Heuristic and Biases Related To Financial Investment and The Role of Behavioral Finance in Investment Decisions - A Study

ZENITH International Journal of Business Economics & Management Research__________ ISSN 2249- 8826
ZIJBEMR, Vol.5 (12), DECEMBER (2015), pp. 82-101

Online available at zenithresearch.org.in
HEURISTIC AND BIASES RELATED TO FINANCIAL INVESTMENT

AND THE ROLE OF BEHAVIORAL FINANCE IN INVESTMENT
DECISIONS – A STUDY
SHABARISHA. N
ASSISTANT PROFESSOR
DEPARTMENT OF TOURISM STUDIES
CHRIST UNIVERSITY
BENGALURU.
ABSTRACT
Decision-making is a versatile action. Decisions cannot be made in an annulled by relying on the
personal resources and complex models, which do not take into consideration the situations. A
situation based on decision-making activity encompasses not only the explicit dilemma faced by
the individual but also drag out to the environment. The most decisive challenge faced by the
investors is in the vicinity of investment decisions. In designing the investment portfolio, the
investors should consider their financial and investment goals, risk forbearance level, and other
constraints. In addition to that, they have to envisage the output return- risk optimization. This
process is better suited for institutional investors; it often fails for individuals, who are
vulnerable to heuristic and behavioural biases. The presence of frequently occurring anomalies in
conventional economic theory was a big contributor to the configuration of behavioral finance.
These ostensible anomalies, and their unrelenting subsistence, directly infringe modern financial
and economic theories, which assume rational and logical behaviour. Such a decision-maker
would consider all relevant information and come up with the best choice under the situations in
a progression known as constrained optimization. The present paper spotlights on Heuristic and
Biases Related to Financial Investment and the Role of Behavioural Finance in Investment.
KEY WORDS: Anchoring, Behavioral finance, Efficient Market Hypothesis, Gamblers Fallacy,
Hindsight Bias, Mental Accounting, Portfolio investment.
1. Introduction
The conventional finance model tries to stumble on realizing financial markets using models in
which investors are “rational”. Although many conventional theories of unreliable complexities
and evocative influence have existed and evolved over the past several decades, the sagacity of
investors is a vital assumption all and diverse. According to No singer (2001), the field of
finance has evolved over the past few decades based on the assumption that people make rational
decisions and that they are unbiased in their predictions about the future. Investors are thought of
as a rational lot that take carefully weighted economically feasible decisions every single time. A
rational investor can be defined as a one that always (a) updates his beliefs in a timely and
appropriate manner on receiving new information; (b) makes choices that are normatively
acceptable.
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Electronic copy available at: https://ssrn.com/abstract=2881151

In the current state of affairs, behavioural finance is flattering a vital part of the decision-making
process, because it profoundly influences investors‟ performance. They can improve their
performance by recognizing the biases and errors of judgment to which all of us are prone.
Understanding the behavioural finance will help the investors to select a better investment
instrument and they can evade repeating the expensive errors in prospect. The relatable issues of
this logical study are how to lessen or eradicate the psychological biases in investment decision
process.
The dictionary meaning for heuristics refers to the process by which people find things out for
themselves usually by trial and error. Heuristics can also be defined as the “use of experience
and practical efforts to answer questions or to improve performance”. Owing to the precision that
more and more information is swell more rapidly, verve for decision-makers in financial markets
has become a mostly inevitable approach, but not always beneficiary. Heuristics may facilitate to
explain why the market occasionally acts in aridiculousway, which is contrary to the model of
flawlessly knowledgeable markets. The construal of new information may necessitate heuristic
decision-making rules, which might later have to be reconsidered.
2. An Overview of Basic Investment Theories
2.1 Efficient Market Hypothesis
"An 'efficient' market is defined as a market where there are large numbers of rational, profit-
maximizes actively competing, with each trying to predict future market values of individual
securities, and where important current information is almost freely available to all participants.
In an efficient market, competition among the many intelligent participants leads to a situation
where, at any point in time, actual prices of individual securities already reflect the effects of
information based both on events that have already occurred and on events which, as of now, the
market expects to take place in the future. In other words, in an efficient market at any point in
time the actual price of a security will be a good estimate of its intrinsic value." (Fama, 1965).
According to Fama, efficiency is distinguished in three different forms:
• Strong-form:Information (public, personal, even confidential) contributes to stock pricing, and,
therefore, does not enable investors to achieve a competitive advantage in investing processes.
• Semi-strong form:Stock prices reflect public financial information (announcements of listed
companies, balanced sheets, assets etc.)
• Weak efficiency:All past stock prices are integrated in current prices; therefore, they cannot be
used for future predictions.
The Efficient Market Hypothesis (EMH) has been a fundamental finance archetype for over four
decades, perhaps the most criticized too. Fama (1970) defined an efficient market as one in
which security prices fully reflect all accessible information, and hypothesis states that real world
financial markets are efficient. Further he says that it would be impracticable for a trading system
based on presently available information to have surplus returns constantly. The conjectural
ground work of EMH is based on three key arguments (a) investors are rational and value
securities sensibly (b) in case some investors are irrational, their trades are random and cancel
each other out without affecting prices (c) rational arbitrageurs eliminate the influence of
irrational investors on market. The fact that Efficient Market Hypothesis was not purely based on
rationality alone but also predicted efficient markets in cases where rationality did not exist, gave
the theory a lot of credibility (Rahul Subhash, 2011).
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Electronic copy available at: https://ssrn.com/abstract=2881151

