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Essay: Are investors rational?

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For many years now, investors, equity valuators, brokers, wealth managers have read and believed in traditional financial models ‘ all of which have the basic assumption of ‘investors are rational’. By investors act rationally, it implies that all the acts of the investor are in order to maximize he/her gain and/or minimize his/her loss. This is the basic assumption of all traditional financial models which also includes the basic Efficient Market Hypothesis by Eugene Fama (1970) which argues that the current price of a stock fully reflects all the available information. The 3 foundations of market efficiency are ‘
1. Investors are rational,
2. Independent deviation from rationality, and
3. Effective arbitrage, in which case the market corrects itself.
From this, the 3 levels of efficient markets (Strong, Weak, and Semi-strong form) are formed.
Over the years there have been many economists who have challenged these traditional financial models in various aspects. Daniel Kahneman and Amos Tversky were the first to challenge the very basic assumption of investors being rational. They argued that investors behaved irrationally at times when they let cognitive and emotional biases to influence their investment decisions.
Many investors rely on either Fundamental analysis of the company’s stock price which leads to the intrinsic value of the stock through a thorough analysis of the environmental factors, Industry factors and company factors that influence the price of a security. Or they rely on technical analysis which states that the prices reflect all information and hence bet on the price through thorough examination of the trend, price, pattern of the price & volume being traded of the security.
However, the fundamental analysis and technical analysis have been mostly exploited by Institutional investors, equity valuators, brokers, equity research teams and mutual funds which form only 41% of the whole stock market participants.
On the other hand retail investors (Individual investors who purchase securities on his or her own personal account and not for any organization), and each one differs in characteristics due to demographic factors like age, social background, educational qualification, gender, etc. Hence every individual investor has differing investment goals, risk tolerance levels, cash inflows and outflows, etc, according to which their optimal investment portfolio changes accordingly through calculated steps and procedures. But many a times retail investors fail to design an optimal investment strategy due to behavioural and cognitive biases. They are highly influenced by emotional and cognitive biases which then reflect in the prices of securities leading to sub-optimal decisions at the individual level and market anomalies and inefficiencies in the market.
To study and address these anomalies which couldn’t be explained by traditional financial theories of CAPM and EMH, hence there was quite a bit of research work done in this field of psychology and finance and now this has given rise to a whole new area called Behavioural Finance. Behavioural finance is defined by Shleifer, A (1999), ‘a rapidly growing area that deals with the influence of Psychology on the behavior of financial practitioners’.
Behavioural finance evolved from the mixture of Psychology with Finance to give the Prospect theory proposed by Daniel Kahneman and Amos Tversky then evolving to blend economics also ‘ to arrive at Mental Accounting and Endowment Effect, originally proposed by Richard Thaler. This is an evolving area with scope for further research and building of the modern financial theories.
Investor’s decision-making of buying, selling or waiting at various junctures is the process of choosing a particular alternative after proper rational evaluation from the various alternatives. Rational investors buy or sell stocks based on this Theory. Hence decision-making in stock market takes into account personal factors (like age, education, income, investment portfolio), technical factors (like expected return, expected risk, CAPM) and also situational factors (like the environment, better insight, global perspective, etc). Another point to be noted is that an optimum investment decision for one individual may not be apt for another investor as it varies with their investment objectives, risk taking ability, cash inflows and outflows. Hence taking rational optimum decision on investment strategy is a very calculated phenomenon.
However, through various literature surveys and researches it has been observed that individual investors are not always rational and a lot of emotions like anxiety, greed, fear and cognitive biases play a major role in taking these investment decisions which are not always optimal and rational. This leads to inaccurate analysis of information and the investment being overvalued or undervalued.
Due to these psychological biases, this decision is not always optimal and the fact that behavioural factors directly impact individual decision making is ignored by various investment advisors and financial professionals leading them to take uninformed and suboptimal portfolios.
Hence the need arises for understanding these biases and to what extent they affect the prices of assets. This will help in intrinsic pricing of securities rightly and creating good investment strategies for the investors and even by the investors, also giving an edge over others.
The Indian Stock Market with two major Stock Exchanges ‘ Bombay Stock Exchange and the National Stock exchange which have been successfully running since the 1990’s have various kinds of investors on a scale of millions, on a day to day basis. Of these almost 57% are Retail Investors. The SENSEX which is India’s oldest stock market index around and after the period of the Global Financial Crisis of 2008 had almost downed 8160 points in a year’s time. Volatility in the stock market at that point of time was tremendously widespread. A similar situation occurred around the Sovereign Debt Crisis in 2012. Indicating extreme movements and volatility in the prices of securities, mainly due to widespread fear and anticipation in the minds of individual investors of the Indian Stock Market. This drives one to bring focus to study the Indian Capital Market from the aspect of behavioural finance.
After a thorough examination of the literature regarding Indian investor’s sentiment, it is inferred that there is very limited study on this aspect done so far. And also the scope of the applicability of behavioural biases on Indian investors has not been explored much.
There are many emotional and cognitive biases like Overconfidence bias, Anchoring, Loss Aversion and Representativeness which have been repeatedly studied in the Indian capital market, however various others have been left out, like Over optimism bias, Familiarity bias, Limited attention, Conservatism, Status Quo bias, Endowment bias, Confirmation bias, Illusion of Control, Aversion to Ambiguity, Prospect theory, Mental Accounting, etc,. Which leads to investors acting irrationally and hence the stock markets do not reflect a true and fair picture through the prices of securities.
Hence the purpose of the research is to capture the various factors that influence the behavior of Indian investors and to what extent. Also these various factors which influence investor behavior are interrelated and cannot be looked at individually. Hence to understand and analyze these variables that influences the retail investor’s behaviour.

Review of literature involves study of existing papers, which have been published by various scholars and researchers across the globe as well as domestic researchers, with variables suiting their geography of study and time of study.
