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International Journal of Transformation in Accounting, Auditing & Taxation

Vol. 1, Issue 1 - 2017



The purpose of this study is to investigate the influence of behavioural biases

overconfidence and loss aversion on the decision making behaviour of individual
equity investor by considering the risk perception as moderator. Behavioural
finance suggests that human decision making involves a combination of cognitive
and affective dimensions. The results of study are helpful for the policy makers,
financial advisor, equity investor, finance teacher and finance students. To
conduct the study, questionnaires were issued to the investors of Islamabad
stock exchange and Lahore stock exchange a total of 250 questionnaires were
distributed of which 160investors responded of which 90% were men and 10%
were women. The results indicated that investors are affected by overconfidence
and loss aversion biases. Loss aversion bias has significant effect because 70% of
the investors were affected and overconfidence bias has significant effect.

The measure with the reworded items is shown in the Appendix 1.

KEYWORDS: Overconfidence, Loss Aversion, Investment Decision, Risk



A person who sacrifices his present benefits for affect the decision making behaviour. History of
the hope of getting some gain in future is called research and debate show that overconfidence is
investor (Bashir et al. 2013). According to a common decision making bias among
traditional finance theory individual investors are individuals and groups (Farsi et al. 2014). It is the
suppose to be rational but the prospect theory systematic overvaluation of one’s decisions and
explained some biases who leads investors to the accuracy of one’s knowledge (Dittrich et al.
irrational behaviour. Bias is unfairness or 2005). Overconfidence is the propensity for
propensity to make decisions while already being people to overestimate their knowledge,
influenced by a fundamental belief (Shefrin, cognitive abilities and the precision of their
2001). There are several biases which effect the information (Bhandari & Deaves, 2006). It is
investor’s decision but this study presents observable that men are more confident than
overconfidence bias and loss aversion bias which women (Muthukrishna et al. 2014).
Research Scholar, Capital University of Science and Technology, Islamabad, Pakistan.
Correspondence E-mail Id:

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Impact of Overconfidence and Loss Aversion Biases on Investment Decision: Moderating role of Risk Perception
Anila RK et al. 24

Overconfident investor in order to gain more Pakistan. Pakistani culture is different from the
returns will use his superior skills and abilities western culture, so there is a need of empirical
(Chen et al. 2007). It is obvious from many research on these biases to reduce the irrational
evidences that overconfidence is predominant in decision making behavior of individual investors.
team oriented skills such as leadership than
decision making and planning (Giambatista & This study has theoretical as well as contextual
Hoover 2014). While “when an investor makes it contribution. Theoretically this paper will
sure not to face loss even earning less profit contribute in prospect theory which represents
percentage it is called loss aversion”. It related to the investors behaviours are linked with their
the individual’s desire to avoid losses than prospects mean biases and contextually, there
comparable profits. Loss aversion bias was are fewer studies available in Pakistan’s culture
developed by Kahneman and Tversky (1979) as and context. Pakistan includes in developing
part of the original prospect theory. It is the countries where financial markets are inefficient.
tendency that people generally feel a stronger Investors get abnormal gains as well as loss due
to several reasons. This study examines the
impulse to avoid losses than to acquire gains.
impact of overconfidence and loss aversion bias
Risk perception is defined as an individual's on investment decision with the moderating role
assessment of how risky a situation is in terms of of risk perception.
probabilistic estimates of the degree of
situational uncertainty, how controllable that The prospect theory related to it as the
uncertainty is, and confidence in those estimates marginal utility of a loss is strictly greater than
(Baird & Thomas, 1985; Bettman, 1973).There are the marginal utility of a comparable gain
two essential ways in which the risk is interpreted (Tversky & Kahneman, 1992). However, Prospect
and acted upon. Risk as feelings refers to our Theory holds that the risk perceptions of
spontaneous and Impulsive reactions to danger individuals are more risk averse in dealing with
and risk as analysis brings logic, reason, and potential gains than losses (Rabin and Thaler,
scientific consideration to bear on risk 2001). Risk aversion causes a dispositional effect
assessment and decision making (Slovic et al. whereby investors tend to let go of winning
2006).The construction of a return-risk trade-off shares too early and hold on to loosing stocks for
is out of reach, it is possible to make suggestions too long. Although we have acknowledged that
relating to the way investment study clubs’ prospect theory does not explicitly consider risk
decision making is affected by different financial, perceptions, Sitkin and Pablo (1992) suggested
economic-psychological and investor-specific that the findings of prospect theory research are
factors (Antonides Van 1990). consistent with a negative relationship between
perceived risk and making risky decisions.
A reasonable amount of studies are conducted on
the relationship of biases and investment LITERATURE REVIEW
decision but there is still gap to introduce new
According to conversional financial theory,
moderators and mediators in order to avoid
investors are the most rational person in order to
irrational decisions. Risk perception is an
make the financial decisions. However, there are
important moderator of the present study which
many instances where emotion and psychology
is not tested before in such underlying
influence our decisions, causing us to behave in
mechanism. Most of the studies in developed
unpredictable or irrational ways. behavioral
countries have linked biases with the investment
finance states that the nature of human is
decision, but there are fewer empirical studies
irrational based on traditions, belief and norms,
conducted in developing countries including