2.2 Behavioral Finance

Behavioral finance is a branch of finance that studies how the behavior of participants in the
financial market and influenced by psychological factors and the resulting influence on decisions
made while buying or selling the market, thus affecting the prices. The science aims to explain
the reasons why it‟s reasonable to believe that markets are inefficient.Daniel Kahneman and
Amos Tversky, recognized as the Fathers of Behavioral Finance.
Lintner (1998),defines behavioural finance as being “the study of how humans interpret and act
on information to make informed investment decisions”.
Olsen (1998), asserts that “behavioural finance does not try to define „rational‟ behaviour or
label decision making as biased or faulty; it seeks to understand and predict systematic financial
market implications of psychological decision processes”.
According to Sewell (2007),“Behavioral finance is the study of the influence of psychology on

the behaviour of financial practitioners and the subsequent effect on markets.”
Thus, Behavioral finance can be defined as a field of finance that proposes elucidation of stock
market anomalies using recognized psychological biases, rather than dismissing them as “chance
results consistent with the market efficiency hypothesis.”(Fama, 1998). It is implicit that
individual investors and market outcomes are subjective to information structure, and various
characteristics of market participants (Banerjee, 2011).
2.3 Human Behavioral Theories
In order to elucidate the diverse irrational investor behaviors in financial markets, behavioral
economists depict on the knowledge of human cognitive behavioral theories from
psychology,sociology and anthropology. Two major theories are depicted in the following
figure; Prospect Theory and Heuristics;
Cognitive Illusions
Heuristics Prospect Theory

Representativeness Loss Aversion
Over Confidence Regret Aversion
Anchoring Mental Accounting
Gamble Fallacy Self Control
Availability Bias
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2.3.1 Heuristic Decision Process

“Heuristics are simple efficient rules of the thumb which have been proposed to explain how
people make decisions, come to judgments and solve problems, typically when facing complex
problems or incomplete information. These rules work well under most circumstances, but in
certain cases lead to systematic cognitive biases” – Daniel Kahneman (Rahul, 2011).
The decision process by which the investors‟find things usually by trial and error, lead to the
development of rules of thumb. In other words, itrefers to rules of thumb which humans use to
made decisions in complex, uncertainenvironments. In reality, the investors‟ decision making
processes are not exactingly rationalone. Thought the investors have collected the relevant
information and objectivelyevaluated, in which the mental and emotional factors are involved. It
is very difficult toseparate. Occasionally it may be excellent, but many times it may result in
poorer decisionoutcomes. It includes:
a). Representativeness Bias: Representativeness is judgment based on overreliance stereotypes.

The investors‟ recent success; tend to continue into the future also. The tendency of decisions of
the investors to make based on experiences is known as stereotype. Gilovich et al (2002) define
Representativeness as “an assessment of the degree of correspondence between a sample and a
population, an instance and a category, an act and an actor or, more generally, between an
outcome and a model."
b). Overconfidence Bias:It is defined as people‟s tendency to overestimate their skills or

abilities,that is, to be too confident of their abilities, knowledge and received information, and, as
result,to make incorrect investing options; it also implies people‟s arrogant attitude towards
stockmarkets. Plous (1993) asserts that „no problem in judgment and decision making is
moreprevalent and more potentially catastrophic than overconfidence‟, and DeBondt and
Thaler(1995) argue that overconfidence is „perhaps the most robust finding in the psychology
ofjudgment‟.
c). Anchoring Bias:It describes the common human tendency to rely too heavily, or „anchor‟ on
one trait or piece of information when making decisions. When presented with new information,
the investors tend to be slow to change or the value scale is fixed or anchored by recent
observations. They are expecting the trend of earning is to remain with historical trend, which
may lead to possible under reactions to trend changes.
d). Gamble Fallacy Bias: It arises when the investors inappropriately predict that tend will
reverse. It may result in anticipation of good or poor end.
e). Availability Bias: The investors place gratuitousburden for making decisions on the most
available information. This happens quite commonly. It leads less return and sometimes poor
results also.
2.3.2 Prospect Theory

