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Development and validation of behavioral biases scale: a SEM approach

Article in Review of Behavioral Finance · November 2020

DOI: 10.1108/RBF-05-2020-0087

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Development and validation Development

of behavioral
of behavioral biases scale: biases scale

a SEM approach
Ritika and Nawal Kishor
School of Management Studies, Indira Gandhi National Open University,
New Delhi, India Received 2 May 2020
Revised 5 September 2020
Accepted 23 October 2020
Abstract
Purpose – This paper attempts to identify the biases in decision-making of individual investors. The paper
aims to develop and validate a higher-order behavioral biases scale.
Design/methodology/approach – Scale development is done by identifying the relevant items of the scale
through existing literature and then, adding new items for some biases. In phase 1, using a structured
questionnaire, data was collected from 274 investors who invest in financial markets. The major dimensions of
the scale have been pruned by using exploratory factor analysis administered on data collected in phase 1.
Higher-order CFA is used to analyze the data and to validate the scale on another set of data (collected in phase
2) containing 576 investors.
Findings – The study reveals that the scale for measuring behavioral biases has many dimensions. It has two
second-order factors and 13 zero-order constructs. Two second-order constructs have been modeled on the
basis of cause of errors in investment decision-making, that is, biases caused due to cognition, biases caused
due to emotions.
Originality/value – Behavioral biases are yet to receive a due attention, especially, in the Indian context. The
present research is focusing on providing an empirically tested scale to test the behavioral biases. Some of the
biases, which have been analyzed using secondary data in previous studies, have been tested with the help of
statements in this study.
Keywords Behavioral biases, Scale development, Investment decision, Behavioral finance
Paper type Research paper

1. Introduction
The traditional finance paradigm works on the assumption that both investors and markets are
fully rational (Kumar and Goyal, 2015). They consider all available information while taking
investment decisions. But it has been observed in practice, that, while taking financial decisions,
investors deviate from being fully rational (Tourani-Rad and Kirkby, 2005; Nigam et al., 2018).
They make their judgments on the basis of personal beliefs, preferences or past events. When
faced with uncertainty, investors take decisions based on irrationality, inconsistency and
incompetence (Kahneman and Tversky, 1982; Stracca, 2004; Barros, 2010). So, the new block of
finance, known as behavioral finance, started manifesting itself in the 1990s in various journals,
newspapers and business publications. This field of finance derives its roots from psychology,
sociology and finance. Behavioral finance attempts to interpret the investor behavior in a better
way by describing the manner in which psychological errors impact the decision-making
process of the investors. Daniel et al. (1998) posit that investment decisions taken by investors
are not always rational. Instead the decisions are influenced by various cognitive “how
investors think” and emotional “how investors feel” factors coined as behavioral biases.
According to behavioral finance, behavioral biases are the psychological errors that arise
from sentiment-driven behavior and lead to irrational behavior of the investors. Majority of

The authors feel grateful to editor and the anonymous reviewers for providing valuable suggestions to Review of Behavioral Finance
improve the quality of article. The authors reiterate their overwhelming thanks and gratitude to the © Emerald Publishing Limited
1940-5979
respondents for providing their valuable responses. DOI 10.1108/RBF-05-2020-0087
RBF the research undertaken in the field of behavioral finance is done using the data from trading
records of investors (Barber and Odean, 2001; Chen et al., 2007). But primary data is a better
indicator of behavior of investors as compared to secondary data (Lin, 2011). Also, the area of
behavioral finance lacks a generally accepted and validated scale for measuring behavioral
biases of individual investors.
So, this study aims to fill this gap by using primary data and focusing specifically on the
behavioral biases of individual investors as they play a significant role in India (Ramadorai,
2013). The purpose of the study is to develop and validate a scale to measure behavioral
biases of individual investors.

2. Theoretical background and literature review

As opposed to the assumption of rationality and perfect knowledge by traditional finance, the
proponents of behavioral finance assert that in real life, decisions are taken with the help of
mental shortcuts also known as heuristics or behavioral biases (Kahneman and Tversky, 1982;
Barber and Odean, 2001). Academic literature attributes two causes of behavioral biases: biases
caused due to inaccurate reasoning (cognitive biases) and biases caused due to emotions
(emotional biases) (Pompian, 2006; Sahi et al., 2013). Cognitive biases arise due to basic statistical
errors, errors in processing of information or errors related to memory. Emotional biases arise
due to illogical reasoning caused by various emotional intuitions or instincts (Pompian, 2006).
Thirteen biases have been considered for the purpose of this study. The main criteria impacting
decision-making of individual investors are represented by these 13 biases.

