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BF Kerala Q 7
BF Kerala Q 7
BEHAVIOR: AN ANALYSIS ON
INVESTORS OF KERALA.
ABSTRACT
The study aims to explore the behavioral factors affecting the investment decision of
individual investors of Indian Stock Exchange with reference investors of Kerala state ,
India. The decision making is a cognitive process based on heuristic which results in
selection of investment avenues from the available alternatives. Behavioral factors such as
overconfidence, representative bias, regret aversion, mental accounting and herd behavior are
taken an independent variable for the study. This study was a descriptive study based on
stratified random and multi stage random sampling methods were applied in selection of
1000 respondents comprising the cross section of population. 916 responses was taken after
the data validation process. Descriptive statistics such percentage analysis , mean value,
factor analysis , chi square was used to test the variables. Exponential Factor Analysis was
applied to identify the significant factors. Five factor were extracted from factor analysis and
its impact was analyzed using Chi Square Test. Representative bias was found to be more
influential factor while herd behavior is the least factors among the investment behavioral
bias. All the variables are found to be statistical significant. Therefore the study concluded
that the behavioral factors have significant impact on the investment decision of the investors
of Kerala.
Rationality and irrationality are the two fundamental aspects of finance theory. The
traditional finance theory ( eg : Expected utility theory of Neumann & Morgenstern(1944))
and the modern finance theory of Markowitz ( eg : Modern Portfolio theory
Markowitz( 1952) Efficient market hypothesis (Fama, 1991)) explain the concept of utility
function of maximizing the wealth with in informal efficient market. The key assumption of
all these theories is that activities of an economic human being are rational and his/her main
target is profit maximization. These theories are based on assumptions that the investor is
rational, riskaverse and uses the utility curve to maximize his wellbeing.
The assumptions of efficient market were violated because of speculations and volatility of
the market, which was termed as “market anomalies”. Although theories of modern finance
were considered to be successful, an alternative theory was developed which explains the
irrational behavior of investor. The alternative theory was named as Behavioral finance
which incorporates the psychological aspects of decision making. The behavioral finance
model emphasizes investor behavior, leading to various market anomalies and inefficiencies.
This new concept for finance explains individual behavior and group behavior by integrating
the fields of sociology, psychology, and other behavioral sciences. It also predicts financial
markets. These psychological themes dealt with the complexity in decision making process.
The complexity emphasize the two aspects of behavioral finance : Behavioral finance micro
and Behavioral finance macro. (Pompain, 2006, pp. 89)
2. Behavioral Finance Macro (BFMA) detects and describes anomalies in the efficient
market hypothesis that behavioral models may explain.
Traditional economic theory suggests that investors act rationally to maximize their returns
from their investment. According to theory, optimal investment selection requires a series
step of decision making process in the allocation of their investment. The decision making
process of the investor varies according to their different preferences related to their aversion
of risk and preference in different composition of their investment portfolio. In normal
circumstances, investment portfolio of an investor will be based on personal attitude to
investment risk and time horizon.
The decision making process is a cognitive process which results in selection of a course of
action among several alternatives. Most of the investors in financial market do not have
sufficient knowledge about the investments and its economic concepts. Therefore , there is a
need to conduct a research on that influences investment decisions (Lusardi & Mitchell,
2006). By exploring the cognitive biases and errors in portfolio management process, the
investor can improve their behavior by avoiding their mistakes and ensure an optimum
portfolio management.
The purpose of the study is to identify the determinant of investment behavior with their
relative importance in managing portfolio.
The determinant of investment behavior was analyzed by applying the concept of behavioral
finance among the individual investors of Kerala, who normally trade at National Stock
Exchange or Bombay Stock Exchange.
a) Overconfidence.
b) Representative bias
c) Regret aversion
d) Mental accounting
e) Herd behavior
H1: There is a significant relationship between overconfidence and the investor’s decision
making.
H2: There is a significant relationship between representative bias and the investor’s
decision making.
H3 : There is a significant relationship between regret aversion and the investor’s decision
making.
H4: There is a significant relationship between mental accounting and the investor’s decision
making.
H5: There is a significant relationship between herd behavior and the investor’s decision
making.
3. LITERATURE REVIEW
(Dhole, 2014) conducted study among the medical graduate to examine the impact of
behavioral traits such as herding, mental accounting, gambling, etc . (D, Gokhan, 2011)found
the gender has interaction with five of the financial behavioral factors such as overreaction,
herding, cognitive bias, irrational thinking and overconfidence). And he also pointed out that
the level of individual savings has an interaction with four of the financial behavioral factors
(overreaction, herding, cognitive bias and irrational thinking).
