Research Based Learning-II

Investor Decision-Making:
The Role Psychological
Biases in the Evaluation
of
decision making

Submitted by
Aditya yadav
System ID-2022834444
BBA Accountingg and Finance
Section-ACCA

Department- MANAGEMENT
Sharda School of Business Studies

SHARDA UNIVERSITY, GREATER NOIDA-201306

INDIA
 Faculty Mentor/Guide
Dr. Khagendra Nath Gangai Sir

DECLARATION

This is to certify that I have gone through all the

past journals, records and research papers which
are related to my topic “Investor decision making
the role phychological biases in the evaluation of
financial investment” This research paper is based
on different past research papers and views on the
topics related to my topic which will help me
knowing the depths on the views on my topic.

Name: ADITYA YADAV

system id:2022834444
 ACKNOWLEDGEMENT

I would like to express my heartfelt gratitude to my

teacher, Dr. khagendra Nath Gangai, for his guidance and
support throughout the research. The expertise, patience,
and dedication have helped in shaping the result of my
research paper.

Dr khagendra Nath Gangai. provided me with important

feedback, questions, and criticism that helped refine my
research paper. His commitment to the subject matter
helped me improving.

I am also grateful for the encouragement and motivation

[Link] Nath Gangawhoi provided me
during the time of research for my topic.
 ABSTRACT

This study investigates the impact of psychological biases

on investor decision-making during the assessment of
financial statements. It draws insights from behavioral
finance and cognitive psychology to analyze biases such
as overconfidence, anchoring, confirmation bias, loss
aversion, and herd mentality. Through empirical research,
the prevalence and consequences of these biases on
financial decision-making are underscored. The paper
discusses various strategies, including education and
decision aids, to mitigate these biases. Real-life case
studies are utilized to demonstrate practical implications.
Ultimately, by acknowledging and tackling biases,
investors can enhance their decision-making processes,
thereby promoting market efficiency and investor well-
being. By fostering a deeper understanding of
psychological biases and their implications for financial
decision-making, this research aims to empower investors
to navigate markets more effectively. Through continued
awareness and implementation of mitigation strategies,
investors can cultivate a more rational approach,
ultimately contributing to the stability and efficiency of
financial markets and the prosperity of investors
worldwide
INTRODUCTION
Humans are always prone to making different biases
toward a specific thing while making various decisions,
psychological biases are kind of little shortcuts that our
brains take during making decisions in various areas of
our lives. They're like mental habits that can lead us to
think or act in certain ways without us even realizing it.
Humans apply psychological biases in almost every aspect
of decision-making. These biases often start from our
brain's efforts to process information quickly and
efficiently, but they can sometimes lead us away from the
correct path or directions, especially when it comes to
making important decisions. The evaluation of a financial
statement is not based on judging it on the first site but it
is based on the Iceberg Theory that depicts how there is
always a deeper story than two that can be easily seen on
the surface. For example, the current ratio of a firm can be
ideal at 2:1 but it could be a case that the current assets
include a majority of debtors that certainly can’t be
collected into cash and equivalents so the decision made
in the first site was to invest in the company but when
someone digs deeper he gets the point that the deeper
story matters which was the content of the current assets
available to the company. Now let's apply this concept to
financial situations. Whenever investors start evaluating
the financial statements of a company, they are trying
their best to figure out how well a company is doing and
whether it's a good investment or not for future reference.
But here's where things get tricky and tough, Our brains
have all sorts of biases that can affect how we evaluate
financial information and make investment decisions in
our day-to-day lives. we can have different biases during
investment decision making such as overconfidence bias,
conformation bias, anchoring bias, loss aversion, herd
mentality, and so on. These are just a few examples of
different psychological biases that can influence financial
evaluation. The tricky and difficult part is that these biases
often operate at a subconscious level of our mind,
meaning that investors might not even realize that they're
being influenced by these biases. As a result, investors
can make different decisions that aren't necessarily
important in their best interest or accurately reflect the
actual true value of an investment. Understanding and
recognizing these biases is very important for investors
and financial professionals so that they can make the best
financial decisions in the long term. As a result by being
aware of how our mental tendencies and employing
strategies work it helps to mitigate their effects, therefore
an investor can make more rational and informed
decisions in the complex world of finance.