2.1 Cognitive biases

The cognitive biases considered for the study are being discussed as follows:
(1) Conservatism bias: Conservatism bias refers to the propensity of people to
insufficiently update their views or forecasts after receiving new information
(Barberis et al., 1998). Due to this bias, investors might underreact to the bad forecast
and react according to their prior beliefs based on earlier forecasts (Luo, 2012).
Analytical reasoning can help to prevent this bias (Hoppe and Kusterer, 2011).
(2) Confirmation bias: Confirmation bias is a type of natural phenomenon that refers to
the likelihood of people to give attention to only those ideas that approve their beliefs
and ignore the ideas that disprove their beliefs. There are lesser studies in behavioral
finance literature pertaining to this bias (Costa et al., 2017). This bias leads to illusion
of knowledge, overconfidence and has an adverse impact on investment performance
(Daniel et al., 1998; Barber and Odean, 2001; Jonas et al., 2001).
(3) Representativeness bias: Representativeness bias is characterized as the habit of
people to categorize thoughts, events and thinking based on past events (Busenitz,
1999). So, whenever any new event or thought arises, they tend to fit that event or
thought to the prior made classifications (Ricciardi and Simon, 2000; Kahneman and
Frederick, 2002). Unsophisticated investors show more instances of this bias (Grether,
1980; Chen et al., 2007).
(4) Anchoring and adjustment bias: Anchoring is the tendency of investors to give
extraneous importance to arbitrarily determined anchors leading them to make
irrational investments (Wright and Anderson, 1989; Ricciardi and Simon, 2000). They
revise their original beliefs based on the starting point, which lead to adjustments that
are insufficient (Tversky and Kahneman, 1974; Piatelli-Palmarini, 1994).
(5) Availability bias: Availability bias is a phenomenon in which people evaluate the
probability of any event on the basis of its easiness of coming to the mind (Tversky
 and Kahneman, 1974). The outcomes that are easily recalled are considered to be more Development
likely as compared to the outcomes that are difficult to recall (Javed et al., 2017). It is of behavioral
due to this bias that people do not analyze all available investment opportunities and
rather invest in securities of a company that spends a lot of money on its
biases scale
advertisements (Barber and Odean, 2000; Harris and Raviv, 2005).
(6) Self-attribution bias: People susceptible to this bias believe that investment successes
are due to their innate skills, whereas the investment losses are attributable to
exogenous factors (Hoffmann and Post, 2014). Higher degree of risk, aggressive trading
and extensified “personal market volatility” are the results of this bias (Gervais and
Odean, 2001). Self-attribution bias can also lead to overconfidence bias (Daniel et al.,
1998; Barber and Odean, 2000; Gervais and Odean, 2001; Mishra and Metilda, 2015).
(7) Ambiguity-aversion bias: This bias refers to the tendency of people to avoid investing
in the securities with uncertain returns (Ellsberg, 1961). This bias arises due to the
reason that people do not like ambiguity and this dislike is more than their dislike for
risk (Knight, 2012). It is due to this bias that people demand higher returns for higher
levels of risk (Maenhout, 2004).
(8) Herding bias: Herd behavior occurs when people take the decisions taken by majority
in order to minimize the regret in case of a loss and uncertainty or in volatile market
conditions (Cipriani and Guarino, 2008; Patel et al., 1991; Messis and Zapranis, 2014).
So, instead of analyzing the available information, they follow the investment
decisions being taken by their friends, family or colleagues (Lakonishok et al., 1992;
Christie and Huang, 1995; Chang et al., 2000).
(9) Mental accounting bias: Investors susceptible to this bias have a tendency to
categorize and organize each component of their portfolio into different mental
accounts (Thaler, 1985; Ritter, 2003). They do not analyze the outcome of complete
portfolio, rather they evaluate the performance of each asset separately (Tversky and
Kanheman, 1986; Agnew, 2006).

2.2 Emotional biases

The emotional biases considered for the study are being discussed as follows:
(1) Loss-aversion bias: According to this bias, investors take measures to avoid losses
and weigh losses more than they weigh gains (Tversky and Kahneman, 1991;
Benartzi and Thaler, 1995). This means that the investors have an inclination to react
strongly to losses as compared to profits (Benartzi and Thaler, 1995; Barberis and
Huang, 2001). Several scholars report that loss aversion is a result of feeling of fear
and distress and leads to status quo bias (Kahneman et al., 1991; Barberis and Huang,
2001).
(2) Overconfidence bias: Due to this bias, investors feel that they have “better than
average” ability to analyze the market (Acker and Duck, 2008; Benartzi and Thaler,
1995; Odean, 1998; Barber and Odean, 2000). Overconfident investors attribute their
investment success to their competence and as a result, they trade more aggressively,
thus leading to increase in the trading volume, short-term momentum (De Bondt and
Thaler, 1995; Barber and Odean, 2001; Statman et al., 2006; Daniel et al., 1998) and
under-diversification (Goetzman and Kumar, 2008).
(3) Self-control bias: Self-control bias is a phenomenon that shows the likelihood of people
to spend more at present and fail to fulfill the long-term goal of saving for tomorrow
due to the lack of self-control (Thaler and Benartzi, 2004). This occurs due to the
RBF reason that the short-term desires of people become so dominant that they feel unable
to maintain the self-discipline required to fulfill their long-term objectives.
(4) Status quo bias: Investors susceptible to this bias resist change, choose the previous
alternative and do not change it even if their previous choice is not an optimal one now
(Kahneman et al., 1991; Burmeister and Schade, 2007). Academic literature reports the
presence of status quo bias in many financial decisions related to pension plan
decisions (Agnew et al., 2003; Samuelson and Zeckhauser, 1988), portfolio holding
decisions related to mutual funds, stocks and so on (Zeckhauser et al., 1991).
(5) Regret-aversion bias: Regret-aversion bias states that individuals feel the pain of
regret when they make errors and in order to avoid this regret pain, they turn to
behaving in an irrational manner (Odean, 1998; Shiller, 2003). It is due to this bias that
people feel twice the pain on losing than the pleasure they feel on winning (Kahneman
and Tversky, 1979; Shiller, 2000).
Although there is an extensive literature related to behavioral finance and biases of
individual investors, but most of the studies use secondary data to analyze the impact of
behavioral biases on investor behavior (Barber and Odean, 2001; Chen et al., 2007; Glaser and
Weber, 2007). Limited studies have been performed using primary data as this area still lacks
a valid and systematic instrument to measure the behavioral biases. Although there are some
studies in Indian context related to behavioral biases, but they have not touched upon some of
the biases (Prosad et al., 2015; Baker et al., 2019). So, taking excerpts from various studies
(Menkhoff et al., 2006; Glaser and Weber, 2007; Kaustia and Perttula, 2012; Prosad et al., 2015;
Shusha and Touny, 2016, Chandra et al., 2017; Rasheed et al., 2018; Raut et al., 2018; Baker
et al., 2019; Mushinada and Veluri, 2019; Jain et al., 2019), this study attempts to develop an
empirically validated and theoretically grounded scale to measure behavioral biases.