Literature review gives highly essential and gives the researcher perspective on what areas are covered previously and what are the various gaps that can be worked on. Since the area of behavioural finance is vast, there are various factors that have been explored and empirically implied by various authors and researchers. This gives us a wider understanding of the field at the same time a starting point to probe and explore more in this arena. Also when one goes through various different opinions and findings by renowned scholars of that field it gives new perspective and can also come across various contradicting and complex findings which have a lot of scope for further research and hence once this scope is identified, that becomes one of the objectives to achieve. Also, if the research proposed by one has already been undertaken earlier, it provides an option for modifying the work by adding a new perspective or altering some of the methods of research to obtain a perspective that will be different from earlier works and thus more valuable.
Review of existing related literature help to interpret the researches that have been done over the years in the field of retail investors’ sentiments. Investors’ behaviour is constantly evolving along with time. In the same way the factors that influence the retail investors’ sentiment are also evolving. Hence this helps in identifying the various areas that have been already studied in this behavioural finance field and what are the research gaps which can be taken up to do further research and also to test the applicability of the various factors in the domestic location.
From the various literature reviews, one thing can be concluded that in the Indian domain, not much research has been done in context of retail investors’ sentiment and the factors influencing it. Hence this gives us scope to explore and establish research and empirical evidence of behavioural finance in the Indian stock market.
The following subheadings were identified and analyzed for the purpose of literature review:
Title of the paper
Tools Used
Variable Identified
Conclusion and Suggestions
1. Lee, C., Shleifer, A., & Thaler, R. H. (1991). Investor sentiment and the closed’end fund puzzle. The Journal of Finance, 46(1), 75-109.
This paper highlights how investors’ sentiments drive the fluctuations in the price of closed-end funds. These funds are like normal equity funds comprising of publicly traded shares, difference being that they have fixed number of units available for subscription and can be traded in recognized stock exchanges. In the beginning these funds start off at a premium price but of late they have been trading at a 10-20% discount. There are various reasons for this; rationally it could be due to agency costs involved, tax liabilities and illiquid assets. Behavioral reasons with research backing stated are that due to changing individual investor sentiments, the prices and discounts of the close ended funds fluctuate. These funds trade at a high discount when the investors are pessimistic about the future returns and vise versa when optimistic. Since there is unpredictability of investors’ sentiments, there lies a risk in holding the closed-end fund. Discounts are a proxy for changes in individual investor sentiments and hence causing the average under-pricing of funds relative to its fundamentals. This same concept applies to returns on smaller capitalized stocks which are traded by individual investors. Hence evidence suggests that securities subject to changing investor sentiments’ risks will trade at, on an average at a discount from their fundamentals. Movements in security prices may be attributed to movements in investor sentiments. The research gap in this paper states that there is scope for further research in this field with larger capitalized securities prices and also exploration the effects of sentiments attached by institutional investors.
2. Soni, P. (2013). Behavioral Finance-Diversion from Traditional Methods of Risk Analysis. International Journal of Applied Research and Studies.
The objective of the study is to analyse that to earn a high return with minimum risk, Investors always look for a better way to construct Portfolio
It has been observed that repeated patterns of irrationality occur in the way humans arrive at decisions and choices when faced with uncertainty. Investors construct their portfolio on the basis of their appetite for risk and return. They rely on the knowledge and experience, and advice from their known or experts. Most of them do not rely on technical or fundamental analysis to make investment decisions.
Various factors influences the investment decisions like – Goodwill of company, Previous experience and knowledge of Investors, Guidance of experts or known, Capital Gain on securities, Dividend declared by the company, tax benefits, time duration of Investment, Investor attitude towards the security, purpose of Investment and capacity of investor to bear the risk etc. The impact of behavioural and emotional factors increases with the volatility in the markets.
The study is limited to Jodhpur city, with a sample size of only 50 respondents.
The analysis is only theoretical without basing the results on any statistical tests.
3. MS. AVANI SHAH; DR. NARAYAN BASER (2012). MUTUAL FUND: BEHAVIORAL FINANCE’S PERSPECTIVE. Asia Pacific Journal of Marketing and Management Review.
The objective of the study id to analyse the investor’s preference in selection of Mutual fund and measuring the fund sponsor quality.
Some findings of the research suggest that age does not have any impact on investor’s preference for Fund performance record, Scheme expense ratio, Reputation of fund manager, Scheme portfolio, Withdrawal facilities, Favourable rating by rating agency, Innovativeness and Entry & exit load. However, it affects the investor’s preference for Funds reputation and brand name and minimum initial investment.
Occupation does not play an important role in investor’s preference for Fund performance record, Scheme expense ratio, Reputation of fund manager, Scheme portfolio, favourable rating by rating agency, Innovativeness of the scheme, Entry & exit load and minimum initial investment. However, it varies with Funds reputation, Withdrawal facilities, and brand name. It was also observed that the fund’s reputation, Withdrawal facilities, brand name, Sponsor’s past performance in terms of risk & return varies among the investor’s of different age and occupation groups. Occupation affects investors’ preference for Fund Sponsor qualities, brand name, Sponsor’s expertise in managing money and Sponsor’s past performance in terms of risk & return.
4. Tversky, A., & Kahneman, D. (1992). Advances in prospect theory: Cumulative representation of uncertainty. Journal of Risk and uncertainty, 5(4), 297-323.
The objective of the study is to develop a new version of prospect theory that employs cumulative rather than separable decision weights and extends the theory in several aspects. Variables used for the study are monetary incentives and numerical probabilities.
The research states that the prospect theory explains major violations in the expected utility theory. It distinguishes the choice process into two phases: Framing (representation of acts, contingencies and outcomes) and Valuation (assess value of prospect and choose accordingly). A cumulative prospect theory gives rise to different evaluations of gains and losses, thereby providing a unified treatment of both risk and uncertainty.
The study confirms existence of framing effects, nonlinear preferences, source dependence, risk seeking and loss aversion. No significant difference was found between payments of flat fee vs incentives. The study thus revealed that monetary incentives are neither necessary nor sufficient to ensure investor cooperativeness, thoughtfulness and truthfulness.
5. Baker, M., & Wurgler, J. (2007). Investor sentiment in the stock market.
The objective of the study is to develop a model for measuring investor sentiment in the stock markets.
