How Financial Literacy and Demographic Variables Relate to Behavioral Biases

Abstract

Purpose- This study examines how financial literacy and demographic variables (gender,

age, income-level, education, occupation, marital- status, investment experience) affect

behavioral biases.

Design/methodology/approach We use one-way analysis of variance (ANOVA), factor

analysis, and multiple regression analysis to examine survey data from more than 500

individual investors in India.

Findings Our results reveal the presence of different behavioral biases including

overconfidence and self-attribution, the disposition effect, anchoring bias, representativeness,

mental accounting, emotional biases, and herding among Indian investors. Hence, the

findings support the view that individual investors do not always act rationally. The results

also show that financial literacy has a negative association with the disposition effect and

herding bias, a positive relation with mental accounting bias, but no significant relation with

overconfidence and emotional biases. Age, occupation, and investment experience are the

most important demographic variables that influence behavioral biases of individual investors

in our sample. Regarding gender, males are more overconfident than are females about their

knowledge of the stock market.

Research limitations/implications Our study may have implications for financial

educators in promoting the financial awareness programs for individuals. Additionally,

financial advisors can potential

decision-making processes.

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Originality/value Despite an extensive literature on behavioral finance, limited academic

research attempts to unravel the relation of how financial literacy and demographic variates

relate to behavioral biases. Our study contributes to this literature by trying to fill this gap.

Keywords: Financial literacy; demographic variables; behavioral biases; survey research,

Indian investors; behavioral finance

Paper type: Research Paper

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1. Introduction

Recent developments in financial markets highlight differences between traditional

and behavioral finance. Traditional finance assumes that people, institutions, and even

markets behave rationally (Baker & Filbeck, 2013). By contrast, behavioral finance

challenges this assumption of rationality and suggests that investors tend to systematically

deviate from optimal financial decision making (Tourani-Rad & Kirkby, 2005). Behavioral

finance draws insights from psychology, finance, and other disciplines to study behavior in

various market settings that deviate from standard assumptions (Yoong & Ferreira, 2013) and

shows that markets are inefficient (Shiller, 2003). Daniel et al. (1998) suggest that individual

investors susceptibility to various behavioral anomalies can be obstacle in maximizing

wealth. Such anomalies of judgments are also known as cognitive illusions or biases.

According to Kahneman and Riepe (1998), reasoning errors are difficult to eliminate.

Therefore, understanding how different behavioral biases can influence investment decision

making is important.

A growing body of literature suggests that financial knowledge is necessary to

improve consumer behavior related to financial products and services. Some studies such as

Takeda et al. (2013) focus on the financial literacy or knowledge of investors. Others claim

that financial literacy affects individual differences in disposition bias (Dhar & Zhu, 2006;

Jonsson et al., 2017). Still another strand of research uses demographic characteristics to

explain differences in investor behavior (Barber & Odean, 2001; Lin, 2011). However, only

scant evidence is available on how financial literacy and various demographic characteristics

of individuals relate to behavioral biases.

This paper investigates the existence of behavioral biases among Indian stock

investors. Only limited research focuses on behavioral finance in India. Individual investors

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play an important role in India because the Indian economy has nine times more individuals

investing directly in the Indian stock market than through mutual funds compared to those in

any other equity market (Ramadorai, 2013).

Empirical research on behavioral biases typically uses trading data of investors

(Barber & Odean, 2000; Dhar & Zhu, 2006; Frazzini, 2006; Chun & Ming, 2009). To obtain

a different perspective, we use survey data collected from 516 investors in the Indian stock

market. According to Lin (2011), primary data more accurately reflect the behavioral aspects

of investors toward investment decision than secondary data.

The study has three major objectives: (1) to determine the presence of behavioral

biases among Indian investors; (2) to analyze how demographic variables affect behavioral

biases of Indian investors; and (3) to explore the relation between financial literacy and

behavioral biases among Indian investors. Existing studies on how financial literacy or

demographics relate to behavioral biases typically focus on Western countries with little

attention to Indian investors. However, the financial service sector in India is now highly

diversified and provides a wide range of investment and saving products. Because Indian

investors have limited skills and poor financial knowledge to evaluate and understand these

nancial products, they tend to

decision making. A need exists to study the behavior of individual investors in India. This

study attempts to help fill that gap and thus contributes to the behavioral finance literature.

The remainder of this study has the following organization. The next section presents

a review of relevant literature and theory involving the investment behavior of individual

investors followed by a discussion of the research methods and hypotheses. The next section

presents the data analysis and findings followed by a summary and conclusions.

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2. Literature Review and Theoretical Background

2.1 Behavioral Biases and Investment Decisions

Behavioral psychologists and financial academics have identified various behavioral

biases affecting investors. Behavioral biases are often the driving force behind individual

investor anomalies. For example, Kahneman and Tversky (1979) introduce prospect theory

suggesting that people make irrational decisions under risk and uncertainty and violate

axioms of expected utility theory. As Sahi et al. (2013) note, understanding individual

investment decisions also requires understanding the various behavioral biases that influence

their decision-making.

Our study focuses on 10 behavioral biases. Below are some studies that address each

of these biases.

Overconfidence and self-attribution: Barber and Odean (2000) find that individual

investors often exhibit overconfidence bias, which leads to excessive trading and poor

performance. Using a combination of survey data and matching trading records of clients,

Hoffman and Post (2014) support the presence of self-attribution bias in which investors

attribute high returns to their investment skills.

Disposition effect: Fogel and Berry (2006) provide empirical support for the presence of

the disposition effect among individual investors. They find that individuals report regret

for holding a losing stock too long and selling a winning stock too soon.