3. Methodology
3.1 Instrument design and refinement
The focus of this study is on behavioral biases of individual investors investing in financial
markets, so an extensive literature review was performed to get the pool of items to describe
the behavioral biases. Existing studies provided 31 items related to various behavioral biases
of individual investors, which were modified and used for this study (Menkhoff et al., 2006;
Glaser and Weber, 2007; Kaustia and Perttula, 2012; Prosad et al., 2015; Shusha and Touny,
2016, Chandra et al., 2017; Rasheed et al., 2018; Raut et al., 2018; Baker et al., 2019; Mushinada
and Veluri, 2019; Jain et al., 2019). Almost all of these studies measured only four to five biases.
Only a few studies focused on seven to eight behavioral biases. Measuring different
behavioral biases of the investor is important as each of the bias can have a serious impact on
investor behavior. So, for some biases where indicators were not sufficient as per existing
studies, new indicators were added and for other biases that have not been covered by the
earlier studies based on primary data (confirmation bias, self-control bias, conservatism bias
and status quo bias), all the new items were added to make a construct.
Like the existing studies related to biases, namely “Confirmation bias,” “Self-control bias,”
“Conservatism bias” and “Status Quo bias,” were either based on secondary data or the data
was collected through experiments conducted on investors (Shefrin and Thaler, 1988;
Samuelson and Zeckhauser, 1988; Barberis et al., 1998; Luo, 2012; Costa et al., 2017; Zahera
and Bansal, 2018). So, new items for these factors were added in this study so as to obtain a
self-reported view of the behavioral biases of individual investors. In order to fulfill the
objectives of this study, 23 new items were added to elicit investors’ response toward various
behavioral biases so as to cover all the major biases. This list was shared with five behavioral
finance experts so as to get a refined and consolidated scale. Their suggestions were
incorporated and the questionnaire including 54 items was designed. Table 1 presents the Development
items of the scale and their sources. of behavioral
3.2 Data collection and methods used biases scale
The sampling frame of this study constituted individual investors of Delhi investing in
financial markets. In order to evaluate the reliability and internal consistency of the scale, a
pilot study was conducted with 50 respondents. Since, the list of individual investors of Delhi
was not available and people want to keep the information about their financial investment
confidential, the data was collected only from the respondents who wished to participate in
the study. So, judgmental sampling technique was considered appropriate for the study
(Wood and Zaichkowsky, 2004). The criteria for choosing the sample required the respondent
to be a resident of Delhi, responsible for making financial investment decisions in the family
and having investments in more than three investment products. The data was collected in
two phases. In phase 1, 350 individual investors were contacted in person during the period
from July 2019 to September 2019 and asked about their interest to cooperate for the study. If
they gave their explicit consent, the questionnaire was filled as a schedule by taking
responses from the respondents in the form of a field survey. The data was collected from 315
respondents and after checking for validation, 274 responses were considered useful for
conducting exploratory factor analysis (EFA). The second phase of the study was conducted
on the refined questionnaire during the period from October 2019 to February 2020. Data
from 600 investors was collected, out of which 576 useable responses were used for
conducting confirmatory factor analysis (CFA). Statistical Package for the Social Science
(SPSS) 20 and Amos 20 software have been used to compile and analyze the data. The study
uses structural equation modeling (SEM) to analyze the unidimensionality of the factors and
to find out the reasons behind cognitive and emotional biases. The reason behind using SEM
here is because it utilizes confirmatory tools to validate a new hypothesized model (Gefen
et al., 2011). SEM constructs a path diagram to show how behavioral biases comprise
cognitive and emotional biases.

4. Results
4.1 Respondent profile
Table 2 shows the characteristics of respondents of phase 1 and phase 2. Participants in
phase 1 of the survey consisted of a majority of males (72.3%) and minority of females
(27.7%). The age group comprising most of the sample was 20–35 years (54.7%) and 35–50
years (21.9%), followed by 50–65 years (14.6%) and more than 65 years of age (8.8%). Almost
60% of the respondents were married and 40% were unmarried. Around half (51.1%) of the
respondents were having a postgraduate degree, 23.4% were having finance-related
education (CA, CFA, CMA etc.), 18.3% were graduates and the rest were having below
graduation as qualification (7.3%). While almost 40% of the respondents were permanent
employees, 30% were retired persons, 22.6% respondents were having their own business or
self-employment and the remaining were financial experts (6.6%). 32.9% of respondents self-
reported their annual income to lie in the category of less than Rs. 5 Lakhs, 30.7%
respondents lie in the income category of Rs. 5–10 lakhs p.a., around 20% have Rs. 10–15
lakhs p.a. income and the remaining reported of having an annual income of more than Rs. 20
lakhs. Around 38% of the respondents were having an investment experience of (5–15) years,
followed by 28.5% respondents of less than five years of investment experience.
Sample in phase 2 comprised mostly of young respondents (20–35 years), followed by
respondents in the age of 35–50 years (22.9%), age of 50–65 years (7.6%) and the remaining
were senior citizens (more than 65 years of age). Almost three-fourth of the respondents were
males and the remaining were females. Almost 55% of the respondents in the sample were
married and rest were unmarried. Most of the respondents (67% approx.) had completed their
RBF Factor Final items of the scale Literature support