The research is based on two assumptions: Investors are subject to sentiments and Betting against sentimental investors is costly and risky. The paper has used a top-down macroeconomic approach for sentiment measurement. It has been observed that stocks of low capitalisation, younger, unprofitable, highly volatile and non dividend paying, growth companies are likely to be disproportionately sensitive to investor sentiments.
Highly volatile stocks are generally riskier to arbitrage because of their speculative nature. Investor sentiment also affects the cost of capital and has real implications on allocation of capital in corporate investments.
6. Baker, M., & Wurgler, J. (2006). Investor Sentiment and the Cross’Section of Stock Returns. The Journal of Finance, 61(4), 1645-1680.
The paper is aimed at providing evidence that investor sentiments may have significant effects on cross-section of stock prices. Firm size and profitability, age, dividends, asset tangibility, growth opportunities and/or distress have been used as different variables for the research.
Stocks that are more sensitive to speculative demand tend to be riskiest and costliest to arbitrage. These volatile stocks are attractive to optimists and speculators but unattractive to arbitrageurs. Some patterns become visible only after conditioning on sentiment; which remain hidden otherwise. There are no perfect and controllable proxies for investor sentiments.
The regression confirms that when sentiments are high, future returns are relatively low for small firms (with volatile stocks, high growth, non dividend paying, unprofitable, distressed) and high for other large firms.
7. Brown, G. W., & Cliff, M. T. (2005). Investor Sentiment and Asset Valuation*.The Journal of Business, 78(2), 405-440.
The objective of the research is to shed light on issue of investor rationality by using a direct survey measure of investor sentiment.
It has been observed that excessive optimism leads to periods of market over valuation. High current sentiment is followed by low cumulative long run returns as market price reverts to its intrinsic value. Sentiments affect smaller stocks to a larger extent. When investors are optimistic, market valuations are higher than the intrinsic value.
Market is over-valued during periods of optimism. Overly optimistic (pessimistic) investors drive prices above (below) fundamental values. Sentiments are largely linked and related to the level of market valuation. Irrational sentiments of investors do affect the asset pricing levels and therefore the models must consider role of investor sentiments in their analysis.

1. Gnani Dharmaja .V, Ganesh .J, Dr. Santhi .V (2012). A Study on the Individual Investor Behavior with Special Referance to Geojit BNP Paribas Financial Service Ltd, Coimbatore. International Journal of Research in Management and Technology.
The study aims at identifying the most and the least influencing factors of the individual investor behaviour. Various factors studied in the literature included Personal Factors like gender, qualification, work status, income and life stage; and Behavioural Factors like financial resources, emotional risk tolerance, financial literacy level etc.
The study found that there is no significant relationship between Emotional Risk Tolerance and Gender, Income, Financial resource tolerance and Financial Literacy Level of the investors.
However, there is a significant relationship between Emotional Risk Tolerance and Work Status, Life stage of the Investor. There is no significant relationship between Investment Time Horizon and Gender, Income and Financial Literacy Level of the investors. But there is a significant relationship between Investment Time Horizon, Qualification of the Investor, Work Status and Life stage, financial resource tolerance of the investors. Majority of investors are male, undergraduates and business owners. Majority of the respondents are influenced by the accounting information of the companies and advocate recommendation is the least influencing group.
However, as the sample population of the study only included the investors of Geojit BNP Paribas Financial Service Ltd, Coimbatore; the results cannot be extrapolated to reflect general retail investor behaviour.
2. Bennet, E., Selvam, M., Vivek, N., & Shalin, E. E. (2012). The impact of investors’ sentiment on the equity market: Evidence from Indian stock market. African Journal of Business Management, 6(32), 9317-9325.
The objective of the study is to analyse the influence of market specific factors on investors’ sentiment. Different tests like Reliability test (using Cronbach’s Alpha) and Unidimensionality test (PLS path modelling) were used for the analysis. The constructs related to investor sentiment studied in the literature were Herd behaviour (HB), Internet led access to information and trade (ILA), Macroeconomic factors (MEF), Risk and cost factor (RCF), Performance factor and confidence level of institutional investors (PFCII) and Best game in town (BG).
It was observed that investor’s optimism reflected in the belief that there is no alternative investment than stock markets (best game in town); Investors believe that other investment options like PF and gratuity will not be able to cover their retirement expenses; HB does not influence investor behaviour, ILA, BG and MEF highly influences, RCF does not influence and PFCII influences the investor’s behaviour.
However the study was confined to 375 investors in Tamil Nadu and the findings are not very relevant in the current market scenario (restricted to 12 months of market performance during time of research). Findings generated kind of contradict the presence of behavioural factors influencing investor’s sentiments (lay more emphasis on publicly available information).
3. Bhunla, A., & Das, A. (2012). Prediction of Investment Behaviour in India: A Study of Capital Market Development and Gross Domestic Investment. International Journal of Management & Business Studies, .
The aim of this paper is to study the relationship between Indian Capital markets and Gross domestic investment and also observe the Capital market’s ability to predict investment behaviour in India. The various factors used for analysis were: Index of market capitalization; The ratio of total value of shares traded in the capital market to GDP; Turnover ratio quantified as the value of total shares traded divided by market capitalization.
The research found that apart from the values of Gross Domestic Investment, none of the capital market development indicators is statistically significant indicating a long run relationship exists between Indian capital markets and gross domestic investment. However, markets lack predictive power of investment behaviour majorly due to small size, shallow organized form of market, and low market capitalization and volumes, which in turn diminishes the liquidity creating ability of the market.
This research was mainly based on secondary data obtained from RBI Statistical Bulletins and not the primary data hence the reliability and applicability is questionable.
4. Latif, M., Arshad, S., Fatima, M., & Farooq, S. (2012). Market Efficiency, Market Anomalies, Causes, Evidences, and Some Behavioural Aspects of Market Anomalies. Research Journal of Finance and Accounting, 2(9-10), 1-13.