Anchoring: Tversky and Kahneman (1974) document the presence of anchoring bias in

which people make estimates by starting from an initial value that they then adjust to

yield a final answer.

Representativeness: Using transaction data of Chinese investors from a large brokerage

house, Chen et al. (2007) find that investors extrapolate recent past returns of stocks they

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 purchase. This evidence indicates that investors tend to exhibit representativeness bias.

Chun and Ming (2009) find that Malaysian investors trade in shares only to get quick

gains and are prone to representativeness and price anchoring biases. Further, they

document that investors are also loss averse and expect to earn higher returns without

considering associated risks.

Mental accounting: Agnew (2006) finds that individual investors are prone to having

behavioral biases such as mental accounting bias.

Familiarity: Tekçe et al. (2016) confirm the existence of familiarity, overconfidence,

representativeness, and status-quo biases among individual Turkish stock investors.

Availability: According to Tversky and Kahneman (1974), situations occur in which

people assess the frequency of a class or the probability of an event by the ease with

which they can bring instances or occurrences to mind. Investors exhibit the availability

heuristic while making decisions, which may later hinder their investment success

Hindsight bias: According to Camerer et al. (1989), individuals who exhibit hindsight

bias tend to be overconfident and overreact to new information.

Emotional bias: Emotional bias includes both loss aversion and regret aversion.

According to Kahneman and Tversky (1979), people sense twice as much pain for what

they lose than pleasure for equal gains. Moreover, regret is an emotional factor that is

generated when people make a wrong decision and consider their past decisions when

making current decisions.

Herding: Feng and Seasholes (2004) find a positive relation between the herding behavior

of individual Chinese investors and their trading location.

2.2 Investor Characteristics and Behavioral Biases

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behavior. Below are some studies that relate demographic variables to the behavioral biases

examined in our study.

Gender: Various researchers document that male investors are more overconfident than

female investors (Barber & Odean, 2001; Bhandari & Deaves, 2006; Lin, 2011; Kumar &

Goyal, 2016). Eagly and Carli (1981) find that females are more prone to herding bias

than are males.

Age: Prosad et al. (2015) examine the influence of demographic characteristics including

age, gender, income, profession, and experience on overconfidence, optimism, the

disposition effect, and herding bias. They find that age, profession, and experience have a

greater influence on behavioral biases than the other factors examined. Tekçe et al. (2016)

identify that overconfidence and familiarity bias among individual investors decrease as

age and wealth increases.

Marital status: Ates et al. (2016) find that the level of overoptimism, overconfidence, and

loss aversion among unmarried investors is significantly higher than for married

investors.

Education: Goo et al. (2010) report that investors with more education have a lower

disposition effect. Bhandari and Deaves (2006) and Deaves et al. (2010) find that

overconfidence increases when individuals have more education. Similarly, Ates et al.

(2016) suggest that representative bias has a greater influence on investors with less

education.

Occupation: Prosad et al. (2015) find that profession influences overconfidence,

optimism, and the disposition effect but does not affect herding bias.

Annual income: In their analysis of the difference in the disposition effect among

individuals, Dhar and Zhu (2006) find that low-income group investors exhibit a great

7
 disposition effect than do others. Similarly, Kumar and Goyal (2016) report a significant

difference in overconfidence bias across differing income levels of individual investors.

Investors in the higher-income group are less confident than those in the low-income

group.

Experience: Glaser et al. (2004) find that more experienced individuals demonstrate a

significantly higher level of overconfidence. Ates et al. (2016) report that overconfidence,

self-attribution, and anchoring biases are associated with more experienced investors.

2.3 Financial Literacy and Behavioral Biases

Noctor et al. (1992) view financial literacy as the ability to make informed judgments

and effective decisions about using and managing money. According to Lusardi and Mitchell

(2011), financial illiteracy is widespread worldwide and knowledge about the stock market is

particularly low. According to Van Rooij et al. (2011), people with a low level of financial

literacy, specifically those less knowledgeable about stocks and bonds, participate less often

in the stock market. In a survey on 516 salaried individuals in India, Bhushan and Medury

(2013) document a level of financial literacy of only 58.30%. Agarwalla et al. (2012) study

the level of financial literacy among the working young in urban India and report a poor level

of financial literacy.

Dhar and Zhu (2006) investigate differences in the disposition effect based on

individual investor characteristics. They find that educated and professional investors have a

low disposition bias. In their analysis of the effect of investment literacy of Japanese stock

investors on their decision-making bias, Takeda et al. (2013) find that individuals with high

investment literacy are less prone to being overconfident.

3. Research Methodology

3.1 Questionnaire Design

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 The questionnaire concerns issues involving financial literacy, demographic variables,

and behavioral biases of individual Indian investors. Both academicians and industry

professionals reviewed the survey instrument as a check for validity. We use several

measures to gauge the financial literacy of Indian stock investors (Lusardi & Mitchell, 2007;

Al-Tamimi & Bin Kalli, 2009; Van Rooij et al., 2011; Ibrahim & Alqaydi, 2013). Several

works provide the basis for measuring behavioral biases of individual investors (Wood &

Zaichkowsky (2004), Chun & Ming (2009), Goo et al. (2010), Lin (2011), Kudryavtsev et al.,

2013).

The survey consists of three sections. Section A describes respondent demographics.

Section B focuses on questions related to financial literacy using a three-point scale: agree,

t s respondents from

predicting the correct answer if they did not know. The questions related to financial literacy

include such areas as knowledge about risk and return, compound interest, portfolio

diversification, and investment management. Section C describes respondent behaviors when

making investment decisions using a five-point scale where 1 = strongly disagree, 2 =

disagree, 3 = neutral, 4 = agree, and 5 = strongly agree. The survey is available from the

authors upon request.