Availability bias The information from my close friends and relatives is a Menkhoff et al. (2006), Shusha
reliable reference for my investment decisions and Touny (2016)
While considering the track record of an investment, I put more Item added through this
weight on its recent performance study
Advertisements are the main source of information for my Menkhoff et al. (2006)
investment decisions
I consider the recent records of a security before investing Jain et al. (2019)
I ignore the past records of an investment before trading Raut et al. (2018)
Herding bias I follow social blogs/forums before purchasing/selling a Baker et al. (2019)
security
I follow others in all my investment decisions Baker et al. (2019)
When I lose money on an investment, I feel less disappointed if Prosad et al. (2015)
other investors also experienced the same loss
I prefer to invest in the assets that other investors are buying Shusha and Touny (2016)
I change my opinion regarding investment in a security after Jain et al. (2019)
hearing conflicting views from analysts
Regret-aversion bias I changed my investment decisions in light of the wrong Item added through this
decisions I had made earlier study
I avoid investing in profitable assets if I had incurred losses in Baker et al. (2019)
similar investments in the past
Holding loss-making investments for longer time is more Baker et al. (2019)
painful than disposing profitable investments early
I became risk-seeking because I have made profits in the past Prosad et al. (2015)
I became risk-averse because I have incurred losses in the past Khan et al. (2017)
I regret when I miss an opportunity of getting good returns Baker et al. (2019)
Overconfidence bias I cannot predict future prices of my investments better than Glaser and Weber (2007)
others. *
I always feel optimistic about the future returns of my Baker et al. (2019)
investments
I am confident of my ability to make investment decisions Prosad et al. (2015)
better than others
I have complete knowledge of various types of investments Jain et al. (2019)
Ambiguity-aversion bias I do not invest when I am not very sure of the returns Item added through this
study
I accept higher returns in case of the investments with higher Chandra et al. (2017)
levels of risk
I prefer investments with secured return Item added through this
study
Anchoring and I usually rely on past experience in the market for my next Jain et al. (2019)
adjustment bias investment
Current price of the security helps me to forecast its future price Shusha and Touny (2016)
I fix a target price for buying and selling the security in Item added through this
advance study
The purchase price of a security is a not big factor to be Baker et al. (2019)
considered while selling it. *
Confirmation bias I am not selective in collecting information about the Item added through this
investments made by me. * study
I value positive information more than negative information Item added through this
regarding my investment choices study
When an investment is not going well, I seek information that Item added through this
confirms I made the right decision study
I ignore the information that does not match my thoughts Item added through this
regarding the future of my investment decision study
Self-control bias It is very difficult for me to keep up my saving goals Item added through this
study
I easily stick to difficult saving objectives once I decide. * Item added through this
study
I lack the self-discipline required to fulfill my long-term saving Item added through this
objectives study
I am able to achieve my saving and investment goals. * Item added through this
study
Table 1.
Items of the scale (continued )
Factor Final items of the scale Literature support
Development
of behavioral
Loss-aversion bias I do not avoid an investment when I fear the loss Baker et al. (2019)
I never sell an investment at a loss with an expectation that it Chandra et al. (2017)
biases scale
will eventually improve
Loss of Rs 1,000 is more painful than happiness of Rs 1,000 Item added through this
profit study
I avoid taking decisions with the fear of incurring losses Item added through this
study
Representativeness bias All my investment decisions are based on trend analysis of Jain et al. (2019)
some of my similar investments earlier
Before selecting an agent/broker, I do not analyze his/her track Item added through this
record study
I make investment decisions based upon my assessment of Baker et al. (2019)
performance of previous investments of similar kind
Conservatism bias I do not easily change my decisions about investments once Item added through this
they are made study
I stick on to old information as future is uncertain Item added through this
study
I keep updating my facts and evidences while investing. * Item added through this
study
Self-attribution bias I am not likely to have a better outcome by making my Rasheed et al. (2018)
investment decision myself. *
Losses incurred in my investment were due to bad luck rather Mushinada and Veluri (2019)
than my poor judgment
I made profits in my investment due to my successful Kaustia and Perttula (2012),
investment strategies Prosad et al. (2015)
Mental accounting bias I do not consider returns from income and capital appreciation Ahmad et al. (2017)
separately. *
I earmark the investments purpose wisely and maintain them Baker et al. (2019)
separately
I categorize my investments into various purposes such as Item added through this
leisure, children’s education and so on study
Status quo bias I like to sell or modify inherited investments. * Item added through this
study
I keep holding the investments because they are familiar to me Item added through this
study
I think about changing my portfolio, but many times I do not Item added through this
change it study
Note(s): Items having (*) on them are negative in sense and were reverse coded for the analysis Table 1.

postgraduation and almost 15% of the respondents were having finance-related education
(CA, CFA, CMA, etc.). Almost 44% of the respondents are having permanent jobs, followed by
one-third of the sample of retired people, self-employed people (20.1%) and financial experts
(5.6%) respectively. Half of the sample respondents were having less than five years of
experience in investing.
In both phases, the sample consisted of a majority of males. It is due to the reason that
Indian society is a male-dominated society and most of the investment decisions in Indian
families are taken by males (Baker et al., 2019). All the aforementioned statistics show that the
sample is a heterogeneous one. Due to this heterogeneity, it becomes interesting to
understand various factors that contribute to the cognitive and emotional biases of the
sample investors.