LITERATURE REVIEW

In Ali and Waheed's (2013) study presented at the annual

meeting of the Society of 2nd - International Conference
on Humanities in London, the authors explore the
determinants of small equity investors' risk assumption
attitude. This research provides valuable insights into the
factors influencing investors' willingness to take on risk in
the equity market, which is pertinent to understanding
investor decision-making behavior. Their findings
contribute to the broader literature on investor psychology
and risk perception, which serves as a foundational
framework for examining the role of psychological biases
in financial decision-making.

Agnew (2006) examined whether behavioral biases vary

across individuals using individual-level 401(k) data. The
study, published in the Journal of Financial and
Quantitative Analysis, sought to understand if behavioral
biases, such as overconfidence or loss aversion, manifest
differently among investors. By analyzing data from
401(k) accounts, Agnew aimed to shed light on the extent
to which individual characteristics influence behavioral
biases in financial decision-making.
Research by [Link] & John R (2002) depicts how
emotional weaknesses and biases affects the investment
decisions, and how the investors emotions differ from the
normal outcomes of decisions that comes out at the end.
This can be avoided by investors making decisons
rationally and logically rather than relying on the feeling
one gets and this research paper effectively works on
solution of it.

Highlighting investors’ psychology, Lo, Rapin, and

Steenbsrger (2005) show that extreme emotional
responses are counterproductive from the perspective of
trading per-formance, as well as in the long-term planning.
Moreover, automatic emotional responses such as fear
and greed often outplay more controlled or rational
responses.

.
Alessi and Petry's (2003) study in Behavioural Processes
explored the link between impulsivity and pathological
gambling severity using a delay discounting procedure.
Their findings suggest that heightened impulsivity
correlates with increased severity of gambling symptoms.
This research underscores the role of impulsivity as a
potential risk factor in addictive behaviors, informing
strategies for intervention and treatment in individuals
struggling with gambling addiction.

In their 2008 study published in the Financial Analysts

Journal, Garvey and Murphy examined whether
professional traders exhibit delays in recognizing their
losses. The study sheds light on potential cognitive biases
affecting trading decisions, such as loss aversion.
Understanding traders' tendencies to realize losses is
crucial for assessing market efficiency and risk
management strategies in financial markets.

Kahneman and Tversky's (1979) seminal work in

Economica introduced Prospect Theory, which
revolutionized the understanding of decision-making
under risk. Their analysis provided insights into how
individuals weigh potential gains and losses, highlighting
deviations from traditional economic models. Prospect
Theory continues to influence research in behavioral
economics, shaping our understanding of human decision-
making processes in various domains.

Pompian (2008) explored the use of Behavioral Investor

Types to enhance client relationships in the Journal of
Financial Planning. His research suggests tailoring
investment strategies based on individual behavioral
profiles, contributing to improved client-advisor
interactions. This approach aligns with the growing
recognition of behavioral finance's significance in shaping
investor decision-making and advisor-client dynamics.

Siddiqui and Shuchita (2009) conducted a survey on the

influence of behavior on stock market investments,
published in The Journal of Management Awareness. Their
study delves into how psychological factors impact
investment decisions, contributing to the understanding of
behavioral finance's role in financial markets. This
research underscores the significance of considering
human behavior in investment strategies and market
dynamics.

Winnett and Lewis (1994) revisited the concept of mental

accounts in household savings behavior in their study
published in the Journal of Economic Psychology. By
examining the relationship between mental accounting
and savings behavior, their research sheds light on the
relevance of traditional economic principles in
understanding modern financial decision-making.

NEEDS AND OBJECTIVES OF RESEARCH

This study seeks to uncover and analyze psychological

biases that influence investor decision-making during the
evaluation of financial statements. It aims to examine how
these biases impact the accuracy of financial analysis and
explore strategies to mitigate their effects. Additionally,
the research aims to evaluate the practical implications of
these biases on investment outcomes and contribute to a
deeper understanding of the psychology behind financial
decision-making. It addresses the necessity to
comprehend the factors shaping investor decisions,
improve investor outcomes by mitigating biases, educate
financial professionals and policymakers, bridge the gap
between theory and practice in investment, and advance
the field of behavioral finance.