3.2 Sample and Data Collection

The target population for the study consists of individual investors in the Indian stock

market.

2010 and 2015. An email survey provided data from 2,000 active accounts from 10 major

cities in India (Mumbai, Ahmedabad, Delhi, Hyderabad, Kolkata, Bangalore, Chennai, Pune,

Jaipur. and Kochi). We chose the sampling frame of 2000 accounts based on the availability

of information about the contact numbers and e-mail addresses of these investors. A total of

530 respondents returned the questionnaire resulting in an initial response rate of 26.5%,

9
which is high for surveys of this type. Excluding 14 responses due to missing data reduced

the sample to 516 respondents.

4. Data Analysis and Findings

We use one-way analysis of variance (ANOVA), factor analysis, and multiple

regression analysis to examine the data. Before conducting these tests, we omitted nine

univariate and six multivariate outliers based on standard measures, resulting in a final

sample of 501 respondents. To detect the univariate outliers, we grouped items representing

single variables and then converted the data values of each observation to a standardized

score (Z score). The results show that the standardized score of nine cases are more than the

acceptable range of ± 3 (Hair et al., 2006). Therefore, we excluded nine cases as univariate

outliers. Further, to analyze the multivariate outliers, we calculated Mahalanobis D 2 measure.

Because the value of D2/df was greater than the acceptable range of 3 as specified by Hair

et al. (2006), we omitted these cases from further analysis.

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4.2 Non-response Bias

Non-response bias is a potential issue in survey research. To test for non-response

bias, we use both Mann-Whitney-U and Wilcoxon W tests to determine whether the

responses of early (first 50) and late (last 50) respondents differ statistically on 10 behavioral

biases (Weiss & Heide, 1993). Because responses are on a Likert-type scale and the

normality of data has not been examined, using these two tests is appropriate to compare the

two groups (De Winter & Dodou, 2010). Table 1 shows no statistically significant differences

at the 0.05 level between early and late respondents on any of the 10 behavioral biase. This

evidence lessens concern about non-response bias.

(Insert Table 1 about here)

4.3 Assumptions of Parametric Tests

Our examination for normality shows that the values of skewness and kurtosis for all

variables are within the acceptable range. To examine for homogeneity, we compute Levene's

test for variables measured on an interval scale across gender. Homogeneity is essential for

performing multiple regression analysis (Field, 2006). Most values, except the disposition

effect and herding, are greater than the 0.05 level. This finding suggests that equal variances

exist for the variables within groups of males and females, which supports the assumption of

homogeneity of variance.

4.4 Background Information

Table 2 summarizes the demographic characteristics of 501 respondents. The sample

consists of 86% males 14% female. The age groups 18 to 30 years (49.9%) and 31 to 45 years

(36.5%) account for the largest portion of the sample. Respondents are typically married

(66.1%) and well educated with 40.5% having a graduate (40.5%) and 41.7% having a

11
postgraduate degree. The majority of respondents work in the private sector (52.3%), earn 6

lakhs or less (61.9%), and have five years or less of investment experience in the stock

market (69.2%).

(Insert Table 2 about here)

4.5 Factor Analysis

We use factor analysis to examine the structure of measurement items corresponding

to different behavioral biases. Specifically, we use principal component analysis (PCA) as the

extraction method with Varimax rotation. The Kaiser-Meyer-Olkin measure of sample

adequacy of 0.843 satisfies the assumption of exploratory factor analysis. Ten components

emerged with an eigenvalue > 1 and explained 66.38% of the total variance. Table 3 presents

an overview of the factor matrix. We chose a rotated factor loading > 0.5 as a threshold (Hair

et al., 2006). Based on the factor analysis, we deleted two items (Q14 and Q15) due to cross-

loading between factors or no individual/distinct loading. These deleted items relate to self-

attribution bias (Q12 and Q13) merged with overconfidence bias (Factor 1). The 10

components resulting from the factor analysis are:

1. Overconfidence and self-attribution bias. Investors who are overconfident have unwarranted

faith in their intuitive reasoning, abilities, and judgments (Pompian, 2006). Because self-

attribution bias can lead to overconfidence, these two biases have a strong association

(Mishra & Metilda, 2015).

2. Disposition effect. Investors scoring high on disposition bias exhibit a tendency to realize

gains but are reluctant to realize losses. That is, these investors tend to sell shares whose

price has increased (winners), while keeping shares that have dropped in value (losers).

3. Anchoring bias. This factor deals with individuals who make estimates by starting from

an initial value or reference point. For investors, the stock purchase price is an important

reference point.

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4. Representativeness. This factor measures whether investors rely on past performance for

making any stock purchase. They trust that if past stock returns are good, then good

performance will continue in the future.

5. Mental accounting. Investors who score high on this factor tend to treat each element of

their investment portfolio separately. Instead of analyzing a outcome,

they tend to examine each stock or asset separately.

6. Familiarity bias

An investor with a high score keeps investing in assets with high media attention or those

in which family or friends invest.

7. Availability bias. This mental shortcut relies on the most recent, relevant, and dramatic

event that comes to mind when evaluating an asset.

8. Hindsight bias

the onset of the past event was predictable and obvious. Generally, investors with

hindsight bias become more overconfident and believe in their ability to forecast the

future.

9. Emotional bias. This factor pertains to items related to loss aversion bias and regret

aversion bias loaded on a single factor. For investors, losses loom greater than equivalent

gains.