(Lubna Riaz,et.al , 2012)every individual is different from others due to various factors which
include demographic factors, age, race and sex, education level, social and economic
background; same is the situation with the investors. The most critical challenge faced by
them is the investment decision; they act in a rational manner and usually follow their
instincts and emotional biases while making investment decisions.
(Arvid Hoffmann O.I, et.al, 2010) analyzes how systematic differences in investors’
investment objectives and strategies impact the portfolios they select and the returns they
earn. The findings provide support for the behavioral approach to portfolio theory and shed
new light on the traditional approach to portfolio theory.
(Chandra, 2008) explore the impact of behavioral factors and investor’s psychology on their
decisionmaking, and to examine the relationship between investor’s attitude towards risk and
behavioral decisionmaking. The findings of this research exhibit the irrational investment
behavior of investor. The investment decisionmaking are influenced by behavioral factors
like greed and fear, cognitive dissonance, heuristics, mental accounting, and anchoring. These
behavioral factors must be taken into account as risk factors while making investment
decisions. This research will help investment advisors and finance professionals judge
investor’s attitude towards risk in a better way, thus leading to better investment decision
making.
(Nelson Maina Waweru, 2008) investigated the role of behavioral finance and investor
psychology in investment decisionmaking at the Nairobi Stock Exchange with special
reference to institutional investors. Using a sample of 23 institutional investors, the study
established that behavioral factors such as representativeness, overconfidence, anchoring,
gambler's fallacy, availability bias, loss aversion, regret aversion and mental accounting
affected the decisions of the institutional investors operating at the NSE. Moreover, these
investors made reference to the trading activity of the other institutional investors and often
exhibited an institutionalherding behavior in their investment decisionmaking.
4. METHODOLOGY :
This is a descriptive study to identify the behavioral factors affecting the investment decision
of the investment with respect to Indian Capital Market. The primary data were collected
through structured questionnaire from the individual investor who resides in Kerala.
Individual investors represent the working households both in private and in public sector.
The Kerala state is the universe of the study and the investors who invest into capital market
is considered to be the population of the study. Stratified random and multi stage random
sampling methods were applied in selection of 1000 respondents comprising the cross section
of population. For the purpose of the study a sample of 1000 respondent were selected from
the state of Kerala by dividing the state into three zones namely the Northern zone , the
Central zone and the southern zone. 916 samples were extracted from the population.
Structured questionnaire was designed for collecting primary data. The study adopted 5 point
likert scale for exploring the determinant of investment behavior. The collected data was
processed and analyzed by suing SPSS software. The statistical techniques such as Cross
tabulation, chisquare , Factor analysis and Cronbach’s Alpha test were applied to obtain the
result from the study.
Age group : Age is a crucial factors which depicts the personal and financial maturity of
the investors. For the present study the age group of the investors are segmented into 5 scales
such as 1824, 2534, 3544, 4555 and above 55. The analysis of the profile indicates that the
age group of 3544 years constitutes the largest group amongst the investors.
Educational qualification : Education plays a vital role in shaping the personality and
formulating the decision. In Kerala the system of education was developed with the help of
state and private agencies. High levels of literacy and higher levels of education among the
Keralaities have been reported. Threefifths of the educated employed were in regular
employment . Educational Qualification of the sample contained 84 investors were up to
Higher Secondary Education , 182 investors were Graduate, 450 investors were Post
Graduates and remaining 160 investors were Professionals. Thus, maximum respondents
were Graduates and Post Graduates i.e. highly qualified.
Income from all sources : Income from all source represent the household income such as
spouse salary, employment income and income from other sources. The sample contained
122 investors with income less than Rs.2 lakh, 335 investors were from the income group of
Rs. 25 lakhs, 280 were from Rs. 510 lakhs, 63 were from the income group of Rs. 1015
lakhs, 58 were from the income group of Rs. 1520 lakhs and remaining 55 investors were
from income group of Rs. 20lakhs and above. Thus, majority of the investors were from the
income group of Rs.25 lakhs. While comparing the income between the genders , it was
found that 38.5% of makes and 31.5% of females are having an income of 200,000 –
500,000. 31.0% of males and 29.5% females are in the category of income group of 500,000
– 10,00,000.
Investment surplus : The respondents were asked their investment surplus per year.
Investment surplus represent the net income after meeting all the expenses. Only if the
investor has more than one source of income for his/her family, he/she will think over the
number of investment avenues. This because the total amount of income decides the amount
of savings after meeting the expenditure in commitments during the lifetime. The investors
who has investment surplus less than Rs 1 Lakhs are 45.9%, followed by investors who has a
surplus income of between Rs 2 Lakhs – Rs 5 Laksh are 39.2%.