4.2 Exploratory factor analysis

First of all, the researcher tested the sample adequacy (Kaiser–Meyer–Olkin (KMO) test) and
normality of data (Barlett’s test of sphericity). The KMO score (KMO 5 0.888) and Bartlett’s
RBF Phase 1 Phase 2
Demographic Valid Valid
characteristics Measures Frequency percentage Frequency percentage

Age (20–35) years 150 54.7 372 64.6

(35–50) years 60 21.9 132 22.9
(50–65) years 40 14.6 44 7.6
Above 65 years 24 8.8 28 4.9
Total 274 100.0 576 100
Gender Male 198 72.3 434 75.3
Female 76 27.7 142 24.7
Total 572 100.0 576 100
Marital status Married 164 59.9 314 54.5
Unmarried 110 40.1 262 45.5
Total 922 100.0 576 100
Educational Below graduation 20 7.3 10 1.7
qualification Graduation 50 18.2 90 15.6
Postgraduation 140 51.1 388 67.4
Finance professional 64 23.4 88 15.3
(CA, CFA, CMA, etc.)
Total 274 100.0 576 100
Occupation Permanent employee 114 41.6 250 43.4
Business/self-employed 62 22.6 116 20.1
Financial expert 18 6.6 32 5.6
Retired 80 29.2 178 30.9
Total 274 100.0 576 100.0
Annual income Up to 5 lakhs 90 32.8 216 37.5
(in Rs.) 5–10 lakhs 84 30.7 206 35.8
10 15 lakhs 56 20.4 68 11.8
15–20 lakhs 30 10.9 40 6.9
Above 20 lakhs 14 5.1 46 8
Total 274 100.0 576 100
Experience in Less than 5 years 78 28.5 288 50
investing (in years) (5–15) years 104 38.0 182 31.6
(15–30) years 29 10.6 44 7.6
(30–50) years 35 12.8 20 3.5
Table 2. Above 50 years 28 10.2 42 7.3
Respondent profile Total 274 100.0 576 100

test of sphericity (Sig 5 0.00) showed that the assumptions of EFA were satisfied. The data
was normal and sample size was adequate (Hair et al., 2006).
In order to verify the items contained in a factor, EFA was used as a part of the study. To
extract the factors for the study, principal component analysis with varimax rotation was
used. Two standards used for extracting the factors were factor loadings and eigenvalue of
the variables, both of which must be more than 0.50 and 1, respectively (Roesch and
Rowley, 2005).
Eigenvalue of all the factors was more than 1, but five items (three items of the construct,
“ambiguity aversion bias” and one item each of “loss aversion bias” and “regret aversion
bias”) were dropped due to small value of factor loading (Table 3). The items were reduced to
49 and EFA reported in extraction of 13 dimensions, which were named according to the
group of items. The 13 dimensions were the behavioral biases, namely “conservatism,”
“confirmation,” “representativeness,” “anchoring and adjustment,” “mental accounting,”
“availability,” “herding,” “self-attribution,” “loss aversion,” “overconfidence,” “self-control,”
“status quo” and “regret aversion.” The dimension, namely “ambiguity aversion bias” was
dropped. Table 3 shows the factor loadings of the final items of the scale. Further, the total Development
cumulative variance explained by all factors was approximately 80% much above the floor- of behavioral
level explanation based on variable–factor ratio (Table 3) (Costello and Osborne, 2005).
biases scale
4.3 Confirmatory factor analysis and model fit
After identifying 13 factors through output of EFA, the obtained factor structure needs to be
confirmed. The hypothesized factor structure according to the refined behavioral biases scale
(BBS) consisting of 49 items was tested for first-order confirmatory factor analysis (1st CFA)
using the data collected from phase 2. CFA on the propounded model was performed using
SEM. Model fit was evaluated using values of CMIN/df, comparative fit index (CFI), goodness
of fit index (GFI), adjusted goodness of fit index (AGFI), p-value and root mean square error of
approximation (RMSEA). Indices of model fit were calculated to determine the fitness of the
measurement model, “Behavioral Biases Scale” comprising of 13 zero-order constructs. The
results of the evaluation of the measurement model showed that the assessed values lie within
the prescribed accepted levels. The CMIN/df (2.181) lies within the prescribed limits
indicating a good fit. The indicators of absolute fit of GFI (0.850) and the RMSEA (0.064) of the
model showed a good fit. The indicators of incremental fit of AGFI (0.806) and CFI values
(0.906) also pointed out a good fit (Table 5). Thus, the results of first-order CFA showed that
the model is a good fit and suitable for further analysis.

4.4 Reliability and validity of the model

In order to assess the reliability and internal consistency, the Cronbach’s α {CA(α)} and
composite reliability (CR) for each construct are evaluated and are shown in Table 4. Some
items were negative in sense, so the responses on those items were reverse coded for analysis.
For each construct, the values of Cronbach’s α and CR are more than the floor level of 0.70 and
are acceptable for basic research (Nunnally and Bernstein, 1967; Fornell and Larcker, 1981).
In order to use a scale with confidence, its validity needs to be assured. In other words, the
scale must fulfill its claims of measuring whatever it is intended to measure. In the current
study, different measures of validity, namely, nomological validity and construct validity, are
used to establish the validity of BBS. Convergent validity and discriminant validity are
assessed to ascertain the construct validity. Nomological validity of a scale refers to ensuring
that there is a logical relationship between the items and the factors on which those items load
on to. Nomological validity was confirmed by results of factor structure reported by EFA and
the first-order CFA. Convergent validity and discriminant validity are assessed to ascertain
the construct validity.
Convergent validity: If various methods used to measure a variable give the same result,
the model is said to possess convergent validity (O’Leary-Kelly and Vokurka, 1998).
Measures, namely CR value and average variance explained (AVE), are used to establish
convergent validity. The values of CR and AVE of all the 13 constructs showed values more
than 0.7 and 0.5, respectively. Also, the criterion that CR must be greater than AVE is also
satisfied in all the 13 constructs (Table 4). Thus, all the conditions to be satisfied for ensuring
convergent validity were met by all the constructs of BBS (Hair et al., 2006).
Discriminant validity: It signifies the degree of uniqueness of the measures of various
latent variables. If the measures, which are supposed to be different, do not correlate
significantly with each other, discriminant validity is verified (O’Leary-Kelly and Vokurka,
1998). Maximum shared variance (MSV), average shared variance (ASV) and AVE are used to
establish discriminant validity. If, ASV < AVE and MSV < AVE, then the construct is said to
possess discriminant validity (Hair et al., 2006). In the current study, the validity toolkit
provided by Professor Gakingston is used to determine the discriminant validity statistics.
The values of MSV as well as ASV of all the 13 constructs in BBS are found to be less than the
RBF Variance
Factor explained Cumulative
Factor Final items of the scale Codes loadings Eigenvalue (%) variance (%)