10. Herding bias.

of others. Investors often rely on the actions of friends, relatives, and colleagues when

buying and selling securities.

(Insert Table 3 about here)

4.6 Reliability Assessment

-item reliability of a scale generated from several items.

13
A or the use of a scale (Sekaran, 2000). Table A1

(appendix) shows a high correlation among all the items in each component. The value of

hat

all the items in each construct are closely related (Hair et al., 2006). We measure the

reliability and internal consistency of the scale using item-to-

correlation to the summated scale score) and inter-item correlation (i.e., the correlation

among items). The results indicate that the item-to-total correlation value is higher than the

recommended value of 0.5 indicating that measuring items of a specific construct share a

high proportion of variance in common (Hair et al., 2006). Further, inter-item correlation

values of each item are also higher than the acceptable limit of 0.3 indicating the presence of

a higher correlation between items of the same construct (Robinson et al., 1991).

4.7 Behavioral Biases of Individual Investors

To analyze the behavioral biases of the 501 survey respondents, we take the average

ranking of behavioral biases in the order of their prominence among individual investors. The

results show that the means of 7 of the 10 biases are greater than 3, indicating that

respondents tend to have different behavioral biases in investment decision making. Mental

accounting, representativeness and overconfidence, and self-attribution biases have the

highest mean scores of 3.43, 3.37, and 3.36, respectively. Familiarity, availability, and

hindsight biases have mean scores below 3, suggesting that most respondents are not prone to

these behavioral biases.

(Insert Table 4 about here)

4.8 Demographic Variables and Behavioral Biases

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 To determine the variation across demographic variables with respect to behavioral

biases, we use an independent t-test and ANOVA. Table 5 shows whether a statistical

difference exists between demographic characteristics (gender and marital status) and

behavioral biases of the respondents. The results indicate that a significant difference occurs

between males and females for overconfidence and self-attribution bias, disposition effect,

mental accounting, and herding bias at the 0.05 level. The mean difference in Table 5

indicates that males are prone to being more overconfident and exhibiting mental accounting

than are females. However, females show both a greater disposition effect and herd behavior

than do males. Further, a significant difference occurs between marital status and mental

accounting bias. The mean score of unmarried respondents is higher than that of married

respondents for mental accounting bias, indicating that unmarried respondents are more

inclined to having mental accounting bias than are married respondents.

(Insert Table 5 about here)

Table 6 presents the difference in behavioral biases based on respondent demographic

characteristics (i.e., age, education, occupation, income, and investment experience). The p-

values in Table 6 indicate that the presence of overconfidence and self-attribution, anchoring,

and herding biases differs significantly with the age. The results also indicate a statistically

significant difference between education level and overconfidence and self-attribution, the

disposition effect, and representativeness. Respondent income level has no significant effect

on behavioral biases. Most behavioral biases, except the disposition effect and emotional

bias, differ significantly with different occupations. Table 6 also shows that behavioral biases

of respondents with investment experience in the stock market differ significantly for

overconfidence and self-attribution, the disposition effect, representativeness, mental

accounting, and herding bias.

(Insert Table 6 about here)

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4.9 How Financial Literacy and Demographic Variables Relate to Behavioral Biases

We calculate the financial literacy score of each respondent by assigning 1 mark to

each correct response and then adding the total marks obtained. The sample mean and median

are 6.73 and 7.00, respectively. Table 7 summarizes the results of the regression analysis for

the seven behavioral biases, with the independent variables grouped into two categories:

financial literacy and demographic characteristics (i.e., gender, age, marital status education,

of each category compared with the reference category. For gender, the reference category

consists of male respondents. For age, the reference category is respondents belonging to the

age group 18 to 30 years. For marital status, the reference category is married respondents.

For education, the reference category comprises respondents with education up to schooling,

which means that the respondents have a school certificate up to 10 + 2. For occupation, the

reference category is private sector employees. For income, the reference category includes

respondents with an annual income of less than Rs 3 lakhs. For investment experience, the

reference category consists of respondents having less than two years of experience.

The results show that respondent behavioral biases vary with both financial literacy

and demographic variables. Table 7 also reveals that across the seven regression models, the

two categories of predictor variables have different explanatory power. We discuss the details

of these seven regression models below.

Model 1. How Financial Literacy and Demographic Variables Relate to Overconfidence

Bias

According to Table 7, this regression model is significant (F = 4.35) at the 0.01 level and the

investment experience are statistically significant. Females are less confident than are males

and retired investors are more confident than private sector employees. Similarly, investors

16
who have more investment experience are prone to greater overconfidence and self-

attribution bias than are investors who have less than two years of investment experience.

The findings of how gender and investment experience relate to overconfidence are

consistent with those of previous studies (Barber & Odean, 2001; Bhandari & Deaves, 2006;

Lin, 2011; Kumar & Goyal, 2016). These findings indicate that males and respondents with

high investment experience are more confident than others.

Model 2. How Financial Literacy and Demographic Variables Relate to the Disposition
Effect

Table 7 shows that this regression model is significant (F = 2.59) at the 0.01 level but

the explanatory power of Model 2 is only 9.3%. The results show that coefficients of

financial literacy and demographic characteristics (i.e., gender, education, occupation, and

investment experience) are statistically significant. Further, financial literacy has a negative

association with the disposition effect, which means that an increase in the level of financial

literacy is associated with a decrease in the disposition effect among investors. The

coefficients of gender and one category of investment experience (i.e., > 5 to 10 years) are

positive and statistically significant at the 0.05 and 0.10 level, respectively. In terms of

education, graduates and postgraduates have a lower disposition effect than investors with

less education. Moreover, self-employed individuals are less inclined to the disposition effect

than are private sector employees.