© Eureka Journals 2017. All Rights Reserved.

International Journal of Transformation in Accounting, Auditing & Taxation
25 Vol. 1, Issue 1 - 2017

the divergence of human beings from it proves it Overconfidence increases with the deviation of
to be imperfect in the decision making (Tversky & actual from optimal investments, indicating that
Kahneman, 1974). Nikiforow (2010) in his study the less accurate their investment decisions are
on fund managers found that even the more the more prone are participants to exhibit
effective training cannot change the irrationality overconfidence (Dittrich, Guth & Maciejovsky,
of human in their decision somehow emotion will 2005; Boukas & Petmezas, 2007).Overconfident
be always there. investors overreact to private and under react to
public signals (Daniel, Hirshleifer &
The impact psychological biases vary from person Subrahmanyam, 1998; Libby & Rennekamp,
to person, due to difference in the personality 2012). Overconfidence bias was measured by
(Gross et al., 1997; Mroczek & Kolarz, 1998;
four factors: self control, market knowledge,
Charles, Reynolds, & Gatz, 2001; Orgeta, 2009;
stock selection ability and specific skill. The
Yeung, Wong, & Lok, 2011).In other words bias is studies revealed that most investors were
unfairness or propensity to make decisions while overconfidence about their knowledge of equity
already being influenced by a fundamental belief
market because of their number of years working
(Shefrin, 2001; Chen, Lakshminarayanan, & in stock market (Kruger, 1999; Alicke et al., 1995;
Santos, 2006). Garcia, Sangiorgl, & Urosevic, 2007).
OVERCONFIDENCE BIAS AND INVESTOR Soll and Klayman (2004) investigated that having
DECISIONS appropriate confidence was important for making
appropriate risky decisions, for knowing when to
Overconfidence investor behavior in financial seek advice and information, and for
markets is typically characterized by communicating one’s knowledge. According to
overestimation by the average rate of return Hilton, Regner, Cabantous, Charalambides, &
from a portfolio and underestimation of its Vautier, (2011) being too confident in our abilities
unpredictability (Bagchi, S.2011; Fischoff, Slovic, could lead to overcrowding out of new evidence
& Lichtenstein, 1977). or alternative perspectives. The other
Overconfidence in predictive success of an overconfident phenomenon is the overestimation
innovation facilitates additional acceptance in of the preciseness of knowledge, which leads
both the persuasion and decision stages when managers to become overly optimistic about
predictions are most likely to occur, whereas favorable outcomes. Overconfidence leads
during implementation and confirmation, the investors to witness surprises sometimes positive
best practice is evolving into a real time & sometimes negative making the financial
alternative rather than forecasted event (Smith, market inefficient based on their wrong forecasts
Kisamore, Stone, Jawahar, 2010; Ben-David, because of their trap with overconfidence
Graham,& Harvey, 2007). Overconfidence (Shefrin & Thaler 1988; Niu, 2010; Sin & Regev,
investors trade more aggressively. Past returns 2013).
leads investors to become overconfident (Sheikh H1: Overconfidence bias is positively associated
& Riaz, 2012; Zaiane, 2013; Qadri & Shabbir, with the investor’s decision.
2014).A manager must estimate the possibility of
success or failure of the innovation. Research LOSS AVERSION BIAS AND INVESTMENT
suggests that people turned to overestimate the DECISION
degree to which their actions will assure a
desired outcome (Miller & Ross, 1975, Inaishi, The concept Loss aversion bias was developed by
Toya, Zhai, & Kita, 2010). Kahneman and Tversky (1979) making an addition