The Prospect theory was originally propounded by Kahneman and Tversky (1979) and later
resulted in Daniel Kahneman being awarded the Nobel Prize for Economics. The theory
differentiates two phases in the choice process: the early phase of framing (or editing) and the
subsequent phase of evaluation. Tversky and Kahneman, by developing the Prospect Theory,
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showed how people manage risk and uncertainty. In essence, the theory explains the apparent
irregularity in human behavior when assessing risk under uncertainty. It says that human beings
are not consistently risk-averse; rather they are risk-averse in gains but risk-takers in losses.
a). Loss aversion: Loss aversion is an important psychological concept which receives
increasing attention in economic analysis. The investor is a risk-seeker when faced with the
prospect of losses, but is risk-averse when faced with the prospects of enjoying gains. This
phenomenon is called loss aversion.
b). Regret Aversion: It arises from the investors‟ desire to avoid pain of regret arising from a
poor investment decision. This aversion encourages investors to hold poorly performing shares
as avoiding their sale also avoids the recognition of the associated loss and bad investment
decision. Regret aversion creates a tax inefficient investment strategy because investors can
reduce their taxable income by realizing capital losses (Anastasios et. al, 2012).
c). Mental Accounting: Mental accounting is the set of cognitive operations used by the
investors to organize, evaluate and keep track of investment activities. Three components of
mental accounting receive the most attention. These first captureshow outcomes are perceived
and experienced, and how decisions are made and subsequently evaluated. A second component
of mental accounting involves the assignment of activities to specific accounts. Both the sources
and uses of funds are labeled in real as well as in mental accounting systems. The third
component of mental accounting concerns the frequency with which accounts are evaluated and
'choice bracketing'. Accounts can be balanced daily, weekly, yearly, and so on, and can be
defined narrowly or broadly.
d). Self Control: It requires for all the investors to avoid the losses and protect the investments.
By mentally separating their financial resources into capital and „available for expenditure‟
pools, investors can control their urge to over consume.
3. Review of Literature
Peter D. Hede, (2012), opines that, in traditional economics, the decision maker is typically
rational and self-interested. This is the Homo economics view of men‟s behaviour in which a
man acts to obtain the highest possible well-being for himself given available information about
opportunities and other constraints on his ability to achieve his predetermined goals. Behavioural
finance has contributed to understand how people value assets in a variety of markets. Investors
and academics alike strive to quantify asset values based on observable factors, but experience
clearly indicates that the human side has very real effects. A clear challenge for behavioural
finance is obviously to bring what the people learned about to make decisions to markets.
Rahul Subhash, (2011), explore that, extreme volatility has plagued financial markets
worldwide since the 2008 Global Crisis. Investor sentiment has been one of the key determinants
of market movements. In this context, studying the role played by emotions like fear, greed and
anticipation, in shaping up investment decisions seemed important. Behavioral Finance is an
evolving field that studies how psychological factors affect decision making under uncertainty.
Further he explores in his work about the influence of certain identified behavioral finance
concepts (or biases), namely, Overconfidence, Representativeness, Herding, Anchoring,
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Cognitive Dissonance, Regret Aversion, Gamblers‟ Fallacy, Mental Accounting, and Hindsight
Bias, on the decision making process of individual investors in the Indian Stock Market.
M. Kannadhasan, (2011), opines that, Decision-making is a complex activity. The susceptibility

of an investor to a particular illusion is likely to be a function of several variables. There is
suggestive evidence that the experience of the investor has an explanatory role in his regard with
less experienced investors being proneto extrapolation (representativeness) while more
experienced investors commit gamblerfallacy.Similarly, behavioural factors play a vital role in
the decision making process ofthe investors. Hence the investors has to take necessary steps to
minimize or avoid illusions for influencing in their decision making process, investment
decisions in particular.
Anastasios, et. al, (2012), explores that, the new theoretical approach accepts people‟s
behavioural weaknesses and asserts that investing failures are a natural consequence of the
special traits of human behaviour. The key element of the emerging theory is the investor-human
being rather than investors as machines. Within this framework, Behavioural Finance treats
investors as individuals and highlights that emotion, biases, and illusions cannot be rationalized;
in addition, it emphasizes that information is inefficient. Stock prices are not random; they are
rather unpredictable as people‟s reaction tone information is unpredictable, as well.
4. Objectives of the Study

The study is undertaken with the following objectives;
01. To differentiate between traditional or standard finance theories and Behavioural finance
theories on investment decisions.
02. To spotlight on Heuristic bias and Prospect theory.
03. To know the influence of Behavioral factors on the investment decisions of retail
investors.
5. Research Methodology
For the purpose of studying the influence of Heuristic bias and Behavioural Finance on
Investment decision, the research design has structured into:
5.1Research Design
Population Shimoga district
Sample Retail Investors of Shimoga District
Sample size 30
Sampling Technique Simple Random sampling
5.2 Data Collection

Primary: A Structured Questionnaire was designed for the purpose of elucidating respondents
(Retail Investors in Shimoga region) opinion towards influence of Heuristic bias and Behavioural
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Finance on Investment decision.