The objective was to analyse the occurrence and possible causes of different types of anomalies with their evidences in different stock markers. Several anomalies studied included Calendar anomalies like ‘ weekend effect, turn of the month effect, turn of the year effect, January effect; Fundamental anomalies like ‘ value anomaly, low price to book, high dividend yield, low p/e, neglected stocks and Technical anomalies ‘ momentum effect, moving averages, trading range break (resistance and support level)
The research found that any new information is not absorbed quickly by the investors. The anomalies may be linked to differential tax treatments, cash flow adjustments and behavioural constraints leading to market over reactions. Due to these anomalies, investors can generate abnormal returns by fundamental and technical analysis.
The research did not explain which bias do the anomalies refer to? What causes these anomalies? The factors of over and under reaction are superficially defined without proper testing and illustration.
5. Chandra, A. (2008, December). Decision Making in the Stock Market: Incorporating Psychology with Finance. In National Conference on Forecasting Financial Markets of India.
This paper aims at identifying the behavioural factors that affect various individual investors while making investment decisions and exploring their impact on the pricing of assets. This also aims at exploring the relation between individual investor’s attitude towards risk and behavioural decision making process. This paper’s research is based on secondary data and literature survey and analysis of literature done in this area of behavioural decision making and investors’ psychology. This paper highlights the collected evidence from various secondary sources and shows how individual investors at irrational at times in making investment decisions due to emotional influences like greed, fear, cognitive dissonance, heuristics, mental accounting and anchoring. This behavioural study will then be further useful for the investment advisors and finance professionals to then incorporate and discount for these factors in their investment and portfolio model to make it more dynamic and efficient.
6. Shaikh, A. R., & Kalkundarikar, A. B. (2011). Analysis of Retail Investor’s Behaviour in Belgaum District, Karnataka State. Analysis, 1(2), 22-39.
The objective was to assess the behaviour of retail investors in Belgaum district of Karnataka state.
The research analyses time horizon expected Rate of Return and verifies correlation between knowledge and level of return expected and occupation and level of risk.
It was observed that the level of knowledge determines expected rate of return (specially for extensive knowledge category) +.096 ; Majority investors belong to the business class category ; Very high percentage of the population is willing to take moderate risk (63.57%) ; Negative correlation exists between level of risk and occupation (-0.053) of investors.
The study is however restricted to Belgaum district only and takes very few into consideration to analyse investor behaviour.
The objective is to study and analyse the rationality of investors of Udaipur during different market expectations, dividend and bonus announcements, impact of age, income levels and other market related info on investment decision. Various factors studied include Demographic factors, Investment details, Behavioural details etc.
It was found that there is no significant association between age and investment behaviour when market is going as per expectations. Also there is no significant association between age and investment behaviour during dividend distribution announcements of listed companies and there is no significant association between age and investment behaviour during bonus announcements. Investors prefer wait and watch policy for taking the decisions and these decisions are impacted by various psychological factors.
The research is restricted to Udaipur and a small sample of 110 investors. The influence of different behavioural factors on investment decisions is not explained, since age is taken as an only factor for analysing investor decision with respect to various information flows in the market.
8. Hiremath, G., & Kamaiah, B. (2010). Some Further Evidence on Behaviour of Stock Returns in India. International Journal of Economics and Finance, 2(2).
The objective of the study is to examine the stock return behaviour in two premier Indian stock markets using Chow-Denning multiple variance ratio and Hinich bicorrelation tests. (Chow Dening: overcomes size distortion of conventional variance ratio test. Hinich: detects linear and non-linear dependencies).
It was observed that CNX Nifty Junior, CNX 500, CNX Bank Nifty, BSE 500, BSE Midcap and BSE Small cap indexes reject the random walk hypothesis and return series are characterized by the presence of linear dependencies. The bicorrelation test rejects the hypothesis of pure white noise process for the full sample period. Serial dependencies were not found to be consistent across the sample period for all indices. The Chow-Denning test rejects the null of random walk for six indices whereas the Hinich test rejects the null of pure white noise for full sample period. The research concludes that Indian stock markets are weak form efficient but not all the time.
The events occurred during the periods of serial dependencies and peculiarity of particular indices can be investigated in future research.
9. Chandra, A., & Kumar, R. (2011). Determinants of Individual Investor Behaviour: An Orthogonal Linear Transformation Approach.
The objective of the study is to examine whether some psychological and contextual factors affect individual investor behaviour. Different constructs and biases taken into consideration are Heuristics involving Representativeness, Overconfidence, Anchoring, Gambler’s fallacy ; Availability Prospect theory including Loss aversion, Regret aversion, Mental accounting, awareness and access to right information (conservativism); Contextual and Behavioural factors like Prudence and precaution, Conservatism, Under confidence, Information asymmetry, Financial addiction ‘ treat accounting and other financial information as less important and separate.
The paper defines less support and evidence for over reaction in stock markets and concludes that broker advices and analyst recommendations often go unheeded. Investors demand information about product quality and safety, company activities etc. ant their behaviour has a significant impact on market movements.
10. E Bennet, M Selvam, Eva Ebenezer, V Karpagam, S Vanitha (2011). Investors Attitude on Stock Selection Decision. International Journal of Management and Business Studies.
The paper analyses investor’s perception of various factors that affect stock markets. 29 variables have been taken under consideration which includes Independent variables like demographics (gender, age, marital status, education, number of dependents, annual income, domicile etc).
The researchers observed that there is no significant relationship between gender and different market factors like earnings, decision making, corporate governance etc. (except positioning factor). There is a significant relationship between marital status and different fundamental and market factors. However, there is no significant relationship between age, education qualification, level of income and different fundamental and market factors.
Factors given highest priority by the investors are ROE, management quality, P/E and other ratios. Factors given lowest priority include analyst recommendation, broker and research report, family and friend recommendation, geographical location, social responsibility etc.
11. Nikhil Rastogi, Chakrapani Chaturvedula, Nupur Pavan Bang (2009). Momentum and Overreaction in Indian Capital Markets. International Research journal of Finance and Economics.
The objective of the research is to study the momentum and over reaction phenomena in the Indian Equity markets. Momentum defines that investors make abnormal profits by buying past winners and selling past losers; which is a part of under reaction hypothesis. Over reaction is evident only in mid cap stocks. Under reaction to new information is prominent in Indian security markets (except for midcap stocks).
Momentum effect leads to overreaction and thereby overconfidence among the Indian investors.