© Eureka Journals 2017. All Rights Reserved.

Impact of Overconfidence and Loss Aversion Biases on Investment Decision: Moderating role of Risk Perception
Anila RK et al. 26

to the prospect theory. Loss aversion is H2: Loss aversion bias is positively associated
characterized by three properties. To begin with, with the investor’s decision.
riches is measured in respect to a given reference
point. Second, the reduction in utility intimated MODERATING ROLE OF RISK PERCEPTION
by a negligible loss with respect to the reference
Sitkin and Pablo (1992) examined a number of
point is constantly bigger in supreme quality than
potentially appropriate individual, organizational,
the increment in utility coming about because of
and problem characteristics that have been
a minimal increase (Mcgraw, Larse, kahneman, &
recognized as predictors of risky individual
Schkade 2010; Gomes, 2005). Third, in spite of
decision making. Decision risk is a used to
the fact that people are risk unwilling in the area
illustrate the alternatives faces of a decision
of increases, they are danger cherishing in the
maker. Risk can also be used to characterize an
area of losses (kahneman and Tversky 1992;
overall decision how risky it is compared to other
Abdellaoui, Bleichrodt, & Paraschiv, 2007). So the
alternatives (Lan & Ozorio, 2014). Malmendier
investors who have more loss averse attitudes
and Nagel (2011) proposed that bad risk
will take least risky decisions this theory
experiences can decrease investors’ willingness
concludes that the tendency of people is
to take risks by decreasing their risk tolerance
generally stronger to avoid losses than to acquire
(i.e., the preference channel).Risk perception is
gains (Thaler, Tversky, Kahneman& Schwartz,
likely to be affected by cognitive biases that arise
1997; Zamir, & Ritov, 2012).
out of ways of thinking known as heuristics
Loss aversion is usually referred to individual’s (Diacon, 2004; Holt & Laury, 2002; Charness &
trend to ease losses as much as possible to Gneezy, 2010).It hints at the fact that people
acquire gains (Kahneman, Knetsch, &Thaler, believe they are above average and that
1991; Kermer, Driver, & Wilson, & Gilbert, 2006). individuals have unrealistically positive
Previous Studies recommend that, perceptions of themselves (Taylor and Brown,
psychologically, losses are two times as influential 1988, Cooper et al., 1988; Sharpe, 1964; Rovison
as gains. Therefore loss aversion direct to risk & Marino, 2013; Vombardini & Treppi, 2012). The
aversion when investor assess the likely gain, a errors made by the professionals are related to
risk aversion individual when will prefer those the length of their confidence intervals.
options in their decisions having low level of risk,
Risk perception is defined as an individual's
this is because most slightly than make gains,
assessment of how risky a situation is in terms of
they would rather stay away from losses
probabilistic estimates of the degree of
(Benartzi & Thaler, 1993; Harinck, Vandigk, Van-
situational uncertainty, how controllable that
Best, & Mersmann, 2007; Kahleman, Knetsch,
uncertainty is, and confidence in those estimates
&Thaler, 1991). However traditional finance
(Baird & Thomas, 1985; Bettman, 1973;
consider this ‘‘endowment effect’’ people are
Kahneman & Teverasky, 1979).Risk perception
keen to pay more to keep for something they will
and overconfidence strongly impact the risk-
own than to obtain something possess by
taking behavior of professionals (Broihanne et al.
someone else and any other conclusion of loss
2014; Simon, Houghtn, & Aquino, 2000).Decision-
aversion is irrational (Heidhues & koszegi, 2008;
makers exhibiting overconfidence, treat their
Tovear, 2009). Koszegi and Rabin (2006) stated
assumptions as facts, they may not see the
that investors do not fully integrate decisions at
uncertainty associated with conclusions
hand with other decisions and events, but the
stemming from those assumptions.
loss aversion attitude of the investor will affect
their investment in the financial market.