Secondary: Journal, News Report, Internet
5.3.1 Data Analysis and Interpretations:

Sl. No. Response of the Question
01. Age- wise classification of Investors
25 – 30 04 13.33%
30 – 35 06 20.00%
35 – 40 09 30.00%
40 and Above 11 36.67%
02. Number of Years of Investing/ Trading in Shares
Less than Five Years 13 43.33%
More than Five Years 17 56.67%
03. Basis for Investment Decision
Self Decision 07 23.33%
Broker/ Friends 11 36.67%
Expert Opinion/ Media 12 40.00%
04. Awareness about Behavioural Finance in Investment Decision
Excellent 05 16.67%
Good 05 16.67%
Average 08 26.67%
Basic 05 16.67%
Poor 07 23.33%
05. Investors’ Response towards Representative Bias
Type of Investors/ Response Young Experienced
Always - (14) 08(57.14%) 06 (42.86%)
Sometimes - (10) 04(40.00%) 06 (60.00%)
Never - (06) 02(33.33%) 04 (66.66%)
06. Investors’ Response towards Overconfidence Bias
Overconfident – (08) 03(37.50%) 05 (62.50%)
Moderately Confident - (09) 03(33.33%) 06 (66.67%)
Confident – (11) 06(54.55%) 05 (45.45%)
Diffident – (02) 01(50.00%) 01 (50.00%)
07. Investors’ Response towards Anchoring Bias
Yes – (15) 07(46.67%) 08 (53.33%)
May be – (09) 05(55.56%) 04 (44.44%)
No – (06) 04(66.67%) 02 (33.33%)
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08. Investors’ Response towards Gambler Fallacy Bias

Yes – (08) 08(100%) 00 (00.00%)
May be – (16) 06(37.50%) 10 (62.50%)
No – (06) 02(33.33%) 04 (66.67%)
09. Investors’ Response towards Availability Bias
Yes – (13) 08(61.54%) 05 (38.46%)
May be – (11) 07(63.64%) 04 (36.36%)
No – (06) 03(50.00%) 03 (50.00%)
10. Investors’ Response towards Loss Aversion
Yes – (12) 05(41.67%) 07 (58.33%)
May be – (07) 03(42.86%) 04 (57.14%)
No – (11) 06(54.55%) 05 (45.45%)
11. Investors’ Response towards Regret Aversion Bias
Yes – (09) 06(66.67%) 03 (33.33%)
May be – (14) 06(42.86%) 08 (57.14%)
No (07) 03(42.86%) 04 (57.14%)
12. Investors’ Response towards Mental Accounting Bias
Yes – (09) 06(66.67%) 03 (33.33%)
May be – (18) 08(44.44%) 10 (55.56%)
No – (03) 03(100%) 00(00.00%)
13. Investors’ Response towards Self Control Bias
Yes – (23) 10(43.48%) 13 (56.52%)
May be – (05) 03(60.00%) 02 (40.00%)
No – (02) 01(50.00%) 01 (50.00%)
Source: Field Survey
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Interpretation:
Above table reveals that respondents‟ (Retail investors in Shimoga city) opinion towards
heuristics and biases related to financial investment and the role of behavioral finance in their
investment decisions. A sample of 30 retail investors is selected for the response. Out of 30
respondents, 17 investors are having more than 5 years of experience in investment (56.67%) and
13 investors are having less than 5 years of experience in investing (43.33%). About 36.67
percent of investors are falls under the age group of 40 and above, and 13.33 percent of investors
are between 25-30 age group. About 40.00 percent of the investors are dependent on expert or
media for their investment decisions. Out of 30 respondents on an average of (26.67%) of
respondents‟ are aware of behavioural finance in investment decisions. About 46.67% of
respondents‟ are always checked the past performance of investment assets before investing in it
(Representative Bias) out of that 57.14% are young investors and 42.86% are of experienced
one.
About 36.67 percent of respondents‟ are confident at the time of investing in the assets, out of
that 54.55% and 45.45% are young investors and experienced investors. It is observed that about
50.00% of the respondents‟ are rely too heavily, or „anchor‟ on one trait or piece of information
when making decisions. About 53.33% of respondents‟ saying in sometimes inappropriately they
are predicting about risk-return trade-off of their investment and that tend will reverse (Gamblers
Fallacy). Further, it is observed that about 43.33% of respondents‟ are taking their investment
decision based on the most available information in the market and which leads less return and
sometimes poor results also(Availability Bias).
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5.3.2 Influence of Behavioural Factors (Heuristics and Bias) on Investment Decision