Sources of income : Source of income plays an important role in deciding the number of
investment avenues to be invested. Even though the respondents are categorized as working
employees, some of the investors do have business in their name of their spouse. Considering
this nature of the respondents , the source of income for investment is categorized as (a)
savings, (b) money extracted from business (c) personal borrowings (d) inherited amount and
(e) bank finance. From the data collected from, it was analysed that 64.8% of sources of
income represents savings. However 15.5% counted to money extracted from business and
9.6% from the inheritance.
Investment experience: Experience of investors in capital market is a vital factor for the
behavioral factors and estimation of risk tolerance level. Long years of experience in
investment helps them to understand the complex behavior of the market and adopt
appropriate strategy so that their overall return from the investment will be maximum. From
the sample, it was analyzed that the investors have experience more than 5 years. 42.7% of
investors have experience more than years in Indian financial market. 35.4% of investors
have the experience have investment experience between 2 5 years.
On the basis of the criteria mentioned above, the component matrix is formed for further
orthogonal rotation using varimax rotation algorithm which is standard rotation method . The
multivariate analysis extracts obviously 16 behavioral components, but five components
were judged sufficient to explain the significant data variance and also qualified the above
mentioned criteria for solving the number of components to be retained problem. In fact, all
the five components so selected seem to explain 64.120 % of total variance and the remaining
variance is explained by other variables as given below :
The observation of the table above provides an insight that only these five components
extracted from the Principal component analysis are significant enough to retain for rotation
and further interpretation as all these components qualify the criteria of the Eigen value –
one.
The questions were designed to explore the levels of behavioral variables’ which has its
impacts on the individual investment decisions at Indian Capital market. The suitability of
data for the purpose of factor analysis was tested using two analyses, namely KMO
test and Bartlett’s test of Sphericity.
The Kaiser MaiyerOlkin Measure of sampling adequacy is a statistic which indicates the pr
oportion of variance in the variables which might be caused by new factors. The KMO
statistic varies between 0 and 1. A value of 0 indicates that the sum of partial correlations is
large relative to the sum of correlations, indicating diffusion in the pattern of correlations
(hence, factor analysis is likely to be inappropriate). A value close to 1 indicates that patterns
of correlations are relatively compact and so factor analysis should yield distinct and reliable
factors .The result derived from Principal Component Analysis along with KMO and
Bartletts Test are given below :
TABLE 4 : KMO AND BARTLETT'S TEST
KaiserMeyerOlkin Measure of Sampling Adequacy. .758
Bartlett's Test of Sphericity Approx. ChiSquare 4303.746
Df 120
Sig. .000
Source : Primary Data
The Kaiser Meyer score of 0.758 shows a high level of data adequacy. This KMO score
means that factor analysis can be used here to reach a meaningful conclusion as 75.8 % of
common variance was explained by the underlying factors. Also the score of Bartlet’s Test of
Sphercity is significant (0.000) with a Chi – Square value of 4303.746.
TABLE 5 : COMMUNALITIES
Initial Extraction
I am confident of my ability to do better that others in stock picking 1.000 .510
My past investment successes were above all , due to my specific skills
1.000 .576
and experience
I have complete knowledge about investment avenues and can realise
1.000 .585
the movements in the market
I feel satisfied with my investment decision in past 1.000 .580
Before the investment decision I evaluate the past price movements to
1.000 .737
predict future price ( Technical analysis )
I strongly believe the current performance of stock is an indicator for
1.000 .652
future performance
News about the company in ( newspapers ,magazines ) affect my
1.000 .712
investment decision.
I seek the opinion from my friends and colleagues 1.000 .720
During the time of bearish market, I borrow money to invest into the
1.000 .731
market
If I hear views from a famous analyst that conflicts with my opinion
1.000 .668
about my stock , I would change my opinion immediately
I will book profits in a winning stock and then felt i could have waited 1.000 .680
I will hold losing stock for too long expecting trend reversal 1.000 .773
I do habit of purchasing lottery tickets 1.000 .558
Invest only on diversified portfolio 1.000 .558
Investment based on time horizon 1.000 .703
I invest for my retirement as savings 1.000 .515
Extraction Method: Principal Component Analysis.
Source : Primary Data
After excluding the factors with loading less than .40 , five factors were extracted from 16
variables . Two variables were excluded as factor loading is less than .40. The following table
depict the factors that affect the behavioral aspects of the investors .
Table 6 exhibits the five behavioral factors that have an influence on investment decisions
of individual investors of Indian Capital Market.