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International Journal of Transformation in Accounting, Auditing & Taxation
27 Vol. 1, Issue 1 - 2017

They, therefore, may inaccurately conclude that a a venture, a tendency towards overconfidence
certain action is notrisky (Scholleova, Fotr, & may have affected these entrepreneurs when
svecova, 2010; Bohme & Danielsen, Kumar, & they were initially evaluating the ventures’
Soresc, 2009) .The overconfidence bias lowers an riskiness.
individual’s perception of the riskiness of
astrategy (Barnes 1984; Russo & Schoemaker H3a: Risk perception moderates the relationship
between overconfidence bias and investment
1992; Biais& Weber, 2009)
decision in such a way that higher the risk
There is some evidence that overconfidence plays perception strengthen the relationship.
an especially important rolewhen one considers
whether to start a venture. Busenitz and Barney H3b: Risk perception moderates the relationship
(1997) found entrepreneurs display greater between loss aversion bias and investment
overconfidence than managers do. Although their decision in such a way that higher the risk
study examined entrepreneurs after they started perception strengthen the relationship.

Risk Perception

Overconfidence Bias
Investment Decision

Loss Aversion Bias

METHODOLOGY Linear Regression & correlation analysis use for

statistical analysis.
Data was collected using questionnaires through
convenience sampling. The sample consisted of MEASURES
the investors of Islamabad and Lahore stock
exchange and brokerage houses. We selected this Overconfidence bias was measured with 10 items
scale developed by Simon, Houghton, and Aquino
sample because most of the investors are there in
(2000). A sample item was ‘I prefer complex to
stock exchange and brokerage houses. The
questionnaire explaining the purpose of the study simple problems’. Cronbach’s Alpha of the scale
assured respondents of strict confidentiality and was 0.820. 4 items scale developed by Hassan,
that participation in the study was voluntarly.250 Khalid, and habib (2014) used to measure loss
questionnaires were distributed of which 160 aversion bias. A sample item was ‘If I lost Rs. 1000
were returned, making the response rate in a game then I will stop game doing more.’
approximately 64percent. Scoring for each Cronbach’s alpha value of scale was 0.758.
construct was done using a five-point likert scale For measurement of investment decision making
with 5 representing “very much” agreement/ the 7 item scale used adopted from Hiran and
satisfaction and 1 representing “very much” Loibl (2008). Sample item was ‘The uncertainty of
disagreement/ dissatisfaction with each item. whether the market will rise or fall keeps me

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Impact of Overconfidence and Loss Aversion Biases on Investment Decision: Moderating role of Risk Perception
Anila RK et al. 28

from buying stocks’. Value of Cronbach’s alpha the stock market’ and the Cronbach’s alpha value
was 0.874. was 0.899.

14 item scale of Simon, Houghton, and Aquino RESULTS

(2000) was used for risk perception
measurement. Sample item of risk perception is Table 1 presents mean, standard deviation,
‘It is always easy to determine the credibility of Pearson correlations and reliabilities among the

Table 1.Mean, Standard Deviation and Correlation Analysis

Variables Mea S.D 1 2 3 4 5 6 7 8
1. Gender 1.218 .4147 1
2. Age 2.875 .6418 .157* 1
3.Qualification 2.862 .8278 .106 .252* 1
4. Experience 3.475 .8463 -.065 .677* .390* 1
5.Overconfidence 3.960 .5702 -.152 .349* .043 .285* 1
6. Loss Aversion 3.504 .9690 .214* .153 .065 .229* .469* 1
7.Investment Decision 3.642 .9076 .047 -.022 .170* -.011 .328* .180* 1
8. Risk Perception 3.600 .8128 -.028 .022 .250* .176* .109 .255* .175* 1
N=160; *p < .05, ** p < .01, S.D for Standard Deviation