Availability bias The information from my A2 0.848 16.4 30.95 30.95

close friends and relatives
is a reliable reference for
my investment decisions
While considering the A4 0.81
track record of an
investment, I put more
weight on its recent
performance
Advertisements are the A1 0.799
main source of
information for my
investment decisions
I consider the recent A3 0.787
records of a security
before investing
I ignore the past records A5 0.776
of an investment before
trading
Herding bias I follow social blogs/ H4 0.875 4.115 7.77 38.72
forums before
purchasing/selling a
security
I follow others in all my H3 0.87
investment decisions
When I lose money on an H2 0.855
investment, I feel less
disappointed if other
investors also
experienced the same loss
I prefer to invest in the H1 0.845
assets that other investors
are buying
I change my opinion H5 0.799
regarding investment in a
security after hearing
conflicting views from
analysts
Regret-aversion bias I changed my investment RA4 0.812 3.15 5.94 44.66
decisions in light of the
wrong decisions I had
made earlier
Holding loss-making RA3 0.779
investments for longer
time is more painful than
disposing profitable
investments early
I became risk-seeking RA5 0.772
because I have made
profits in the past
I became risk-averse RA6 0.727
because I have incurred
losses in the past
I regret when I miss an RA1 0.718
opportunity of getting
Table 3. good returns
Results of exploratory
factor analysis (continued )
 Variance
Development
Factor explained Cumulative of behavioral
Factor Final items of the scale Codes loadings Eigenvalue (%) variance (%)
biases scale
Overconfidence bias I cannot predict future O2 NEW 0.873 2.65 5 49.66
prices of my investments
better than others. *
I always feel optimistic O1 0.867
about the future returns of
my investments
I am confident of my O4 0.858
ability to make
investment decisions
better than others
I have complete O3 0.845
knowledge of various
types of investments
Anchoring and I usually rely on past AN3 0.886 2.606 4.92 54.58
adjustment bias experience in the market
for my next investment
Current price of the AN4 0.863
security helps me to
forecast its future price
I fix a target price for AN1 0.861
buying and selling the
security in advance
The purchase price of a AN2 0.821
security is a not big factor NEW
to be considered while
selling it. *
Confirmation bias I am not selective in CF2NEW 0.89 2.277 4.3 58.87
collecting information
about the investments
made by me. *
I value positive CF3 0.87
information more than
negative information
regarding my investment
choices
When an investment is CF1 0.863
not going well, I seek
information that confirms
I made the right decision
I ignore the information CF4 0.815
that does not match my
thoughts regarding the
future of my investment
decision
Self-control bias I easily stick to difficult SC4 0.882 2.135 4.03 62.9
saving objectives once I NEW
decide. *
It is very difficult for me to SC3 0.828
keep up my saving goals
I am able to achieve my SC1 0.821
saving and investment NEW
goals. *
I lack the self-discipline SC2 0.816
required to fulfill my long-
term saving objectives

(continued ) Table 3.
RBF Variance
Factor explained Cumulative
Factor Final items of the scale Codes loadings Eigenvalue (%) variance (%)

Loss-aversion bias I never sell an investment LA3 0.77 1.95 3.68 66.58
at a loss with an
expectation that it will
eventually improve
Loss of Rs 1,000 is more LA2 0.769
painful than happiness of
Rs 1,000 profit
I avoid taking decisions LA4 0.747
with the fear of incurring
losses
Representativeness All my investment R3 0.871 1.848 3.49 70.07
bias decisions are based on
trend analysis of some of
my similar investments
earlier
Before selecting an agent/ R2 0.849
broker, I do not analyze
his/her track record
I make investment R1 0.777
decisions based upon my
assessment of
performance of previous
investments of similar
kind
Conservatism bias I don’t easily change my CS1 0.917 1.595 3.01 73.08
decisions about
investments once they are
made
I stick on to old CS2 0.914
information as future is
uncertain
I keep updating my facts CS3 0.877
and evidences while NEW
investing. *
Self-attribution bias I am not likely to have a SA1 0.858 1.464 2.76 75.84
better outcome by making NEW
my investment decision
myself. *
Losses incurred in my SA3 0.82
investment were due to
bad luck rather than my
poor judgment
I made profits in my SA2 0.778
investment due to my
successful investment
strategies
Mental accounting I do not consider returns MA3 0.835 1.371 2.59 78.43
bias from income and capital NEW
appreciation separately. *
I earmark the investments MA2 0.742
purpose wisely and
maintain them separately
I categorize my MA1 0.717
investments into various
purposes such as leisure,
children’s education and
so on

Table 3. (continued )
 Variance
Development
Factor explained Cumulative of behavioral
Factor Final items of the scale Codes loadings Eigenvalue (%) variance (%)
biases scale
Status quo bias I like to sell or modify SQ2 0.852 1.252 2.36 80.79
inherited investments. * NEW
I keep holding the SQ3 0.735
investments because they
are familiar to me
I think about changing SQ1 0.696
my portfolio, but many
times I do not change it
Note(s): Items having (*) on them are negative in sense and were reverse coded for the analysis Table 3.