Model 3. How Financial Literacy and Demographic Variables Relate to Anchoring Bias

Table 7 indicates that this regression model of anchoring bias is significant (F = 1.76)

at the 0.05 level and Model 3 explains 6.5%. Middle age investors (31 to 45 years old) are

negative and statistically significant at the 0.05 level. This finding shows that middle age

investors are less prone to having anchoring bias than are young investors. Table 7 also

indicates that the coefficients of two categories of occupation (i.e., retired investors and

17
others) are positive and statistically significant at the 0.05 level, which denotes that retired

investors and housewives are more prone to having anchoring bias than are private sector

employees.

Model 4. How Financial Literacy and Demographic Variables Related to

Representativeness Bias

As Table 7 shows, the regression Model 4 is significant (F = 2.48) at the 0.01 level

and its explanatory power is 8.9%. Further, the coefficients of age and education are negative

and statistically significant. The coefficients of occupation and investment experience are

positive and statistically significant, which indicates that investors who are older than 60 are

less prone to exhibiting representativeness bias compared to young investors. Similarly,

graduates and post graduates are less inclined to having representativeness bias than those

with education up to schooling. Retired investors show more representativeness bias in their

investment decision making than do private sector employees. This finding shows that greater

investment experience is associated with greater representativeness bias relative to less

experienced investors.

Model 5. How Financial Literacy and Demographic Variables Relate to Mental

Accounting Bias

According to Table 7, regression Model 5 is significant (F = 4.52) at the 0.01 level

and its explanatory power is 15.2%. The coefficients of all the variables are statistically

significant indicating that a positive association between financial literacy and mental

accounting. As financial literacy increases so does mental accounting bias. Females and

investors having a doctorate degree are less inclined to exhibit mental accounting bias

relative to the reference category. The graduate and post-graduate categories in education,

retired, and other categories of occupation, investors who have more experience are less

prone to mental accounting bias than those in the reference category.

18
Model 6. How Financial Literacy and Demographic Variables Relate to Emotional Bias

The results indicate that regression Model 6 of emotional bias are not statistically

significant (F = 0.911). This finding shows that the predictor variables do not explain the

variance in this model.

Model 7. How Financial Literacy and Demographic Variables Relate to Herding Bias

Table 7 demonstrates that the regression Model 7 on herding bias is significant (F =

power is 11.1%. The results show that

financial literacy has a significantly negative relation to herding bias at the 0.05 level. The

evidence also indicates that older investors are less inclined toward herding relative to those

in the reference category. The coefficients of public sector employees and others categories

of occupation are positive and statistically significant. However, the coefficients of the self-

employed category under occupation are negative and statistically significant at the 0.05

level.

5. Discussion and Conclusions

Despite an extensive literature on behavioral finance, limited academic research

attempts to unravel the relation between financial literacy and behavioral biases, especially in

India (Sahi & Arora, 2012). Our study contributes to this literature by trying to fill this gap.

. The depth and efficiency of Indian

financial markets make investing an attractive opportunity for individual investors. Market

regulators and policy makers are concerned about the behavioral tendencies of individual

investors.

We examine the presence of behavioral biases using a sample of individual investors

in India. Our survey results reveal the presence of different behavioral biases including

overconfidence and self-attribution, the disposition effect, anchoring bias, representativeness,

19
mental accounting, emotional biases, and herding among Indian investors. Hence, our

findings support the view that individual investors do not always act rationally. Instead,

emotions, heuristics, and other biases affect their investment decision making.

Our evidence also shows that the level of financial literacy and demographic

characteristics of investors are related to specific behavioral biases. The results show that

financial literacy has a negative association with the disposition effect and herding bias,

which is consistent with Dhar and Zhu (2006) and Jonsson et al. (2017). Further, financial

literacy has a positive and significant effect on mental accounting bias but is not related to

overconfidence bias. This latter finding contrasts with Takeda et al. (2013) because

increased investment literacy does not help in limiting the overconfidence bias of Indian

investors.

Our results reveal that age, occupation, and investment experience are the most

important demographic variables that influence behavioral biases of individual investors in

our sample. Regarding gender, the findings reveal that males are more overconfident than are

females about their knowledge of the stock market, which is consistent with Lewellen et al.

(1977), Barber and Odean (2001), Bhandari and Deaves (2006), Lin (2011), and Kumar and

Goyal (2016). Moreover, older investors are less prone to exhibiting herding bias and

representativeness bias that are younger investors. This evidence suggests that young or

novice investors feel more secure about their returns after they discuss their investment

decisions with colleagues and friends.

Another finding is that overconfidence is related to increased investment experience,

which is consistent with Bhandari and Deaves (2006), Deaves et al. (2010), and Prosad et al.

(2015). Moreover, investors with graduate and postgraduate degrees are less inclined to the

disposition effect than are less educated investors, a finding consistent with Dhar and Zhu

20
(2006). However, income has no significant relation on most behavioral biases except mental

accounting bias.

Overall, our findings confirm that individual investors in India are prone to different

behavioral biases and that financial literacy and demographic variables are related to these

biases. Based on the ranking of different behavioral biases in order of their presence, mental

accounting, representativeness, and overconfidence appear to be the most prominent biases

exhibited by our sample of individual investors.

Our study may have implications for financial educators in promoting the financial

awareness programs for individuals. Financial advisors can potentially become more

effective by understandi -making processes, which in turn can result

investors who understand how behavioral biases can influence their investment decisions

may be able to make more effective decisions. Future researchers should undertake additional

studies to determine the generalizability of our findings beyond a sample of individual

investors in India.