The results in Table 1 shows that Overconfidence has the largest mean (3.96) and loss aversion has
has significantly positive influence on investment the smallest mean in variables of study (3.50).
decision (r = .328**).Loss Aversion has positive Results of (table1) also show the standard
association with investment decision (r= .180*,). deviations of variables, loss aversion has the
The risk perception has also significant positive largest standard deviation (.9690) and
association with investment decision (r=.175*). overconfidence has the smallest standard
Results of (table 1) shows that overconfidence deviation (.5702).
Table 2.Results of Regression Analysis for Outcomes and Moderation
Predictors Investment Decision
β R² ΔR²
Step 1
Control Variable .029
Step 2
OC .504*
LA .426 *
RP .371* .147 .118*
Step 3
LAxRP .183* .175 .028

The regression analysis in (table 2) shows that outcomes also shows that lose aversion has
overconfidence bias has significant positive significant positive impact on investment decision
impact on investment decision with (β=.504*, (β=.426*, p<.05).
p<.05).The results of regression analysis for

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International Journal of Transformation in Accounting, Auditing & Taxation
29 Vol. 1, Issue 1 - 2017

The risk perception has also significant positive accepted. Our study shows that when investors
impact on investment decision (β=.371*, p<.05). are loss averse than they invest less., Malmendier
The regression analysis results for moderation in and Negel (2011) proposed that bad and worse
(table 2) shows that risk perception moderate the risk experiences can decrease investors’
relationship between overconfidence, loss willingness to take risks by reducing their risk
aversion and investment decision with (β=.294*, tolerance
p<.05) and (β=183*, p<.05) respectively.
Managers should take the appropriate and
The first hypothesis of my study is reliable decision relating to investment. These
overconfidence bias is positively associated with decisions must relate to current situation of
the investor’s decision is accepted. Our study market and economic condition of the country.
shows more the overconfidence lead to reliable For making more profitable and affective to
investment decision. Past research shows that organization the managers should need to
overconfidence investors invest more because compare their performance with other
they get more returns in past (Zaiane, 2013). organization. In this way they bring suitable,
According Soll and Klayman (2004) investigated affective and reliable changes for their
that the appropriate confidence is important for organization and also make better economic
making risky decision. So our result is consistent condition of the country. Sometime managers
with past researchers. show the overconfidence attitude towards their
investment decision and this attitude create the
The second hypothesis of my study is loss
situation of biasness. They believe on their
aversion bias is positively associated with the abilities and invest without taking precautionary
investor’s decision it also accepted our study measures. But the actual situation is
explain that loss averse investors avoid in
contradicting it because their past abilities are
investment because they want to save from loss. not enough for present condition of running the
Past research shows that the more loss averse organization in best way. Past returns lead
investors attitudes will take less risky investment
investors to become more confident for future
decision and this theory make a decision that the
(Sheikh &Riaz, 2013).
leaning of people is stronger to avoid losses then
to acquire increments.(zamir , &Ritov, 2012) Managers should give consideration at
ratification phase to guarantee that experience is
The third hypothesis of my study is risk entrap in a feedback loop to avoid and save
perception moderate the positive relationship
mistakes in upcoming and in future decision
between overconfidence bias and investment (Smith, Kisamore, Stone & Jawahar , 2010). On
decision it is accepted. Our study shows that the other hand, some investors and managers are
when our confidence is more about our abilities
risk averse at this stage people avoiding losses to
of investment so we invest more. Past research acquiring gains. So mangers should also be the
shows that overconfidence and risk perception loss averse to save from big losses. Risk
strongly influence the risk-taking attitude and
perception is also important factor for managers,
behavior of professionals (Broihanne et al.2014). because risk can be used to characterize an
The fourth hypothesis of my study is risk overall decision how it is risky and compare with
perception strengthen the relationship between other alternatives (Lan & Ozario, 2014).
loss aversion and investment decision it is also