1)Anchoring Bias:Anchoring bias refers to the

tendency for individuals to rely too heavily on the first
piece of information they receive when making decisions,
even when that information may not be relevant or
accurate. Imagine you're shopping for a new laptop, and
the first price you see is $1000. Even if other laptops with
similar specifications are priced lower, you might still
subconsciously compare them to the initial $1000 price
tag. This anchoring effect can lead to skewed perceptions
of value and influence decision-making in various
contexts.

2)Availability Bias:Availability bias refers to the

tendency for individuals to rely more heavily on
information that is readily available in their memory when
making decisions. For example, if investors frequently
hear news reports about a particular industry performing
well, they may overestimate the attractiveness of
investments in that industry while overlooking other
opportunities. This bias can lead to suboptimal investment
decisions as investors fail to consider a comprehensive
range of information and alternatives.

3)Representativeness Bias:Representativeness
bias occurs when investors make judgments about an
investment based on how closely it resembles their
preconceived notions or stereotypes, rather than
considering relevant statistical information. For instance, if
an investor believes that a certain industry is always
profitable, they may overlook warning signs or fail to
analyze the actual financial data of individual companies
within that industry. This bias can lead to overlooking
important factors and making decisions based on
subjective perceptions rather than objective analysis.

4)Loss Aversion:Loss aversion refers to the

psychological tendency for investors to experience the
pain of losses more acutely than the pleasure of gains. In
other words, the emotional impact of losing money is
greater than the satisfaction gained from making a profit
of the same magnitude. This bias can lead investors to
make risk-averse decisions, prioritizing the avoidance of
losses over the pursuit of potential gains, even when the
rational choice may involve taking calculated risks for
higher returns.

5)Overconfidence Bias:Overconfidence bias refers

to investors' tendency to overestimate their own abilities
and knowledge in financial decision-making. This can lead
to behaviors such as excessive trading, concentrating
investments in a few assets, and neglecting diversification
strategies. Despite potential risks, overconfident investors
may believe they possess superior skills or insights,
leading to suboptimal portfolio management and
increased vulnerability to market fluctuations.
REFERENCES

Ali, I., & Waheed, M. S. (2013). Determinants of Small

Equity Investor’s Risk Assumption Attitude. Paper
presented at the anual meeting fort he Society of 2nd. -
International Conference on Humanities, London, June 17-
18.

Agnew, J. R. (2006). Do behavioral biases vary across

individuals? Evidence from individual level 401(k) data.
Journal of Financial and Quantitative Analysis, 41 (4), 939-
962

Alessi, S. M., & Petry, N. M. (2003). Pathological gambling

severity is associated with impulsivity in a delay
discounting procedure. Behavioural Processes, 64 (3),
345–354.

Garvey, R., & Murphy, A. (2008). Are professional traders

too slow to realize their losses? Financial Analysts Journal,
60 (4), 35-43

Roszkowski, M., & Grable, J. (2005). Estimating risk

tolerance: the degree of accuracy and the paramorphic
representations of the estimate. Financial Counseling and
Planning, 16 (2), 29-47

Kahneman, D., & Tversky, A. (1979). Prospect theory: An

analysis of decisions under risk. Economoterica, 47 (2),
263-292.

Winnett, A., & Lewis, A. (1994). Household accounts,

mental accounts and savings behaviour: Some old
economics rediscovered? Journal of Economic Psychology,
16 (4), 431 – 448.

Siddiqui, S., & ve Shuchita, S. (2009). Behaviour Influence

on Stock Market Investments: a surve. The Journal of
Management Awareness, 12(2), 95-104.

Pompian, M. M. (2008). Using Behavioral Investor Types to

Build Better Relationships with Your Clients. Journal of
Financial Planning, 21(10), 64-76.

Shalini, K. S., Ashok, P. A., & Nand, D. (2013). An

Exploratory Inquiry into the Psychological Biases in
Financial Investment Behavior. Journal of Behavioral
Finance, 14(2), 94-103.
[Link]