21
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Table 1. Statistical Tests for Non-response Bias

This table reports the results of Mann-Whitney-U and Wilcoxon W tests for non-response
bias, which compare the responses from the first and last 50 respondents on the following
behavioral biases: OS = overconfidence and self-attribution bias, DE = disposition effect,
ANCH = anchoring bias, REP = representativeness bias, MA = mental accounting bias, FAM
= familiarity bias, AVL = availability bias, HS = hindsight bias, EM = emotional bias, and
HERD = herding bias. None of the tests is statistically significant at the 0.05 level.

OS DE ANCH REP MA FAM AVL HS EM HERD

Mann- 1154.5 1179.0 1203.5 1030.0 1121.5 1111.5 1164.0 1162.0 1241.0 1110.5
Whitney U
Wilcoxon W 2429.5 2454.0 2478.5 2305.0 2396.5 2386.5 2439.0 2437.0 2516.0 2385.5

Z .662 .499 .323 1.541 .897 .969 .603 616 .062 .975
Asymptotic 0.508 0.618 0.746 0.123 0370 0.333 0.546 0.538 0950 0.329
Significance
(2-tailed)

28
Table 2. Demographic Profile of the Survey Respondents

This table shows the demographic characteristics of 501 survey respondents from one of
.

Profile Group Frequency %

Male 431 86.0

Gender
Female 70 14.0
18 to 30 250 49.9
31 to 45 183 36.5
Age
46 to 60 49 9.8
> 60 19 3.8
Married 331 66.1
Marital Status
Unmarried 170 33.9
Up to schooling 23 4.6
Graduate 203 40.5
Education
Post graduate 259 51.7
Doctorate 16 3.2
Private sector employee 262 52.3
Public sector employee 54 10.8
Occupation Self-employed 144 28.7
Retired 22 4.4
Others 19 3.8
Less than 3 lakhs 116 23.2
3 to 6 lakhs 194 38.7
Annual Income
> 6 to 10 lakhs 124 24.8
> 10 lakhs 67 13.4
Less than 2 years 204 40.7
Investment
2 to 5 years 143 28.5
Experience in the
> 5 to 10 years 80 16.0
Stock Market
> 10 years 74 14.8

29
Table 3. Rotated Component Matrix from the Principal Component Analysis

This table shows the factor loadings of different behavioral biases from using PCA where OS
= overconfidence and self-attribution bias, DE = disposition effect, ANCH = anchoring bias,
REP = representativeness bias, MA = mental accounting bias, FAM = familiarity bias, AVL
= availability bias, HS = hindsight bias, EM = emotional bias, and HERD = herding bias.
Component
Items
1 2 3 4 5 6 7 8 9 10
OS1 0.776
OS2 0.714
OS3 0.706
OS4 0.710
OS5 0.631
OS6 0.657
DE1 0.797
DE2 0.804
DE3 0.746
ANCH1 0.775
ANCH2 0.750
ANCH3 0.772
ANCH4 0.717
REP1 0.692
REP2 0.808
REP3 0.639
MA1 0.647
MA2 0.818
MA3 0.816
FAM1 0.793
FAM2 0.883
FAM3 0.853
AVL1 0.802
AVL2 0.757
AVL3 0.760
HS1 0.824
HS2 0.804
HS3 0.680
EM1 0.589
EM2 0.687
EM3 0.671
EM4 0.665
EM5 0.705
EM6 0.691
HERD1 0.838
HERD2 0.838
HERD3 0.802
HERD4 0.855
HERD5 0.720

Note: The extraction method is PCA and the rotation method is Varimax with Kaiser Normalization. Rotation
converged in seven iterations.

30
Table 4. Ranking of Behavioral Biases

This table ranks the behavioral biases based on their mean values for the 501 respondents.

Behavioral Bias Mean Rank

Mental accounting 3.43 1
Representativeness 3.37 2
Overconfidence and self-attribution 3.36 3
Anchoring 3.33 4
Emotional bias 3.28 5
Herding 3.17 6
Disposition effect 3.13 7
Availability 2.69 8
Hindsight bias 2.64 9
Familiarity 2.40 10

31
Table 5. Behavioral Biases across Gender and Marital Status of Individual Investors

This table shows the mean difference in behavioral biases for gender and marital status.
Numbers in italics show significance at the 0.05 level or higher.

t-test for Gender t-test for Marital Status

Variables Levene's t-value Significance Mean Levene's t-value Significance Mean
test (2-tailed) Difference test (2-tailed) Difference

Overconfidence and 0.361 3.692 0.000 0.256 0.810 1.196 0.232 0.056
self-attribution
Disposition effect 0.001 0.033 0.534 0.740
Anchoring 0.078 0.890 0.579 0.455
Representativeness 0.587 0.995 0.320 0.073 0.021 0.420
Mental accounting 0.355 3.742 0.000 0.302 0.262 0.048
Emotional bias 0.293 0.390 0.697 0.025 0.602 0.717
Herding 0.000 0.011 0.130 0.626

32
33
Table 6. ANOVA for Demographic Variables and Behavioral Biases

This table reports the results of one-way ANOVA for behavioral biases across demographic characteristics: age, education, occupation, income,
and investment experience. Numbers in italics show significance at the 0.05 level or higher.

