attribution and overconfidence. In other words, the investors’ rationality influences the
biased self-attribution and overconfidence behaviour significantly. Moreover, the
modification indices suggested a positive covariance between the error variances of
biased self-attribution (e20) and overconfidence (e21) and the correlation coefficient is
0.768 which is statistically significant. This implies that if there is an increase in biased
self-attribution then the overconfidence behaviour increases and vice versa. This finding
complies with that of previous studies (Daniel et al., 1998; Gervais and Odean, 2001; Chuang
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and Lee, 2006; Mishra and Metilda, 2015; Mushinada and Veluri, 2018a, b).
The evidence from the first structural model shows that the individual investors identify
their investment demand, such as recognising that investing in stock markets is a better way
to increase their wealth and it also allows them to buy and sell stocks often. At the same time,
they search for external information (e.g. refer to publicly available resources, exchange
information with family, relatives, friends and seek advice from brokers, analysts or
investment consultants) and internal information (e.g. previous investment experience). They
also evaluate alternatives or establish the critical criteria for investment by performing
fundamental and technical analysis along with a focus on transaction costs. Owing to the
interrelationship between all the aspects of investors’ rationality, they might go back and forth
while taking a final decision as towards the investment. In this process, they may be subjected
to various behavioural biases because of their limited recognition of demand and information
or previous successful investment experience owing to bounded rationality. The findings
confer with a similar argument of Simon (1982, 1991) who suggested that the existence of
psychological anticipation tendency is the foundation of bounded rational behaviour. The
results also support the findings by previous studies that the decision-making process is
highly influenced by the psychological factors which may ultimately lead to an irrational and
uncertain financial decision (Lin, 2011; Prosad et al., 2015).

5.3 Measurement Model 2

The study proceeds with second measurement model aimed at examining how the demographic
variables of investors differ in two proposed behavioural biases. The demographics of
individual investors consist of 69.27 per cent of male and 30.73 per cent of female respondents.
The majority of investors fall in the age group of 38–47 years (32.81 per cent) followed by
28–37 years (28.64 per cent). The average annual income of 64.84 per cent of the respondents is
less than Rs 5,00,000 per annum followed by 29.68 per cent of respondents having an average
annual income between 5 and 10 lakh rupees per annum. All the respondents have at least five
years of trading experience, in that 40.62 per cent have an experience of more than 10 years. The
majority of sample contains respondents from various occupations like business (47.65 per cent)
followed by service (33.60 per cent). It is observed that most of the respondents (68.75 per cent)
do not have any education/certification in financial markets. Moreover, the female respondents
possess low financial literacy compared to the male respondents.
A measurement model is constructed to evaluate how well the observed exogenous
variables, i.e., gender, age, occupation, annual income, financial education/certification and
trading experience, do predict endogenous variables, i.e., biased self-attribution and
overconfidence. Figure 3 shows the estimations of parameters for the second
 e3
0.76
Y10
Elucidating
0.87
0.81 0.90 Biased
investors
e2 Y11 0.77 Self-Attribution rationality
0.60
e1 Y12
0.81
0.61
–0.29 e17 Y13 0.78
0.61 0.78
e16 Y14 Overconfidence Figure 3.
0.75
0.56 Measurement Model 2
e15 Y15

measurement model. A CFA is conducted using 384 samples to evaluate construct validity.
All validity measures for second measurement model are significant showing adequate
convergent validity. On the other hand, the estimation of measurement model resulted in
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statistically significant probability value indicating that the model was successful in
estimating all parameters, thereby resulting in a convergent solution. The study proceeds to
look into alternative goodness-of-fit statistics which are helpful to understand whether the
model is fit for establishing causal relationship between latent variables or not. It is
understood from goodness-of-fit statistics that CMIN/df is less than 3, RMR is less than 0.05
and RMSEA is 0.062 along with PCLOSE being non-significant. Moreover, almost all the fit
indices (GFI, AGFI, NFI, RFI, IFI, TLI and CFI) are above 0.95 and close to 1. Finally,
HOELTER’s Critical N (CN) values at both 0.05 and 0.01 levels are 314 and 413, respectively
(above 200). It is obvious that the measurement Model 2 is a best fit model and acceptable
for further analysis.