Construct CA(α) AVE CR MSV ASV

Representativeness bias 0.913 0.7836 0.91537 0.2025 0.1205

Confirmation bias 0.947 0.793 0.939 0.137 0.216
Conservatism bias 0.924 0.806 0.926 0.078 0.056
Self-attribution bias 0.909 0.771 0.91 0.144 0.126
Mental accounting bias 0.869 0.711 0.879 0.26 0.114
Anchoring bias 0.947 0.82 0.948 0.212 0.126
Availability bias 0.931 0.735 0.932 0.26 0.161
Herding bias 0.958 0.822 0.958 0.25 0.123
Loss-aversion bias 0.872 0.712 0.881 0.336 0.154
Status quo bias 0.827 0.623 0.829 0.27 0.119
Regret-aversion bias 0.887 0.539 0.85 0.336 0.196 Table 4.
Overconfidence bias 0.96 0.856 0.96 0.212 0.113 Reliability and validity
Self-control bias 0.874 0.629 0.869 0.096 0.039 for zero-order
Source(s): Gakingston statistical toolkit output constructs

Third-order
Second-order models model
Recommended First-order Cognitive Emotional Behavioral
Indices value model biases biases biases

CMIN/ <3 2.181 2.206 2.938 2.181

DF
CFI ≥0.9 0.906 0.946 0.93 0.942
GFI ≥0.9 0.850 0.843 0.862 0.851
AGFI ≥0.8 0.806 0.806 0.815 0.798
p-value ≥0.05 0.000 0.000 0.000 0.000 Table 5.
RMSEA ≤0.1 0.064 0.065 0.082 0.064 Model fit indices

values of their AVE respectively (Table 4). So, results show that the measurement model used
in the study is valid in respect of discriminant validity (Hair et al., 2006).

4.5 Second-order measurement model

If the researcher wants to confirm about various components or subconstructs into which the
various proposed constructs used in the study load onto, then the statistical method to be
RBF employed is named as second-order CFA. Using the factor loadings of the principal construct,
second-order model helps in establishing causal effects in between the principal construct
and its subconstructs to ensure that the subconstructs load on to the proposed second-order
construct. The model was tested for two second-order constructs, namely “cognitive biases”
and “emotional biases.” After applying second-order CFA in the study, it was observed that
all the criteria of the fitness indexes of both the second-order constructs have been
satisfactorily met (Table 5). The results of model fit of the second-order constructs have been
reported in Table 5.
Results also indicated that the second-order constructs “cognitive biases” and “emotional
biases” are suitable to represent and explain the relationship between the first-order
constructs. The results depicted that the highest factor loading of cognitive biases is with
availability bias (0.71), followed by factor loadings of herding (0.61), self-attribution (0.61),
confirmation (0.60), representativeness (0.59), mental accounting (0.59), anchoring and
adjustment (0.57) and conservatism (0.39) (Figure 1). The results show that “cognitive biases”
is an exogenous variable caused by eight endogenous variables, namely availability bias,
herding bias, self-attribution bias, confirmation bias, representativeness bias, mental
accounting bias, anchoring and adjustment bias and confirmation bias (Figure 1). In case of
emotional biases, regret-aversion bias showed the highest factor loading of 0.82 followed by
loss aversion (0.71), status quo (0.56), overconfidence (0.52) and self-control (0.32) (Figure 2).
So, “emotional biases” is an exogenous variable caused by five endogenous variables, namely
regret-aversion bias, loss-aversion bias, status quo bias, overconfidence bias and self-control
bias (Figure 2). The results showed that subconstructs showing various biases load properly
on to their respective two second-order constructs, namely “cognitive biases” and “emotional
biases” (Figures 1 and 2).

4.6 Higher-order measurement model

Due to the theoretical underpinning about the structure of behavioral biases (Pompian and
Wood, 2006; Zahera and Bansal, 2018) and high value of the covariance (0.97) between the two
second-order constructs (cognitive biases and emotional biases) of the BBS, the model was
tested for a third-order CFA. Cognitive biases and emotional biases showed a factor loading
of 0.97 and 1 respectively with behavioral biases. Based on the value of path coefficients,
emotional biases show more significant impact on the biased investment behavior of
individual investors.
The model fit indices of the third-order model showed satisfactory values (Table 5). Both
of the second-order constructs loaded well on the third-order construct. So, the model is a good
fit. The BBS consisting of two second-order factors and 13 zero-order constructs is well
supported. The results support the academic literature related to behavioral biases (Pompian
and Wood, 2006; Zahera and Bansal, 2018). The graphical presentation of the high-order
model of the BBS scale is depicted in Figure 3.

5. Discussion
Investors do not reflect complete rationality while making investment decisions. The results
of the present study confirmed this belief. Financial behavior of investors is affected by their
mental abilities to process complete information available to them. Their preference toward
choosing various investment avenues and securities depends on their prior beliefs, past
experiences and the trend of the market. Investors rather than analyzing the existing
information, take help from friends, colleagues and brokers. Investors admit being swayed by
emotions and goals at the time of taking investment decisions. Understanding various
behavioral biases is necessary to control these biases and improve investment outcome. The
 Development
of behavioral
biases scale

Note(s): R = Representativeness bias, CF = Confirmation bias, CS = Conservatism bias, Figure 1.