Investor Behavioural Mean Mode Median Variance Standard Coefficie
Type Factors Deviation nt of
variation
(%)
Representativeness 1.070 0.571 0.875 5.041 2.245 209.81
Overconfidence 1.833 2.444 2.072 4.489 2.119 115.60
Anchoring 1.312 0.778 2.144 4.251 2.062 157.16
Young Gamble Fallacy 1.125 0.800 1.000 4.391 2.095 186.22
Investors
Availability Bias 1.222 0.889 1.125 4.133 2.033 166.37
Loss Aversion 1.571 0.714 1.400 4.352 2.086 132.78
Regret Aversion 1.300 1.000 1.253 3.040 1.744 134.15
Mental Accounting 1.324 1.286 1.313 2.678 1.636 123.56
Self Control 0.857 0.526 0.700 7.627 2.762 322.29
Overconfidence 1.618 1.857 1.585 3.162 1.778 109.89
Anchoring 1.071 0.667 0.875 5.041 2.245 209.62
Gamble Fallacy 2.500 1.625 1.700 7.286 2.699 107.96
Experienc Availability Bias 1.333 0.833 1.200 2.861 1.691 126.86
ed
Loss Aversion 1.375 0.700 1.143 4.641 2.154 156.65
Investors
Regret Aversion 1.567 1.556 1.563 1.663 1.289 82.260
Self Control 0.750 0.542 0.616 11.188 3.345 446.00
Overconfidence 1.726 2.151 1.829 3.826 1.949 112.75
Anchoring 1.192 0.723 1.509 4.646 2.154 183.39
Gamble Fallacy 1.813 1.213 1.350 5.839 2.397 147.09
Total Availability Bias 1.278 0.861 1.163 3.497 1.862 146.62
Loss Aversion 1.473 0.707 1.272 4.497 2.120 144.72
Regret Aversion 1.434 1.278 1.408 2.352 1.517 108.21
Self Control 0.804 0.534 0.658 9.408 3.054 384.15
Source: Author developed
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Interpretation:
Table 5.3.2 provides statistical evidence for the difference in means that was observed. To check
whether there were any significant differences between the two groups(Young Investors and
Experienced Investors) in the dependent variable on each of the independent variables the data
provided by „Group Statistics‟ was examined. It can be observed that the mean difference
between the various biases in the two groups were significantly different. Similarly, it is clear
from the above table that the values of both the mean and coefficient of variation of different
biases are varying as per its importance and its influence on investment decision based on both
the young investors and experienced investors perspective. Higher the mean values of the biases
are having lowered the value of coefficient of variation. Based on the mean and coefficient of
variation; the different biases are categorized into three groups based on their importance and its
influence on investment decision as highly influential, moderately influential and less influential.
They are as follows;
Table no- 5.3.3 Classification of different biases related to financial investment and its
influence on investment decision.
Classification based on its influence on investment decision
Young Investors Experienced Investors
Biases
Investors (Young+Experienced)
HI MI LI HI MI LI HI MI LI
Representativeness   
Overconfidence   
Anchoring   
Gamble Fallacy   
Availability Bias   
Loss Aversion   
Regret Aversion   
Mental Accounting   
Self Control   
Source: Author Developed
(Note: HI- Highly Influential, MI- Moderately Influential, LI- Less Influential)
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To summarize, both the investor types are highly, moderately and less influenced by the different
heuristics and biases related to financial investment on their investment decisions. In total
overconfidence, gamblers fallacy, and loss aversion biases are highly affecting the investment
decisions of retail investors whereas, availability, regret aversion, and mental accounting biases
are moderately affecting on investors‟ investment decisions. On the other hand,
representativeness, anchoring, and self-control biases are affecting on investor‟s investment
decisions at a lower rate. To sum up all the heuristics and biases of behavioral finance are
affecting on the investment decisions of retail investors in the study area.
5.3.3 Test Application

For the purpose of studying the relationship between heuristics and biases related to financial
investment and the role of behavioural finance in investment decisions, following hypotheses are
developed:
01. Both the investor types are likewise affected or unaffected by the behavioural biases
02. Both the investor types are evenly likely to be exhibit representative bias
03. Young Investors are likely to be less overconfident than experienced investors
04. Both the investor types are evenly likely to exhibit anchoring bias
05. Both the investor types are evenly likely to exhibit gamblers fallacy bias
06. Both the investor types are evenly likely to exhibit availability bias
07. Both the investor types are evenly likely to exhibit loss aversion bias
08. Both the investor types are evenly likely to exhibit regret aversion bias
09. Both the investor types are evenly likely to exhibit mental accounting bias
10. Both the investor types are evenly likely to exhibit self-control bias.
In order to study the aforesaid relationship and to check the feasibility of the above hypotheses
the researchers have used the Chi square independency test.
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Testing of Hypotheses:
01. Representative Bias
H0 Both the investor types are evenly likely to be exhibit representative bias
H1 Young Investors are more likely to be exhibit representative bias
Type of Investors/ Response Young Investors Experienced Investors Total

Always 08(6.53) 06(7.47) 14
Sometimes 04(4.67) 06(5.33) 10
Never 02(2.80) 04(3.20) 06
Total 14 16 30
Calculated Value: 1.22
Table Value: x2.05.2 = 5.991(Level of Significance is 5% and Degree of Freedom is 2 i.e.