5.4 Structural Model 2

The second structural model is developed to understand the relationship between
behavioural biases and investor’s personal characteristics. It is observed from goodness-of-
fit statistics that CMIN/df is less than 3, PNFI is more than 0.5, GFI and CFI are more than
0.95, RMSEA is less than 0.06 along with PCLOSE being non-significant. Moreover, most of
the fit indices (AGFI, NFI, RFI, IFI and TLI) are above 0.90. Finally, HOELTER’s CN values
at both 0.05 and 0.01 levels are 229 and 261, respectively i.e., above 200. It is obvious that the
structural Model 2 is a best fit model and acceptable for further analysis. Figure 4 shows the
structural paths and estimations of parameters for the second structural model. Table III
presents the structural relations and related statistics for the structural Model 2.
From the estimation value of path coefficients in Figure 4, it is understood that the gender,
age, occupation, annual income and trading experience play the most important role in
explaining the difference of behavioural biases. The findings are consistent with the studies of
Bhandari and Deaves (2006) and Mishra and Metilda (2015). Analysis of the results indicates
that occupation and trading experience have a positive impact on both biased self-attribution
and overconfidence behaviour. It is also understood that those investors who are in service,
either public or private are prone to these behavioural biases. The results indicate that
investors who have relatively less trading experience are subjected to biased self-attribution
making them more overconfident. These findings are consistent with the studies of Gervais
and Odean (2001). Even though biased self-attribution leads to overconfidence, the average
levels of overconfidence are greatest in those individuals who have been trading for a short
time. With more experience, people develop better self-assessments.
On the other hand, age and annual income have a negative impact on both biased
self-attribution and overconfidence behaviour. It is understood from the results that the
 RBF e9
1.00
Gender e7

–0.14 0.76
0.21 0.87 Y10 e1
1.00 –0.33 Biased 0.90 0.81
e10 Age Y11 e2
Self-Attribution 0.77
0.19 0.59
–0.37 Y12 e3
–0.23
1.00 0.04
e11 Occupation
–0.26
0.39
0.73

0.31
1.00
e12 Annual Income
0.56 –0.35 –0.16
–0.16 e8
–0.32
0.63
1.00
Financial 0.29 0.79 Y13 e4 –0.36
–0.23 e13 Education/ 0.09
0.78 0.61
Certification
Overconfidence Y14 e5
0.73
0.44 0.53
Figure 4.
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Y15 e6
Structural Model 2 e14
1.00 Trading
Experience

Standardized
Regression regression
Structural relation weights SE CR P weights

Annual income ← e12 0.592 0.021 27.677 *** 1.000

Certification ← e13 0.464 0.017 27.677 *** 1.000
Experience ← e14 5.981 0.208 28.765 *** 1.000
Occupation ← e11 0.708 0.026 27.677 *** 1.000
Age ← e10 1.132 0.041 27.677 *** 1.000
Gender ← e9 0.469 0.017 28.102 *** 1.000
Biased self-attribution ← gender −0.402 0.165 −2.440 ** −0.140
Overconfidence ← gender −0.298 0.107 −2.786 ** −0.158
Biased self-attribution ← age −0.397 0.073 −5.458 *** −0.335
Overconfidence ← age −0.274 0.048 −5.725 *** −0.350
Biased self-attribution ← occupation 0.352 0.093 3.805 *** 0.186
Overconfidence ← occupation 0.199 0.060 3.304 *** 0.159
Biased self-attribution ← annual income −0.524 0.121 −4.325 *** −0.231
Overconfidence ← annual income −0.473 0.080 −5.909 *** −0.316
Biased self-attribution ← financial education/certification 0.126 0.147 0.854 0.393 0.043
Overconfidence ← financial education/certification 0.175 0.096 1.825 * 0.091
Biased self-attribution ← trading experience 0.087 0.015 5.918 *** 0.387
Overconfidence ← trading experience 0.064 0.010 6.633 *** 0.436
Y10 ← biased self-attribution 1.000 0.872
Y11 ← biased self-attribution 0.974 0.043 22.428 *** 0.898
Y12 ← biased self-attribution 0.866 0.049 17.841 *** 0.765
Y13 ← overconfidence 1.000 0.795
Table III.
Structural relations Y14 ← overconfidence 0.828 0.064 12.999 *** 0.780
and related statistics Y15 ← overconfidence 0.820 0.063 12.999 *** 0.729
for structural Model 2 Notes: CR, critical ratio; P, probability (*p o 0.1; **p o0.05; ***p o0.001)

young investors are subjected to biased self-attribution and overconfidence. Moreover, the
investors who fall into lower income group are prone to these behavioural biases. These
findings are consistent with the studies of Barber and Odean (2000, 2001), Goetzmann and
Kumar (2008) and Korniotis and Kumar (2011). Attributing differences in investment
 patterns to individual’s personal characteristics has received considerable interest recently Elucidating
(Goetzmann and Massa, 2002; Lin, 2011; De et al., 2011; Mishra and Metilda, 2015). investors
From Table III, it is understood that there is a negative relationship between gender and rationality
both biased self-attribution (t ¼ −2.440, ρ o0.05) and overconfidence (t ¼ −2.786, ρo0.01)
that is consistent with the findings of Acker and Duck (2008) and Lin (2011). It implies that
males are subjected to biased self-attribution and relatively more overconfident than
females. This supports the findings of Barber and Odean (2001) and Mishra and Metilda
(2015) that men are more overconfident than women. In India, a large number of the
investment accounts belong to males. Moreover, male members of a family operate their
own accounts and also of female members. It is observed that financial education (t ¼ 1.825,
ρo0.1) influences the overconfidence behaviour but does not impact the biased
self-attribution. It implies that educated investors slightly tend towards overconfidence
supporting the findings by Mishra and Metilda (2015). This indicates that even the financial
education could cause harm, in that it fosters overconfidence.
The modification indices suggested a positive covariance between the error variances of
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biased self-attribution (e7) and overconfidence (e8) and the correlation coefficient is 0.730
which is statistically significant. This implies that if there is an increase in biased
self-attribution then the overconfidence behaviour increases and vice versa. This finding
complies with that of previous studies (Daniel et al., 1998; Gervais and Odean, 2001; Chuang
and Lee, 2006; Mishra and Metilda, 2015; Mushinada and Veluri, 2018a, b). Finally, the
evidence from the second structural model shows a strong relationship between behavioural
biases and investor’s personal characteristics, particularly gender, age, occupation, annual
income and trading experience.