12. Dharani, M., & Natarajan, P. (Sept 2011). Impact of Demographic factors on Retail Investor’s Investment Decisions.Indian Journal of Finance, .
This paper studies the impact of demographic factors like ‘ Age, Gender, Marital Status, level of income, market knowledge, educational qualification and number of dependents; on retail investors’ investment decision.
Findings from this study indicate that Age has negative relation with level of risk taken; Gender (to female) has a negative relation with level of risk taken; Marital status has no relation with the level of risk taken; Level of income has a positive relation with level of risk taken; Market knowledge has a positive relationship with risk taken; Education qualification has a positive relation; Number of dependents has a negative relation with the level of risk taken.
In brief demographic factor’s play huge influence on individual investors’ risk perception and hence their investment in various risky securities.
However, the study is only confined to the Belgaum district of Karnataka, hence geographically limited results. And the sample size is restricted to 700 which may not reflect the entire population.
13. Shanmugsundaram, V., & Balakrishnan, V. (2010). Investment Decision-making – a behavioural approach. International Journal of Business Innovation and Research, 4(6), 584-597.
This paper aims to study, if investors’ decisions are influenced by various factors of age & income distribution. Also if investors react rationally to capital market information like results announcements, dividends announcements, bonus announcements. Also to analyse the influence of age on investment portfolio and criteria for investment.
It’s gathered from this paper that investors are mostly rational. But they are influenced by information like announcements of annual results, dividends and bonus. There is a significant relation between age and industry prospects in investor portfolios. There is a significant relation between age and information triggers, lower the age, more rational reaction to information triggers like results, stock splits, mergers, bonus, dividends.
They mostly stay invested with outlook of long term growth and prefer to wait and watch. They are influenced by various psychological factors.
However, this study is limited to only 100 investors from Chennai city. There is further scope of study of behavioural characteristics of various categories of investors like, retail & institutional, domestic institutional and foreign institutional investors.
14. Sahni, D. Behavioural Finance: Testing Applicability of Indian Investors. International Journal of in Multidisciplinary & Academic Research, .
This study aims to test the applicability of Behavioral Finance theories on Indian Investors. They use 2 variables of behavioural finance ‘ Loss aversion and Anchoring and analyses its applicability in Indian Capital markets and investors.
The findings of this study include, risk aversion in gains causes investors to sell too quickly into rising stock prices, thereby depressing prices relative to fundamentals. Conversely, risk seeking in losses causes them to hold on too long when prices decline, thereby causing the prices of stocks with negative momentum to overstate fundamental values. Maximum of the investors were anchored to past prices where they perceived that a continuous increase in stock index for 5 days will be followed by a decline – showing a reversal to anchored price (and vise versa for continuous decline).
There is scope for further study on other biases (variables), and geographically limited data.
15. Kukreja, G. (Dec 2012). Investor’s Perception for stock Market: Evidences from National Capital Region of India.Interdisciplinary journal of contemporary research in business,4(8), 711-726.
This study aims to discover that how the various services provided by brokers are perceived by the investors and how these services are utilised by the investors.
Educational qualification has significant influence on transparency of transaction, tax advantage, past performance of the company in cash market. Occupation has significant influence on investment pattern, services of the stock broker, risk and uncertainty in future & option, and size of investment in future & option. Further, Occupation has significant influence on services of the stock broker in future & option. Age is having significant influence in cash market, future & option, and life insurance products. Various factors influencing perception of investors towards the Indian Capital Market are, Investment influence, Convenient investment, Investment benefit, Service satisfaction, Client service, and Charges and liquidity.
However the study was conducted targeting the investors in NCR region. The sample of 120 investors of NCR, may not reflect the opinion of the entire population of the country.
16. Bennet, E., & Selvam, M. (2011). Investors’ Perception of the Factors Influencing the Stock Selection Decision. Available at SSRN 1793822.
The objectives of this research is to identify the investors’ perception of the influence of Social, Political, Economical, Regulatory, Technological, Environmental and Legal (SPERTEL) risks on the value of equity shares in the market.
This study indicates how demographic factors have a significant influence on investor perception of (SPERTEL) risks. Married and unmarried investors give equal importance to PERTEL risks while valuing the shares. But there is significant difference between married and single in the case of social factors. There is significant difference between the age groups in the case of political regulatory and legal factors. No significant difference in SPERTEL factors between different levels of investors classified on the basis of educational qualification, different occupations, basis of places of living, different levels of Income Groups. Hence SPERTEL risk has a significant influence on the value of the equity shares in the market.
Scope for further study is by complementing findings of this study by further investigation on the areas of other internal factors like, Intra Country, Inter Country, Investor and Managers, Psychological Factors such as Heuristics, Framing, Mental Accounting, etc.
17. Bennet, E. (2011, December). Stock-Specific Factors and its Influence on Investors’ Sentiment: Evidence from Indian Stock Market. In 2012 Financial Markets & Corporate Governance Conference.
The aim of this research is to analyse the individual investor’s sentiment. This study also analyses the influence of Stock Specific Factors (Financial Characteristics, Psychological Factors, Quality of Management, Expected Events Surrounding the Stock and the Book Value, Recommendation of the Financial Community, Price Cut-off Rules, Who else Buy?, Past Price Performance and Sector Attractiveness and Price Earnings Ratio and Familiarity with the Products and Services) on investors’ sentiment.
Study found that during the period of the Post Global Crisis, Investors’ Optimism was influenced by Stock Specific Factors like Quality of Management (QM), Expected Events Surrounding the Stock, Book Value (EESS) Risk and Cost Factor (RCF) and Recommendation by the Financial Community (RFC).But, the overall Stock Specific Factors did not have much influence on Investors’ Sentiment in India.
18. Agrawal, K. (2012). A Conceptual Framework of Behavioral Biases in Finance.The IUP Journal of Behavioral Finance, 9(1), 7-18.
The main purpose of this paper is to develop a conceptual framework of the various behavioral biases by identifying their antecedents or causes, the interactions between them, and their outcomes or consequences. Also explores the possibilities of overcoming the biases.