(C - 1 X R - 1= 2-1 X 3-1= 2)
Interpretation: The Calculated value is lower than the table value (1.22 <5.991). Hence, null
hypothesis is accepted and alternative hypothesis is rejected and the suggestion is that both the
investor types are evenly likely to be exhibit representative bias.To recapitulate, overall results
suggested that investors were highly prone to endure from the Representativeness bias which can
cause them to make serious errors while investing, the young investors slightly more than the
experienced ones.
02. Overconfidence Bias

H0 Young Investors are likely to be less overconfident than experienced investors
H1 Young Investors are likely to be more overconfident than experienced investors

Overconfident 03(3.47) 05(4.53) 08
Moderately Confident 03(3.90) 06(5.10) 09
Confident 06(4.77) 05(6.23) 11
Diffident 01(0.87) 01(1.13) 02
Total 13 17 30
Table Value: x2.05.3 = 7.815 (Level of Significance is 5% and Degree of Freedom is 3 i.e.
(C - 1 X R -1= 2-1 X 4-1= 3)
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Interpretation: The Calculated value is lower than the table value (1.08 < 7.815). Hence, null
hypothesis is accepted and alternative hypothesis is rejected and the suggestion is that young
investors are less likely to exhibit overconfident bias than experienced investors.
03. Anchoring Bias

H0 Both the investor types are evenly likely to be exhibit anchoring bias
H1 Young Investors are more prone to be anchoring as compared to experienced
investors.

Yes 07(8.00) 08(7.00) 15
May be 05(4.80) 04(4.20) 09
No 04(3.20) 02(2.80) 06
Total 16 14 30

(C - 1 X R - 1= 2-1 X 3-1= 2)
investor types are evenly likely to be exhibit anchoring bias.
04. Gamblers Fallacy Bias
H0 Both the investor types are evenly likely to be exhibit gamblers fallacy bias
H1 Young Investors are more likely to be exhibit gamblers fallacy bias

Yes 08(4.27) 00(3.73) 08
May be 06(8.53) 10(7.47) 16
No 02(3.20) 04(2.80) 06
Total 16 14 30

(C - 1 X R - 1= 2-1 X 3-1= 2)
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Interpretation: The Calculated value is higher than the table value (9.56 > 5.991). Hence, null
hypothesis is rejected and alternative hypothesis is accepted and the suggestion is that young
investors are more prone to gamblers fallacy bias than experienced investors.
05. Availability Bias
H0 Young Investors are more likely to be exhibit availability bias
H1 Both the investor types are evenly likely to be exhibit availability bias

Yes 08(7.80) 05(5.20) 13
May be 07(6.60) 04(4.40) 11
No 03(3.60) 03(2.40) 06
Total 18 12 30

(C - 1 X R - 1= 2-1 X 3-1= 2)
investors are more prone to availability bias than experienced investors.
06. Loss Aversion Bias

H0 Both the investor types are evenly likely to be exhibit loss aversion bias
H1 Young Investors are more likely to be exhibit loss aversion bias

Yes 05(5.60) 07(6.40) 12
May be 03(3.27) 04(3.73) 07
No 06(5.13) 05(5.87) 11
Total 14 16 30

(C - 1 X R - 1= 2-1 X 3-1= 2)
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investor types are evenly likely to be exhibit loss aversion bias.

07. Regret Aversion Bias
H0 Young Investors are more likely to be exhibit regret aversion bias
H1 Both the investor types are evenly likely to be exhibit regret aversion bias

Yes 06(4.50) 03(4.50) 09
May be 06(7.00) 08(7.00) 14
No 03(3.50) 04(3.50) 07
Total 15 15 30

(C - 1 X R - 1= 2-1 X 3-1= 2)
investors are more likely to be exhibit regret aversion bias than experienced investors.
08. Mental Accounting Bias

H0 Young Investors are more likely to be exhibit mental accounting bias
H1 Both the investor types are evenly likely to be exhibit mental accounting bias

Yes 06(5.10) 03(3.90) 09
May be 08(10.20) 10(7.80) 18
No 03(1.70) 00(1.30) 03
Total 17 13 30

(C - 1 X R - 1= 2-1 X 3-1= 2)
investors are more likely to be exhibit mental accounting bias than experienced investors.
97
09. Self-ControlBias
H0 Both the investor types are evenly likely to be exhibit self-control bias
H1 Young Investors are more likely to be exhibit self-control bias