Variables Age Education Occupation Income Investment Experience

Between Groups Mean F p-value Mean F p-value Mean F p-value Mean F p-value Mean F p-value
Square Square Square Square Square
Overconfidence 0.599 2.398 0.067 0.614 2.459 0.062 0.546 2.187 0.069 0.105 0.416 0.742 5.010 22.500 0.000
and self-
attribution
Disposition effect 0.059 0.135 0.939 2.39 5.625 0.001 0.636 1.458 0.214 0.644 1.475 0.220 1.380 3.210 0.023
Anchoring 1.960 4.721 0.003 0.370 0.870 0.457 2.420 5.920 0.000 0.165 0.386 0.763 0.028 0.065 0.979
Representativeness 0.065 0.199 0.897 0.852 2.644 0.049 1.630 5.184 0.000 0.621 1.919 0.126 0.759 2.350 0.071
Mental 0.718 1.789 0.148 0.513 1.275 0.282 0.982 2.462 0.044 0.554 1.376 0.249 2.570 6.590 0.000
Accounting
Emotional bias 0.441 1.781 0.150 0.145 0.580 0.628 0.136 0.544 0.704 0.307 1.235 0.296 0.175 0.701 0.552
Herding 1.150 2.637 0.049 0.351 0.794 0.498 3.030 7.200 0.000 0.702 1.596 0.190 1.480 3.420 0.017

34
Table 7. Regression Analysis on Behavioral Biases across Financial Literacy and Demographic Variables

This table reports the results of linear regression on behavioral biases across financial literacy and demographic characteristics. Numbers in
italics show significance at the 0.05 level or higher.
Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7
Overconfidence Disposition effect Anchoring Representativeness Mental Accounting Emotional bias Herding
p p p p p p p
Constant 2.102 0.000 3.072 0.000 2.727 0.000 2.528 0.000 2.090 0.000 2.195 0.000 2.674 0.000
Financial literacy 0.007 0.721 030 0.022 019 0.154 002 0.849 0.040 0.001 017 0.088 029 0.026
Gender (male = 0) 0.187 0.023 0.190 0.032 0.017 0.846 063 0.412 206 0.012 010 0.880 0.123 0.162
Age (18 to 30 = 0)
31 to 45 0.041 0.451 024 0.743 160 0.030 0.028 0.658 0.219 0.001 055 0.339 172 0.019
46 to 60 .084 0.336 0.060 0.611 038 0.747 064 0.531 0.149 0.174 0.119 0.195 002 0.989
> 60 293 0.107 0.263 0.288 017 0.947 405 0.058 272 0.237 0.097 0.614 418 0.089
Marital status (Married = 0) 0.051 0.330 002 0.976 008 0.911 0.083 0.181 0.251 0.000 0.023 0.678 066 0.352
Education (Up to schooling =
0)
Graduate 121 0.259 457 0.002 108 0.459 218 0.085 133 0.327 0.097 0.391 0.188 0.195
Postgraduate 062 0.560 537 0.000 098 0.498 254 0.044 108 0.425 0.053 0.641 0.129 0.373
Doctorate 0.063 0.698 174 0.426 058 0.791 242 0.201 419 0.040 0.095 0.575 0.029 0.895
Occupation (Private sector
employee = 0)
Public sector employee 088 0.228 0.098 0.326 0.106 0.284 0.072 0.402 118 0.200 0.056 0.470 0.346 0.000
Self-employed 0.048 0.360 161 0.024 058 0.411 0.048 0.433 076 0.252 032 0.566 172 0.016
Retired 0.320 0.050 247 0.263 0.495 0.026 0.672 0.000 0.460 0.025 045 0.792 0.108 0.624
Others 0.028 0.808 0.011 0.947 0.377 0.018 0.474 0.001 0.352 0.017 0.142 0.249 0.278 0.079
Income (< 3 lakhs = 0)
3 to 6 lakhs 0.021 0.720 0.079 0.320 0.048 0.544 103 0.133 0.135 0.065 018 0.770 0.045 0.563
> 6 to 10 lakhs 0.041 0.538 012 0.891 0.033 0.712 0.021 0.787 0.183 0.029 0.062 0.376 0.045 0.617
> 10 lakhs 0.001 0.989 114 0.276 055 0.599 055 0.542 0.051 0.596 070 0.388 119 0.254
Investment experience (< 2
years = 0)
2 to 5 years 0.331 0.000 0.121 0.105 0.039 0.606 0.152 0.019 0.152 0.030 0.077 0.185 0.064 0.720
> 5 to 10 years 0.416 0.000 0.167 0.087 0.052 0.594 0.146 0.084 0.194 0.033 0.099 0.194 140 0.643
> 10 years 0.377 0.000 106 0.320 0.012 0.912 0.054 0.561 0.312 0.002 0.066 0.425 0.125 0.572
R2 0.147 0.093 0.065 0.089 0.152 0.035 0.111
F 4.35*** 2.59*** 1.76** 2.48*** 4.52** 0.91 3.15***

35
Note: n = 501, = unstandardized coefficient; p = significance value; gender, age, marital status, education, occupation, income, and investment experience converted into dummy variables. We
use variance inflation factors to measure how much the variance of the estimated regression coefficients are inflated as compared to when the predictor variables are not linearly related. We use
the Durbin Watson statistic to detect the presence of autocorrelation in the residuals (prediction errors) from a regression analysis. **, *** significant at the 0.05 and 0.01 level respectively.