6. Conclusion and implications

It is believed that the investors are subjected to various cognitive biases, in spite of making
an attempt to behave rationally. The first measurement and structural models are developed
based on the hypothesised model that there is a relationship between investors’ rationality
and behavioural biases. The second measurement and structural models are developed
based on the hypothesised model that there is a relationship between investor’s personal
characteristics and behavioural biases. The results of study are very significant and comply
with the hypothesised models.
From the first structural model, it is understood that the relationship between investors’
rationality and behavioural biases is statistically significant. This implies that the investors’
rationality can accurately predict the degree of biased self-attribution and overconfidence.
Moreover, there is a statistically significant positive covariance found between biased
self-attribution and overconfidence implying that an increase/decrease in biased
self-attribution results in the increase/decrease in overconfidence behaviour and vice versa.
This is consistent with the findings of recent studies in the Indian context (Mishra and
Metilda, 2015; Mushinada and Veluri, 2018a, b).
The results of the second structural model have shown that the personal characteristics
of an investor, particularly gender, age, occupation, annual income and trading experience
have an impact on the behavioural biases. The gender, age and annual income negatively
impacted the behavioural biases, whereas the occupation and trading experience positively
impacted them. Male investors have exhibited biased self-attribution and overconfidence
behaviour. With respect to age and trading experience, young investors and those who have
less trading experience are subjected to these behavioural biases, respectively. The
investors who are in service and have relatively less income are prone to behavioural biases.
It is observed that investors’ financial education or certification makes them slightly
overconfident. The findings are similar to those of recent studies by Lin (2011) and Mishra
and Metilda (2015).
 RBF The empirical evidence of this study significantly contributes to the efforts to link the
rational decision making with the irrational behaviours of investors. This study also verifies
that the individual investors may simultaneously possess complex rational and irrational
thinking logics in their investment behaviour. The study provides several results which are
consistent with prior literature on self-attribution and overconfidence. This is the first study
in the Indian context to provide empirical evidence for existence of these two behavioural
biases at an individual investor level. This study can be helpful in providing an insight into
the prevailing behavioural biases in the Indian stock market. The study contributes to the
areas of investors’ rationality, self-attribution and overconfidence for emerging markets
such as India.

6.1 Implications of the study

The overall Indian stock market is affected, if investors suffer from behavioural biases. So it is
a huge responsibility for all the stakeholders to take enough care and caution to be rational in
investment decision making. They can resort to counter attack on behavioural biases by
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“de-biasing” themselves (Glaser and Weber, 2010; Mushinada and Veluri, 2018a, b). The
results of the study have significant managerial implications for different stakeholders such
as the individual investors, fund managers, policy makers and academic community.
The investors should perform a post-analysis of each investment, so that they become
aware of past behavioural mistakes and stop continuing the same. Success often comes from
restraining the emotions and overcoming behavioural biases. They can “de-bias”
themselves through behavioural training sessions and financial literacy programs. This
might help investors to minimise the negative impact of self-attribution and overconfidence
on their expected utility. Particularly, they need to invest for the long term, identify their
level of risk tolerance, determine an appropriate asset allocation strategy and rebalance
portfolios frequently.
It is suggested that the fund managers should try to identify behavioural biases in their
clients before designing their portfolios. They also have to be very careful about the volatility
based trading strategies in pursuit of profitability. Most important is that they have to
“de-bias” themselves by applying proper knowledge and making rational investment
decisions in order to avoid a “wealth loss” situation for investors and themselves.
There are some policy implications for an emerging market like India. First, the domestic
investor base has to be strengthened because the stock market participation by the majority of
savers in India is quite low. This may be achieved through the harmonisation of corporate
governance, accounting and listing, as well as standard rules and practices. Second, the
behavioural training and financial literacy programs have to be conducted for investors to make
them aware of various behavioural biases and the ways to handle it. The need for promoting
financial education arises on the account of various demographic, market driven, technological
and social factors that contribute to a nation’s economic growth and development.
It is suggested that the future studies can be conducted on both market level and
individual account data simultaneously to understand the existence of behavioural biases
among the investors. Also, the investors’ behaviour can be studied through psychology
research which involves elaborate surveys or well-designed experiments in order to vary the
behaviour in which researchers are interested in observing and controlling.

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Corresponding author
Venkata Narasimha Chary Mushinada can be contacted at: mvnchary@gmail.com

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