Yes 10(10.73) 13(12.27) 23
May be 03(2.33) 02(2.67) 05
No 01(0.93) 01(1.07) 02
Total 14 16 30

(C - 1 X R - 1= 2-1 X 3-1= 2)
Interpretation: The Calculated value is lower than the table value (0.47< 5.991). Hence, null
investors are evenly likely to be exhibit self-control bias.
6. Summary and Findings
The paper attempted to analyze the effects of nine identified behavioral biases on the decision
making process of investors, namely: Representative, Overconfidence, Anchoring, Gamblers
Fallacy, Availability, Loss Aversion, Regret Aversion, Mental Accounting and Self-control
Biases. Effects of these nine factors on the decision making process of a sample of 30 retail
investors from Shimoga district was studied. Out of this sample, two sub-samples of 17 and 13
investors each were created: (i) experienced investors – with more than 5 years of investing
experience; and (ii) Young investors – with less than 5 years of experience. The sample and sub-
samples have been processed and analyzed using statistical tools like mean, mode, median,
average; standard deviation and coefficient of variation, and the hypotheses were tested using the
Chi-squared test for Independence.
The results from Chi-squared tests (seen in Table 6.1.1) suggested that 4 out of the 9 biases could
not be determined to be affecting one investor type more than the other. This pointed in the
direction that it would not be pale to say that younger investors and experienced investors can be
98
divided as two entities who behave differently while investing. Chi-squared tests indicated that
both young and experienced investors were suffering from almost all the biases studied. In this
background, it could be argued that being subject to these behavioral biases had played a
noteworthy role in the investment decisions.
Table 6.1.1 Chi squared Tests: Summary of Results

Name of Bias Investors Biased????
Young Investors Experienced Investors Both
Representative _ _ Yes
Overconfidence _ Yes _
Anchoring _ _ Yes
Gamblers Fallacy Yes _ _
Availability Yes _ _
Loss Aversion _ _ Yes
Regret Aversion Yes _ _
Mental Accounting Yes _ _
Self-control _ _ Yes
Source: Author developed
7. Recommendations
Following are the main recommendations;
01. Understanding the Biases- Pogo, the folk philosopher created by the cartoonist Walt
Kelly, provided an insight that is particularly relevant for investors, “We have met the
enemy- and it‟s us”. So, investors should understand their biases (the enemy within).
02. Investors are to make regular attempts to amplify their attentiveness on behavioral
finance by educating themselves on the field.
03. Studying about the biases, and reflecting on their decisions are possible to facilitate
accomplish enhanced self-understanding of to extent and manner to which the investors
gets influenced by emotions whilst making financial decisions under uncertainty.
04. Wakefulness about behavioral biases and its application in the course of making
investment decision would be escalating the shrewdness of investment decisions thus
making way for elevated market efficiency.
05. Investors should follow a set of quantitative investment criteria prior to and after making
investment.
99
06. Investors should control on their investment environment like if a person is on a diet, he
should not have tempting sweets on his dining table. Likewise investors‟ should regulate
and control their investment environment to carry out disciplined investment activity.
07. Behavioral Finance should be given more significance in the Academic Curriculum, if it
has not previouslybeen given.
8. Conclusion:
The single term „Volatility‟ which has dominated the world of financial stock markets since
2008, acute movements in global indices and stock prices for the reason that of dread and
eagerness has, as it is hypothetical to, made being hard-hitting for a lucid investor. Market
sentiments have been observed to lean wildly from positive to negative in the shortest
timeframes like weeks, days and hours. In this background, understanding illogical investor
behavior deserves more importance. Behavioral finance - a comparatively new meadow that
came into significance in the 1980s – spotlight on the effect of psychology on financial decision-
making. It studies how investors understand new information and take action on it to make
decisions under uncertainty.
To conclude, new paradigm of Behavioural Finance emerged as a model that successfully