36
Appendix 1

Table A.1. Reliability of the Research Instrument

-
item correlation and corrected-item total correlation. Note that S.D. = standard deviation, OS
= overconfidence and self-attribution bias, DE = the disposition effect, ANCH = anchoring
bias, REP = representativeness bias, MA = mental accounting bias, FAM = familiarity bias,
AVL = availability bias, HS = hindsight bias, EM = emotional bias, and HERD = herding
bias.
Corrected
Cronbach's Inter Item
Construct Item Statement Mean S.D Item-Total
Alpha Correlation
Correlation
I am an experienced
OS1 3.20 0.950 0.648
investor.
I feel that on average
my investment
OS2 3.32 1.005 0.548
performs better than the
stock market.
When I purchase a
winning investment, I
OS3 feel that my actions and 3.45 0.961 0.575
knowledge affected the
Overconfi-
result.
dence and
I feel more confident in
self- 0.818 0.56 - 0.39
my own investment
attribution OS4 3.40 1.037 0.565
opinions over opinions
Item 6
of financial analysts.
My past profitable
investments were
OS5 mainly due to my 3.41 0.968 0.562
specific investment
skills.
I believe that my skills
and knowledge of stock
OS6 3.40 1.027 0.592
market can help me to
outperform the market.

responses to good or
bad news and tend to
DE1 3.17 0.997 0.634
sell profitable stocks
too early and sell losing
Disposition
stocks too late.
effect 0.792 0.58 - 0.54
I am often reluctant to
Item 3 DE2 3.08 0.927 0.622
realize losses.
I sell profitable stocks
because I am afraid that
DE3 3.13 1.095 0.653
the stock price would
fall again.
I compare the current
stock price with their
ANC
recent 52-week high 3.39 1.040 0.615
H1
Anchoring and low price to justify
0.818 0.63 - 0.46
Item 4 my stock purchase.
I am unlikely to buy a
ANC
stock that was more 3.07 1.001 0.604
H2
expensive than last

37
 Corrected
Cronbach's Inter Item
Construct Item Statement Mean S.D Item-Total
Alpha Correlation
Correlation
year.
When I decide to sell a
ANC
stock, I keep its 3.63 1.131 0.695
H3
purchase price in mind.
In a falling market, I
ANC hold a losing stock till
3.24 1.128 0.646
H4 its price returns to its
purchase level.
I forecast the changes in
stock prices in the
REP1 3.22 0.904 0.544
future based on the
recent stock prices
I rely on past
Representa- performance to buy
tiveness REP2 stock because I believe 3.36 0.990 0.733 0.52 - 0.42 0.602
Item 3 that good performance
will continue.
You tried to avoid
investing in companies
REP3 3.51 1.071 0.530
with history of poor
earning
My investment in stock
A does not effects my
MA1 3.52 0.968 0.603
investment decision in
stock B.
My decision to buy
Mental gold or a house does
accounting MA2 not affect my 3.29 1.063 0.786 0.58 - 0.53 0.637
Item 3 investment in stock
market.
I tend to treat each
element of my
MA3 3.47 0.963 0.642
investment portfolio
separately.
I just look at the
FAM1 company names before 2.57 1.087 0.693
investing.
I prefer to invest in
Familiarity FAM2 those shares where my 2.28 1.022 0.770
0.863 0.74 - 0.64
Item 3 father has invested.
I am in X industry, so I
only invest
FAM3 2.35 1.085 0.758
in companies of this
industry.
I prefer to buy stocks
on the days when the
AVL1 2.61 1.063 0.735
value of the Nifty- 50
Index increases.
I prefer to sell stocks on
Availability the days when the value
AVL2 2.53 1.011 0.786 0.75 - 0.41 0.678
Item 3 of the Nifty- 50 Index
decreases.
I prefer to buy local
stocks than
AVL3 2.91 1.055 0.482
international stocks
because the information

38
 Corrected
Cronbach's Inter Item
Construct Item Statement Mean S.D Item-Total
Alpha Correlation
Correlation
of local stocks is more
available.]
You were able to
predict the collapse of
HS1 Sensex in the wake of 2.44 0.975 0.553
2007 global financial
crisis.
You would be
Hindsight convinced, if In 2006-
bias 07 someone had told 0.719 0.53 - 0.40
HS2 2.60 0.926 0.584
Item 3 you that a financial
crisis is about to happen

You believe, you have

gained more if your
HS3 2.87 0.922 0.483
advisor had waited for a
longer period.
I will not increase my
investment when the
EM1 3.03 1.064 0.500
market performance is
poor
You are more
concerned about a large
EM2 loss in your stock than 3.40 1.004 0.618
missing a substantial
gain/profit.
You feel nervous when
large paper losses (price
EM3 3.31 0.993 0.586
drops) have in your
Emotional invested stocks.
Bias When it comes to 0.812 0.53 - 0.31
Items 6 investment, no loss of
capital (invested
EM4 3.31 1.062 0.575
money) is more
important than
returns/profits.
I feel more sorrow
about holding losing
EM5 stocks too long than 3.27 1.049 0.599
about selling winning
stocks too soon.
I often feel regret for
EM6 selling a winning stock 3.38 1.057 0.559
too early.
I rarely consult others
HERD
before making stock 3.18 0.885 0.722
1
purchases or sales.
Other investors'
decisions of buying and
HERD
selling stocks have 3.15 0.982 0.789
Herding 2
impact on my 0.889 0.73 - 0.48
Item 5
investment decisions.
I usually react quickly
to the changes of other
HERD
investors' decisions and 3.10 1.024 0.750
3
follow their reactions to
the stock market.

39
 Corrected
Cronbach's Inter Item
Construct Item Statement Mean S.D Item-Total
Alpha Correlation
Correlation
I consult others (family,
HERD friends or colleagues)
3.20 1.091 0.796
4 before making stock
purchased.
I follow social blogs/
HERD
forums before making 3.22 0.900 0.605
5
stock purchase/sale.

40