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Impact of Overconfidence and Loss Aversion Biases on Investment Decision: Moderating role of Risk Perception
Anila RK et al. 30

LIMITATIONS AND FUTURE DIRECTIONS financial crisis?. Transition Studies Review,

19(3), 291-312.
The sample size of the study is not sufficient for [5]. Biais, B., Hilton, D., Mazurier, K., &Pouget,
more efficient and reliable findings and the data S. (2005). Judgemental overconfidence,
is also taken from some regions and investors. self-monitoring, and trading performance
The questionnaire was distributed for collection in an experimental financial market. The
of data in which the common bias was involved Review of economic studies, 72(2), 287-
and further studies need to avoid these 312.
limitations. Future researchers should also [6]. Bagchi, S. (2011). Can overconfidence
expand their research work for risk perception by explain the consumption hump?.Journal of
adding additional outcomes variables into their Economics and Finance, 35(1), 41-70.
studies like risk aversion and risk tolerance and [7]. Ben-David, I., Graham, J. R., & Harvey, C. R.
show the separate impact on investment decision (2007). Managerial overconfidence and
in one framework. The researcher should explore corporate policies (No. w13711).National
additional reaction of behaviour of the investors Bureau of Economic Research.
to expand their studies. This study can be done [8]. Bombardini, M., & Trebbi, F. (2012). Risk
on other sectors also because in this study focus aversion and expected utility theory: an
was only on brokerage houses and stock experiment with large and small stakes.
exchange of Islamabad and Lahore but we also Journal of the European Economic
collect data from other brokerage houses and Association, 10(6), 1348-1399.
stock exchange like Karachi stock exchange and [9]. Biais, B., & Weber, M. (2009). Hindsight
brokerage houses. Mix method for collecting data bias, risk perception, and investment
can be used that is interviews etc. Future performance. Management Science, 55(6),
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sample size in this way data would be reliable and [10]. Boehme, R. D., Danielsen, B. R., Kumar, P.,
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and the cross-section of stock returns:
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1. Thinking hard and for a long time about something gives me little satisfaction.
2. I trust my initial feelings about people.
3. I prefer to do something that challenges my thinking abilities rather than something that requires
little thought.
4. I believe in trusting my hunches.
5. I prefer complex to simple problems.
6. I try to avoid situations that require thinking in depth about something
7. When it comes to trusting people, I can usually rely on my "gut feelings".
8. My initial impressions of people are almost always right.
9. I don't like to have to do a lot of thinking.
10. I can usually feel Well when a person is right or wrong even if I can't explain how I know.

1. I am risk averse.
2. If I have Rs.500, 000 excess, I would prefer to invest in risky alternative.
3. If I lost Rs. 1000 in a game then I will stop game doing more.
4. If I inherited Rs. 2000, 000; I would prefer to choose less risky investment option.

1. Money is most important goal of my life.
2. It is the more satisfying to save than to invest money.
3. Stock market are unpredictable that’s why I would never in stocks.
4. I would invest a larger sum of money in stock.
5. The uncertainty of whether the market will rise or fall keeps me from buying stocks.
6. I prefer to save money because I am never sure when things will collapse and I will need money.
7. I budget my money very well.

1. I usually have a fear to invest in stocks that have a sure gain.
2. I am hopeful when undertaking investment in stocks that have exhibited a sure loss.
3. I am cautious about stocks which show sudden changes in price or trading activity.
4. I usually have worry investing in stocks that have had a past negative performance in trading.
5. My investment in stocks is largely based on investment knowledge, experiences and education.
6. I am always attracted to investing in stocks.
7. I usually consider the credibility of brokerage firms that provide the financial services.
8. I can easily ascertain the expertise of the brokers offering service.
9. It is always easy to determine the credibility of the stock market.
10. I can easily tell the reputation of brokerage firms staffing service.
11. I feel that the idea of participating in a buy/sell on the stock market is appealing.
12. I am usually at ease with the stock trading system on the KSE.
13. I am often not afraid to invest in stocks that have shown a past positive performance in trading.
14. I feel regret of a drop in the price of a stock I have purchased.

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