The findings of the paper include many of the biases are caused by constraints on time, cost and capacity of individuals to process all the available information. Also biases triggered by the external environment like insufficient information or information overload, are not within the control of the individual. Biases triggered by the internal environment are more likely to be controllable by the individual. Intentional are the biases when the person uses it purposefully and unintentional are when there is less attention. Also some biases are caused by other biases like self attribution bias is a source of overconfidence bias. Other biases interact with each other in the process of decision making and intermediate outcomes of the bias involve different illusions which affect the speed of decision making. The findings are recorded through a survey of relevant literature. The variables include all kinds of biases which are overconfidence, over optimism, representativeness, familiarity, conservatism, status quo and endowment.
The gaps of this paper includes that several biases may be also active simultaneously, which makes an empirical investigation complex and difficult to operationalize. Future researchers might test the propositions that can be developed from the framework presented.
19. Chandra, A., & Sharma, D. (2010). Investment Management by Individual Investors: A Behavioral Approach. The IUP Journal of Behavioral Finance, 7(1), 7-18.
The objective of the research is to study the specification of the way of driving momentum by investors’ psychological biases which have been drawn from the psychological experiments’ results and to determine the contextual psychological biases that seem proper to Indian investors.
Different observations made explain Over/Under opportunism saying that the investors are under opportunistic and prefer to limit the risk by reducing number of shares bought, but they are over opportunistic when it comes to buying stocks at high price. The sensitivity to rumours is high in Indian investors (particularly liquid stocks) and they are less influenced by overconfidence (26%). Indian investors exhibit over opportunism with respect to prices of stocks (71%) and majority of them are conservative (85%) and highly influenced by representativeness bias.
The study is restricted to Delhi (NCR) region and is also confined to a few biases only. Only financial intermediaries have been used as sample data (instead of stock investors).
‘ The research work done in domestic markets has been confined to particular regions like Tamil Nadu, Belgaum, Udaipur, Delhi NCR, Chennai etc.
‘ Some research articles have based their findings only on secondary data obtained from RBI Statistical Bulletins and other stock exchanges.
‘ Factors like over and under reaction have been superficially defined without proper testing.
‘ Scope of study of behavioural characteristics with reference to risk perception of investors like retail & institutional, domestic and foreign institutional investors is limited.
‘ Several biases may also be active simultaneously, which makes an empirical investigation complex and difficult to operate. However, future researches might be used to test the propositions developed and look into some more propositions that can be developed from the existing frameworks presented.
‘ In the Indian Capital market, the impact of behavioural biases has been little researched on and hence there is huge scope for this kind of research in this geographical domain and the impact of the behavioural biases on the Indian Capital Markets and pricing. Hence in the research is trying to establish the existence of these biases in the Indian capital market through primary research and then statistical analysis on it to further observe its significance.
‘ The next point observed is that these variables/biases which impact the various investors’ decisions can be further analyzed statistically to find the relation between them and their dependence on each other. Hence through the various research and statistical tools, a relation between the variables can be established and their level of interdependence can be found, also how significantly each variable impacts the investment decisions also can be found.
‘ This will further lead to understand the investors’ sentiments and the variables linked to it. This can be useful to the investors’ in various ways; like when they are next taking a decision, they can try to keep it as much rational possible. This also can help the financial professionals and advisors who will know what biases to look out for in the capital markets and in what proportion. Hence before-hand discounting or including these biases when estimating an optimal investment decision is the most favourable method which will also provide a competitive edge.
‘ Scope for further research: The literature from various other countries has shed light on what are the various biases but has not been able to measure the impact of these biases and throw light on how it affects asset prices and the price discovery mechanism in the markets. How every this requires empirical research and secondary market data which goes beyond the scope of this research hence it has been overlooked. Nevertheless there is lots of further scope in this field for further research.
‘ Findings of this study can be complemented by further investigation on the areas of other internal factors like, Intra Country, Inter Country, Investor and Managers, Psychological Factors such as Heuristics, Framing, Mental Accounting, etc
There are many emotional and cognitive biases like Overconfidence bias, Anchoring, Loss Aversion and Representativeness which have been repeatedly studied in the Indian capital market, however various others have been left out and only theoretical literatures have been analysed on them. Evidence of their existence has not been established through primary research for these other biases.
Hence can be concluded that in the Indian domain, not much research has been done in context of retail investors’ sentiment and the factors influencing it. Therefore this gives us scope to explore and establish research and evidence of existence of behavioural and cognitive baises in the Indian stock market.
The research will mainly deal with capturing the various factors which influence the investor behaviour in Indian capital market. Different psychological and behavioural factors influencing investor sentiments will be recorded and analysed.
Traditional Finance theories have a gap which is filled by Behavioural Finance theories. However, much work is yet to be done in this field. From the literature review above, the gaps have been analyzed and the main take away is that in the Indian Capital market, the impact of behavioural biases has been little researched on and hence there is huge scope for this kind of research in this geographical domain and the impact of the behavioural biases on the Indian Capital Markets and pricing. Hence in my research I am trying to establish the existence of these biases in the Indian capital market through primary research and then statistical analysis on it to further observe its significance.
The next point observed is that these variables/biases which impact the various investors’ decisions can be further analyzed statistically to find the relation between them and their dependence on each other. Hence through the various research and statistical tools, a relation between the variables can be established and their level of interdependence can be found, also how significantly each variable impacts the investment decisions also can be found.
This will further lead to understand the investors’ sentiments and the variables linked to it. This can be useful to the investors’ in various ways; like when they are next taking a decision, they can try to keep it as much rational possible. This also can help the financial professionals and advisors who will know what biases to look out for in the capital markets and in what proportion. Hence before-hand discounting or including these biases when estimating an optimal investment decision is the most favorable method which will also provide a competitive edge.
The literature from various other countries has shed light on what are the various biases but has not been able to measure the impact of these biases and throw light on how it affects asset prices and the price discovery mechanism in the markets. How every this requires empirical research and secondary market data which goes beyond the scope of this research hence it has been overlooked. Nevertheless there is lots of further scope in this field for further research.’