FACTOR 1: REPRESENTATIVE BIAS
Representative bias factor extracted by the factor analysis accounts for 24.070 of data
variance. The Indian individual investors agreeing the fact that their investment decision was
represented by past price movement and the current performance of the stock. They believe
that current trend is the indicator for the future performance of their stock. Even at the time
of bearish they borrow money for the take advantages at the time of upward trend.
FACTOR 2 : OVERCONFIDENCE:
The overconfidence is the tendency of the investor to relay more on their abilities and skills.
It implies realistically trusting in one’s abilities and very optimistic in assessment of own
knowledge or control over a situation. This bias makes the investors to outperform the
market. Four questions were put forward to investors specifically to assess their
overconfidence bias.
Kahneman and Riepe (1998) point out at the importance of overconfidence for financial
decision taking, in that, overconfidence combined with optimism, produces overestimation
of individual knowledge, exaggeration of the ability to control events, and risk
underestimation
TABLE 8 : OVERCONFIDENCE
Std. Analysis Cronbach's
Mean Deviation N Alpha
This factor extracted by the factor analysis accounts for 14.007 % of data variance. The
Indian individual investors seems to be trusting their predictive skills and conceived the
ability in stock picking.
From the study it was analyzed that majority of the investors were satisfied with their
investment decision and confident about their skills and experience. The study strongly
supports the study of (Allen & Evans, 2005) which suggests that people usually believe in
their skills and knowledge to outperform the market. The two factors that contribute to
overconfident bias were: illusion of knowledge and illusion of control. The illusion of
knowledge occurs when the investor’s feels they have complete knowledge about the
investment avenues.
Regret aversion is a part of prospect theory, it exhibit the investors behavior in which losses
are three times painful than the pleasure of gain. It is an negative emotion evoked from
different choices that could generate a preferred outcome. It express the tendency of investor
to purchase lottery tickets for a better future. From the analysis it has been identified that,
even though the investors purchase lottery but it is not for investment but a service to society
based on various schemes offered by Kerala Government.
A feeling on self blame n bad decision, that is emotion generated by seeing the winning stock
which was already sold out was high among the investors in Kerala. The degree of regret for
losing stock with an expectation of trend reveal explains the correlation of regret aversion
with the experience to hold the stock for expecting a trend reversal (Fogel & Berry, 2006).
Mental accounting describes the propensity of the people to place some events into different
mental accounts based on certain attributes. There are three component of mental
accounting. The first components capture how outcomes are perceived and experienced, and
how decisions are made and subsequently evaluated. The second component of mental
accounting involves the assignment of activities to specific accounts. The third component of
mental accounting concerns the frequency with which accounts are evaluated and choice
bracketing. Each of the components of mental accounting violates the economic principles of
fungibility (Thaler, 1999). Therefore based on the attribute three variables are selected for
identifying the mental accounting.
The concept of mental accounting is same as Prospect theory of (Kahneman & Tversky,
1979), which implied the individual will deconstruct their investment problem into local
decision with their cognitive simplicity. This is the reason why they prefer to invest based on
fixed time horizon and using diversified portfolio. The segregation are based on the
integration of multiple gains with fixed investment objectives.
Herd behavior is the most generally accepted observations on financial markets worldwide in
a psychological context. People generally trust friends , relatives and colleagues more while
taking a decision. Or they will be stereotyped with the recommendations provided by famous
analyst. This explains the market price reflects the outcome of investors’ collective
assessment and as a result the true value of the market may be incorrect.
The significance of the five factors were extracted from Exploratory factor analysis was
tested using the Chi square analysis. The result of Chisquare analysis was listed below Table
12 .
C
TABLE 12 : CHI-SQUARE TEST FOR TESTING THE SIGNIFICANCE
Using the Chisquare analysis it was identified that all the 5 variables are highly significant
with respect their investment decision. As the P value is less than .05, the null hypothesis was
rejected there by accepted the alternative hypothesis. .
7. CONCLUSIONS
This study has helped in extracting the factors that has an impact on investing activity of
investors . There are five behavioral factors of individual investors was analyzed , such as :
Overconfidence, representative bias, regret aversion, herd behavior and mental accounting.
All the behavioral factors found to be significant with the investment decision. This research
is an investigation into individual investors, not institutional investors. The investors
perception on investment behavior was collected using questionnaire and applied exploratory
factor analyses procedure. The empirical result was validated and its reliability was checked
using Cronbach's Aplha statistics. On the other hand, understanding the behavioral factors
influencing investors’ decision can help financial institutions to make their marketing
strategies.
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