Academic journal article IUP Journal of Management Research

Behavioral Biases in the Decision Making of Individual Investors

Academic journal article IUP Journal of Management Research

Behavioral Biases in the Decision Making of Individual Investors

Article excerpt

Introduction

Conventional finance theories are based on the assumptions that people act rationally and consider all available information in their decisions related to investments (Dedu et al., 2012). According to Somil (2007), principles of maximization, self-interest and consistent choice commonly underpin the rational economic factor. Over the last few decades, it has been discovered that contrary to the assumptions and theories of conventional finance, many irrational behaviors related to investment judgment occur in real life. The theory of rational investor has been opposed by neoclassical economic theory which proposes that every investor or every person has limited access to information and an individual is bounded by external constraints and one's own behavior. In fact, individual investors make mental shortcuts in the process of investment decision making. According to Behavioral Finance (BF) approach, several psychological biases influence decision making of both individual investors and institutional investors.

A large body of empirical research indicates that real individual investors behave differently from one another. A number of previous studies (e.g., Glaser and Weber, 2004; Lehenkari and Perttunen, 2004; Massa and Simonov, 2005; Brown et al., 2006; Fogel and Berry, 2006; Lim, 2006; Chen et al., 2007; Campbell and Sharpe, 2009; Kliger and Kudryavtsev, 2010; Talpsepp, 2011; Chandra and Kumar, 2012; and Hon-Snir and Cohen, 2012) investigated behavioral biases that generally occur in decision making of the investors. The findings of such studies clearly indicate that each specific study focused only on one or a few behavioral biases. And that's why the literature appeared scattered. Of course, such studies enable us to develop a fair understanding of manifestations of various behavioral biases and their likely impact on investment decisions of the investors in one or other situation. But, in reality, a number of behavioral biases in aggregate influence the investment decisions. The review of such biases may help develop a better understanding of the issues concerning the behavior of the individual investors. Such observations trigger the interest of the authors of this paper to carry out a qualitative review of the phenomena under reference. A broader view of the various biases that influence investors' investment attitudes and tendencies, may enable individual investors to broaden their concept and to evolve better investment strategies, and the same may enhance the level of expertise of the investment professionals. In this paper, we have made a review of various behavioral biases that affect investment decision making of the individual investors. Irrational decision-making tendencies of individual investors, as revealed in earlier research, have been particularly highlighted. Potential solutions to mitigate the impact of investors' biases have also been discussed. Finally, future research needs relevant to such an area have been indicated. This paper has provided a concrete base for future research and, in this sense, this paper contributes significantly to the body of knowledge in the area of financial management in general and investment management in particular.

Methodology

A multi-stage process has been adopted to carry out the present study. First of all, seven keywords, viz., individual investor, investment behavior, behavioral biases in investor's decision making, cognitive biases in investor's decision making, psychological biases in investor's decision making, irrational decision making of individual investors, and behavioral finance have been identified for the purpose of searching the literature relevant to the theme of the present study. Second, Business Source Complete (EBSCO host database) was accessed, and using the chosen keywords, search was carried out for identifying the relevant research articles, and thus 155 full text research articles relevant to the theme of the present study were identified and downloaded or obtained using the library services of the institutes in which the authors are working. …

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