Second-order construct
SA = Self Attribution bias, MA = Mental Accounting bias, AN = Anchoring and Adjustment Bias, – cognitive biases
A = Availability Bias, H = Herding bias, CB = Cognitive Biases

segregation of BBS into cognitive and emotional biases is suitable as different measures are
required to adjust for and control these biases. Since, illogical reasoning is the main reason
behind cognitive biases, they can be corrected by better information, proper advice and
educating investors about these biases, but emotional biases are hard to rectify. Till now, the
effort to improve investment performance has been attributed to improve financial literacy,
but now the financial advisors as well as the investors need to understand that they must
train themselves to stop getting affected by their emotions. Fear of losing money and
resistance to accept investment mistakes need to be kept aside for getting good investment
returns. Investment targets and strategies must be modified according to latest news about
various securities. Clinging on to loss-making investments or any returns target will not
RBF

Figure 2.
Second-order construct
– emotional biases
Note(s): LA = Loss Aversion bias, SQ = Status Quo bias, O = Overconfidence bias,
SC = Self Control bias, RA = Regret Aversion bias, EB = Emotional Biases

make the situation better, would rather deteriorate the available returns. Investors need to
understand whether to scale up or move down the efficient frontier to match their risk and
return preferences with their behavioral propensities. Many investors use the services of
financial advisors for taking investment decisions. In order to provide customized financial
 Development
of behavioral
biases scale

Note(s): R = Representativeness bias, CF = Confirmation bias, CS = Conservatism bias,

SA = Self Attribution bias, MA = Mental Accounting bias, AN = Anchoring and Adjustment Bias,
A = Availability Bias, H = Herding bias, CB = Cognitive Biases, LA =Loss Aversion bias, Figure 3.
Higher-order model of
SQ = Status Quo bias, O = Overconfidence bias, SC = Self Control bias, RA = Regret Aversion bias, behavioral biases
EB = Emotional Biases, BB = Behavioral Biases

advice to various clients, the financial advisors need to understand investors’ investment
behavior. Also, on recognition of the nature (emotional or cognition) of the client, financial
advisors dealing with emotional clients will be able to handle biased behavior in a better way.
RBF 6. Implications
Implications for theory: Academically, this study makes a significant contribution in the field
of behavioral finance by providing an instrument for the measurement of various behavioral
biases. The scale has augmented the understanding of investment decision-making by
focusing on biases of individual investors. The scale will prove to be of immense help to the
researchers in this field by providing them an opportunity to analyze many behavioral biases
on which there exist less studies in the literature.
Implications for practice: The scale formulated in this study is a comprehensive one to
assess various biases and attribute it to the causes of those biases. Using this scale, the
financial advisors can assess the behavioral biases present in their clients and provide them
the required customized feedback for minimizing their biases, thus helping them to enhance
their investment outcomes. The paper also holds significance because, the awareness of the
biases is essential to ensure the minimization of biases. The scale can also be used to assess
the effectiveness of various financial awareness and education classes designed to minimize
the behavioral biases of investors. The scale will also prove beneficial to policymakers as they
would understand the biased behavior of investors during periods of market stress, crisis and
others.

7. Conclusion
This study made a new attempt to develop and validate a higher-order hierarchical structure
of behavioral biases. The findings proved that the scale developed to measure behavioral
finance has multiple dimensions. BBS is a higher-order scale consisting of two second-order
factors. The paper studied 13 biases under two main causes of behavioral biases. The first
second-order dimension “Cognitive Biases” consisted of eight subdimensions or biases,
namely “representativeness bias,” “confirmation bias” and “conservatism bias,” “self-
attribution bias,” “anchoring bias,” “mental accounting,” “availability bias” and “herding
bias.” Another second-order dimension “Emotional Biases” consisted of five biases, namely
“regret aversion bias,” “loss aversion bias,” “status quo bias,” “self-control bias” and
“overconfidence bias.” The findings are in accordance with the concepts proposed by the
researchers of behavioral finance and psychology (Pompian and Wood, 2006; Oechssler et al.,
2009; Sahi et al., 2013; Zahera and Bansal, 2018), arguing that the financial behavior of
investors is affected by flaws caused due to their irrational thinking and emotions. The
present study confirmed that it is not only thinking and calculation abilities that have an
impact on the decision-making of investors, but their emotions have a larger impact on the
investment decisions that they take (Mellers et al., 1999; Slovic et al., 2002). Availability bias
manifested itself as a strong indicator of cognitive biases. It shows that people want to avoid
the hassles and pain associated with investment decisions. So, they take the shortcut of
analyzing the information on the basis of its ease of being recalled. Regret-aversion bias
showed a strong correlation with emotional biases, indicating that people compromise their
investment returns in order to save themselves from the regret of making bad investment
decisions. The feeling of regret is so strong that they sometimes remain at their status
quo and at other times, they become risk-seeking or risk lovers due to past investment
experiences.

8. Limitations and future research

There are many potential limitations in this study, which can be improved upon in future.
This scale has been devised by using inputs from individual investors only. The scale can be
modified and used to assess the behavioral biases of other parties involved in investment
decision-making such as institutional investors, financial advisors and so on. This study is
based on the responses collected from investors living in Delhi only. Geographical area can be Development
extended to include different respondents living in other parts of the country as a sample to of behavioral
validate this scale.
biases scale
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Further reading
Ricciardi, V. (2008), “The psychology of risk: the behavioral finance perspective”, in Fabozzi, F.J. (Ed.),
Handbook of Finance: Investment Management and Financial Management, John Wiley and
Sons, New Jersey, NJ, Vol. 2, pp. 85-111.

Corresponding author
Ritika can be contacted at: ritikaaneja.aneja@gmail.com

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