The reason and purpose of doing research is to discover and explore answers to various questions. Here the aim is to establish and uncover areas and relations not previously discovered in the direction of fulfilling the objectives of the research. This then can be analyzed and interpreted for further use. Research Methodology chapter provides the structure that will be in place for doing the research. This also gives clarity of the statement of problem; the objectives of the research, hypothesis, and all those methods which are used during the course of the research are included under this chapter. This also highlights the fact that why a particular method of research or technique is being done for the specific scenario and type of study.
Unlike the traditional theories, the need of the hour is a market theory which includes the behavioural and psychological factors of investors’ sentiment. Hence for that purpose the various factors need to be recognized which impact the investors’ sentiment in the Indian capital market. Also how these variables affect the various investment decisions investors make is the next important question to be answered.

Demographic Variables:
1. Age group to which the retail investor belongs to.
2. Gender of the retail investor.
3. Income (p.a) of the retail investor.
4. Profession
5. Education level
Behavioural Variables:
1. Participant in equity markets
2. Risk Level
3. Type of Participant
4. Stop Loss
5. Booking of Profit
6. Herding behavior
7. Increased risk taking after losses
Sentiment (Baises) Variables:
1. Anchoring and adjustment Bias:
Anchoring depicts how individual investors tend to remember and benchmark the most recently remembered price or a price index, this price acts as an anchor to which the investors tend to compare and relatively evaluate the current price. This leads to the tendency of investors to make investment decisions based on this relative valuation and not absolute valuation and many a times investors have the tendency to hold on to the stocks in hopes of the price being revised to the anchored price.
2. Availability Bias (Heuristics):
The availability bias or commonly known as rule of thumb causes judgments or decisions about the likelihood or frequency of an occurrence based on readily available information or own reasoning, not necessarily based on complete, objective or factual information.
3. Ambiguity aversion Bias:
People Hesitate when probability of something is ambiguous or uncertain. People do not like to gamble when probability distributions seem uncertain. In general, people hesitate in situations of ambiguity, a tendency referred to as ambiguity aversion.
4. Cognitive dissonance:
Cognitive dissonance is a mental state of imbalance and confusion which occurs when contradictory facts or statements intersect. Hence in these circumstances individuals suffer from selective perception where on registers information that is in conformance with the selected course which leads to a view of incomplete facts and hence inaccurate. This also leads to selective decision making where the decision subconsciously is made and any contradictory facts are overlooked by the individual.
5. Confirmation Bias:
Refers to a type of selective perception that emphasizes ideas that confirm one’s beliefs, while devaluing whatever contradicts one’s beliefs. Here one, convinces oneself of whatever it is that the person wants to believe. Undue emphasis to events that confirm outcomes one desires and downplay what contradicts one’s desires.
6. Conservatism:
Conservatism is a mental process in which people cling to their prior views or forecasts at the expense of acknowledging new information. They also under react to new information, and try to maintain decisions which were derived from the previous estimate rather than acting on the updated information. People affected by this bias cling to their prior view/forcast, even at the expense of less or not acknowledging any new information. They find it very hard to move away from initial position, even when move occurs, it is very slow.
7. Endownment Bias:
The minimum selling price that people state tends to exceed the maximum purchase prices that they are willing to pay for the same good.
If one loses an object possessed, magnitude of loss is much greater than the magnitude of gain if the same object is newly acquired. People value the asset more which they possess and feel loss greatly when it is taken away, rather than when they do not possess the asset.
8. Framing Bias:
Tendency of the decision maker to respond to various situations differently based on the way the choice or question is presented or framed.
9. Hindsight Bias:
Once event has elapsed, people with this bias tend to perceive that this event was predictable, even if it was not. People affected by this bais feel, “I knew it all along” after the event has occurred, this behaviour is precipitated by the fact that actual outcomes are more readily grasped by people’s minds than the infinite array of outcomes that could have but did not materialize.
10. Illusion of Control:
The people who are affected by this bais have the tendency to believe that they can control or at least influence outcomes when, in fact, they cannot.
11. Loss Aversion:
Loss aversion is the greater sensitivity of investors’ sentiment to losses than to gains. This aroused from the prospect theory given by Kahneman and Tversky, in which it was observed that investors feel a stronger impulse to avoid losses than to acquire gains. They impact or sentiment generated by happiness from a gain of one value is less than the sentiment generated by loss of the same value. This leads the retail investors to hold on to the loss making investments for too long in the hope of making profit.
12. Familiarity Bias:
Investors affected by this bias tend to be overly optimistic about the markets, the economy, and the potential for positive performance of the investments they make in a familiar environment.
13. Overconfidence Bias:
Individuals who suffer from this bias are over confident about their abilities, where they think they are smarter and are better informed than others. Under this also can be categorized into prediction overconfidence where the investors for example, while estimating the future value of a stock will provide for a very narrow leeway since they are very overconfident about their judgment which exposes them to higher risks. Also some investors suffer from certainty overconfidence where they are extremely certain of the decision taken and will stick by it, blinding themselves to the prospect of loss and once this bubble is broken they are extremely surprised or disappointed.
14. Status Quo Bias:
An emotional bias that predisposes people facing an array of choice options to elect whatever option ratifies or extends the existing condition in lieu of alternative options that might bring about change. (William Sameulson and Richard Zeckhauser; 1988).
15. Regret Aversion Bias:
People exhibiting regret aversion avoid taking decisive actions because they fear that, in hindsight, whatever course they select will prove less than optimal. Results with people holding on for too long to their investments to avoid admitting errors or regretting the probable opportunity in the future, if such occurs.
16. Recency Bias:
A cognitive predisposition which causes people to more prominently recall and emphasize recent events/observations, than those that occurred in the near or distant past. Here they extrapolate patterns and make projections based on historical data samples.
17. Representativeness Bias:
Representativeness bias reveals that some investors tend to rely on stereotypes or a rough best fix approximation which leads to base rate negligence. Here an investor may categorize companies into various A class, B class or C class categories where A Class companies are value stocks and C class companies are according to their perception really bad companies, and based on this the investor will draw conclusions about the risks and rewards expected from these companies. This bias also leads to sample size negligence. Here an investor assumes that small sample sizes of the data is representative of the population and hence base his/her investment decision on this. This could lead to investors making errors in investment decisions due to examining only the past few years stock returns or financials.