attempted to challenge and disprove the traditional financial theory. The study found out that,
with the omission of Cognitive illusions, investors affected from all biases in a significant
manner. Chi-squared tests had exposed that all the investors were affected by the various biases
while making investment decisions. It could not be said that either investor group was more
prone to being affected by behavioral biases as a whole, when compared to the other. Both the
young and experienced investors were affected by the biases in a similar manner. Hence, by
focusing on individual investors, Behavioural Finance, is generally recognized as a new, more
comprehensive and evolutionary theoretical framework, which is not a mere adversary of the
conventional theory, but fundamental approach that enables enhancing investing processes and
propositions.
References:
01. Anastasios Konstantinidis1, Androniki Katarachia2 , George Borovas3 and Maria Eleni
Voutsa4 (2012), Scientific Bulletin – Economic Sciences, Vol. 11/ Issue 2
02. Banerjee, Arindam. 2011. Application of Behavioral Finance in Investment Decisions:
An Overview. The Management Accountant 46 (10): 869 – 872.
03. De Bondt, W. and Thaler, R., 1995. Financial decision-making in markets and firms: A
behavioral perspective. Handbooks in Operations Research and Management Science,
Vol. 9, pp. 385-410.
04. Fama, Eugene F. 1965. Random Walks in Stock Market Prices. Financial Analysts
Journal 21 (5): 55 - 59.
100
05. Fama, Eugene F. 1970. Efficient Capital Markets: A Review of Theory and Empirical
Work. Journal of Finance 25 (2): 383 - 417.
06. Gilovich, Thomas, Griffin, Dale, and Kahneman, Daniel.2002. Heuristics and Biases:
The Psychology of Intuitive Judgment. Cambridge: Cambridge University Press.
07. Kahneman, Daniel and Tversky, Amos. 1979. Prospect Theory: An Analysis of Decision
under Risk. Econometrica 47(2): 263 – 291.
08. M. Kannadhasan, (2011), Role of Behavioural Finance in Investment Decisions
09. Nofsinger, John R.2001. Investment madness: how psychology affects your investing –
and what to do about it. USA: Pearson Education
10. Plous, S., 1993. The psychology of judgment and decision making. McGraw-Hill, New
York.
11. Peter D. Hede, (2012), Financial Decision-making and Investor Behaviour, Ventus
Publishing ApS, (Downloaded from bookboon.com, ISBN 978-87-403-0285-1.
12. Subrahmanyam, Avanidhar. 2007. Behavioral Finance: A Review and Synthesis.
European Financial Management 14(1): 12-29.
101

Heuristic and Biases Related To Financial Investment and The Role of Behavioral Finance in Investment Decisions - A Study

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ZENITH International Journal of Business Economics & Management Research__________ ISSN 2249- 8826

ZIJBEMR, Vol.5 (12), DECEMBER (2015), pp. 82-101

HEURISTIC AND BIASES RELATED TO FINANCIAL INVESTMENT

Electronic copy available at: https://ssrn.com/abstract=2881151

Electronic copy available at: https://ssrn.com/abstract=2881151

2.2 Behavioral Finance

According to Sewell (2007),“Behavioral finance is the study of the influence of psychology on

2.3 Human Behavioral Theories

Heuristics Prospect Theory

Over Confidence Regret Aversion

Anchoring Mental Accounting

Gamble Fallacy Self Control

2.3.1 Heuristic Decision Process

a). Representativeness Bias: Representativeness is judgment based on overreliance stereotypes.

b). Overconfidence Bias:It is defined as people‟s tendency to overestimate their skills or

2.3.2 Prospect Theory

M. Kannadhasan, (2011), opines that, Decision-making is a complex activity. The susceptibility

4. Objectives of the Study

5.2 Data Collection

Finance on Investment decision.

5.3.1 Data Analysis and Interpretations:

08. Investors’ Response towards Gambler Fallacy Bias

5.3.2 Influence of Behavioural Factors (Heuristics and Bias) on Investment Decision

5.3.3 Test Application

Type of Investors/ Response Young Investors Experienced Investors Total

Table Value: x2.05.2 = 5.991(Level of Significance is 5% and Degree of Freedom is 2 i.e.

02. Overconfidence Bias

Type of Investors/ Response Young Investors Experienced Investors Total

03. Anchoring Bias

Type of Investors/ Response Young Investors Experienced Investors Total

Table Value: x2.05.2 = 5.991(Level of Significance is 5% and Degree of Freedom is 2 i.e.

Type of Investors/ Response Young Investors Experienced Investors Total

Table Value: x2.05.2 = 5.991(Level of Significance is 5% and Degree of Freedom is 2 i.e.

Type of Investors/ Response Young Investors Experienced Investors Total

Table Value: x2.05.2 = 5.991(Level of Significance is 5% and Degree of Freedom is 2 i.e.

06. Loss Aversion Bias

Type of Investors/ Response Young Investors Experienced Investors Total

Table Value: x2.05.2 = 5.991(Level of Significance is 5% and Degree of Freedom is 2 i.e.

investor types are evenly likely to be exhibit loss aversion bias.

Type of Investors/ Response Young Investors Experienced Investors Total

Table Value: x2.05.2 = 5.991(Level of Significance is 5% and Degree of Freedom is 2 i.e.

08. Mental Accounting Bias

Type of Investors/ Response Young Investors Experienced Investors Total

Table Value: x2.05.2 = 5.991(Level of Significance is 5% and Degree of Freedom is 2 i.e.

Type of Investors/ Response Young Investors Experienced Investors Total

Table Value: x2.05.2 = 5.991(Level of Significance is 5% and Degree of Freedom is 2 i.e.

6. Summary and Findings

Table 6.1.1 Chi squared Tests: Summary of Results

To conclude, new paradigm of Behavioural Finance emerged as a model that successfully

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