18. Self Attribution Bias:
Self attribution bias is the tendency of individuals to attribute their success to their own talent or foresight (Self enhancing); whereas blame their failure to external factors like bad luck (Self protecting).
19. Self Control Bias:
A tendency which causes people to consume today, at the expense of saving for tomorrow. It is also a conflict between people’s overarching desires and their inability, stemming from a lack of self discipline, to act concretely in pursuit of those desires. Here, people tend to sabotage their own long term objectives for temporary satisfaction like spend more today at the expense of saving for tomorrow, fail to plan, lose sight of basic financials, etc.
20. Mental Accounting Bias:
Mental Accounting describes individuals’ tendency to categorize and put the various assets or money into various different mental buckets or accounts, which impacts their financial decision to a large extent. These categories may be purpose driven which may lead to separation of income or investment for the purpose of the college fund or retirement fund. This also explains why many individuals are inclined to preserve capital/capital appreciation and expend interest income.
Dependent Variable:
Behavioural Factors are:
1. Level of risk undertaken in equity markets
2. Type of Market Participant
3. Herding
4. Increased risk taking after losses
Independent Variable:
Demographic Factors are:
1. Gender
2. Age group
3. Income group
4. Profession
5. Education level
Sentiments (biases) Factors are:
1. Anchoring and adjustment bias
2. Availability bias
3. Ambiguity aversion
4. Cognitive dissonance
5. Confirmation Bias
6. Conservatism
7. Endowment Bias
8. Framing
9. Hindsight
10. Illusion of Control
11. Loss aversion
12. Familiarity Bias
13. Overconfidence
14. Status Quo Bias
15. Regret Aversion
16. Recency
17. Representativeness
18. Self attribution
19. Self Control
20. Mental Accounting
I. To study the retail investor’s behavior in the Indian Capital Market.
II. To record the factors influencing the behavioral patterns by such retail investors.
III. To study whether retail investors’ sentiments and behavior influence the Indian capital markets or not.
It is necessary to understand the link between the objectives and the variables. In the first objective, investor’s behavior is the action that the investors take. Hence this will involve the study of demographic variables verses behavioral variables. In the second objective, Factors can be catagorised into Demographic factors and Sentimental (biases) Factors and their influence on behavioural variables of the investors. The third objective is a study of the investor’s sentiment and their influence on the investor’s behavior.
Ho: There is no significant difference between the Demographic Factors and Behaviour of the investors in the Indian Capital Market
H1: There is significant difference between the Demographic Factors and Behaviour of the investors in the Indian Capital Market
Ho: There is no significant difference between the Sentiments of investors and their behaviour in the Indian Capital Market
H1: There is significant difference between the Sentiments of investors and their behaviour in the Indian Capital Market
Primary data is used for the study and the data is collected with the help of a structured questionnaire. The main respondents for the study are the retail investors of Bangalore City, Karnataka, who invest in the Indian capital market and are they work on personal capability and not any institutional.
The sample size for the study since is a pilot study is 55 respondents which are chosen at random and convenient sampling is done.
It is always ideal to test the entire population in order to arrive at the accurate result but in most cases the entire population becomes too large to test and because of which it is impossible to include the entire population.
Sampling is the process of selecting a few samples from a bigger group called the population for the purpose of becoming the basis of estimating and proving the hypothesis and also the research. The sampling method used for the study is ‘Selective Sampling’. This involves deliberate selection of units from the population for constituting a sample representative of your entire population.
Questionnaire is to be used as a tool for collecting primary data. The questionnaire has under gone a process of evaluation and scrutiny by experts of psychology and finance for determining the reliability and effectiveness of the questionnaire. Then is presented to the sample investors for their honest answer and feedback. These questions are prepared by taking into consideration the views generated by the literature review and need of recognizing the biases and its effect on investment decisions.
Various steps in the research broadly will be:
‘ Validity and reliability testing of the instruments.
‘ Cronbach alpha test for each construct in the questionnaire
‘ Identification of the variables
‘ Correlation analysis of the factors
‘ Validating the hypothesis through the results obtained
‘ Significance testing of the hypothesis
To test the reliability of the questionnaire: Cornbach’s Alpha Test
Cornbach’s Alpha tests the reliability of scales used in the questionnaire and a Cornbach’s Alpha score ranges from 0 to 1, higher the score, more reliable the scale is. A pilot study to be conducted with response from 5 respondents initially so that it is possible to make changes to the questions that are confusing for the respondents. With this pilot study, it becomes possible to simplify few questions that created complexity in the mind of respondents.
3.11.1 Co-relation
It is the statistical method of identifying the direction of relationship between two variables. It is the tool that shows what happens to the value of one variable if the value of other variable is changed. Will that other variable show positive movement or negative or will not change at all. Co-relation helps identify the relationship between the variables.
3.11.2. CHI SQUARE Test
The Chi-square test, tests how likely it is that an observed distribution is due to chance. It is also called a goodness of fit test, because it measures how well the observed data fits with the expected distribution if the variables are independent.
This requires the data to be counted and divided into categories. This will not work with parametric or continuous data.
This also tests the null hypothesis that the variables are independent. Wherever the observed data doesn’t fit the model, the likelihood that the variables are dependent becomes stronger, thus proving the null hypothesis incorrect.
Cross tabulation (or crosstabs for short) is a statistical process that consensus the categorical data to create a contingency table. This is heavily used in survey research, business intelligence, engineering and scientific research. This provides a basic picture of the interrelation between two variables and can help find interactions between them.
This study is a Descriptive Research where after the data and variables are identified by the literature review they are put to authentication and various statistical tools and tests to enable decision making.
To make this study effective following procedure will be followed;
i. Understand the research requirements
ii. Prepare Questionnaire
iii. Pilot run the questionnaire
iv. Collection of Data
v. Analysis
vi. Report Submission
vii. Recommendation and suggestions
This chapter has made clear the way in which this research should be approached. It laid down the framework for the research. It also showed the relevance and importance of various statistical tools that can be used in the research. It also laid down the foundation for the systematic research.

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