Business Research

Methods
Research proposal:
A Behavioral Finance Approach to
Decision Making in Investments at Stock Exchange : A
case from Pakistan
Submitted to:
Dr. Tasneem Akhter
Submitted by:
Daood Andullah

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14209003

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Business Research Methods

Table of Contents
1.

INTRODUCTION.................................................................................................................................................6

1.2 PROBLEM STATEMENT................................................................................................................ 6

1.3

AIM OF THE STUDY............................................................................................................ 7

1.4

RESEARCH OBJECTIVE......................................................................................................... 7

1.5

RESEARCH QUESTION............................................................................................................. 7

1.6 LIMITATIONS OF THE STUDY....................................................................................................... 7

2 PROPOSED THEORETICAL/CONCEPTUAL FRAMEWORK..............................................................................8
2.1DECISION MAKING (LITERATURE & ARGUMENTS)..............................................................................8
3PROPOSED RESEARCH METHODOLOGY..........................................................................................................13
3.1 SAMPLE SELECTION (SIZE AND TECHNIQUES)..................................................................................13
3.2 POPULATION FRAME................................................................................................................ 13
3.4

UNIT OF ANALYSIS........................................................................................................... 13

3.5 TYPE OF STUDY.................................................................................................................................................13

3.6

TIME HORIZON................................................................................................................ 13

3.7

INSTRUMENT DEVELOPMENT/SELECTION................................................................................13

3.8

PROPOSED DATA COLLECTION PROCEDURES.............................................................................13

3.9

PROPOSED DATA ANALYSIS TECHNIQUES.................................................................................13

3.10 PROPOSED DATA ANALYSIS SOFTWARE.......................................................................................14

REFERENCES LIST....................................................................................................................................................15

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Acknowledgement:
I start this project with the name of ALLAH who is most beneficent and HE created us with the clot
of blood and who gives me the ability, talent and potential to accomplished this task, and also gave me
skills to make a command on this subject, without Allahs will its impossible.
I thank my parents, who pay for my education, necessities and needs, and specially my most worthy
and respectable Instructor Dr, Tasneem Akhter. She gave me complete attention during whole semester
through her valuable support and encouragement I have fulfilled this task. Her words of wisdom will
always be remembered, and I am convinced that the knowledge of Business Research Method that she
has shared with me would help me all through my professional career.
So I would like to thank all my respondents and those who will help me to complete the questionnaire
and project work as well.

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1. INTRODUCTION
Academic finance has been developed since when the efficient markets theory was accepted.(Shiler,
R, 2003). Olsen (1998) notes, the models of traditional finance do not fully consider individual
behavior. In order to tackle this issue and to make more reliable finance practices efforts were made
to analyze financial decision making on a different perspective .Thus was developed the
Behavioral Finance which is a newly developed discipline (Kengatharan,N & Kengatharan,L ,
2014).It studies how psychology plays its role in financial decision making (Shefrin, 2001). It
elaborates the psychological factors influencing the investment decision making at financial
markets (Babaraju K, B, 2014).
It also explains the expected and unexpected behaviors of investors and markets (Kumar,2013).
Recent research shows that mainly investors tend to make emotional decisions than logical ones
(Kumar,2013). According to Ritter (2003), human decision making is a result of many perceptional
biases.
It examines how emotions work in investors decision making and eliminates unreal assumptions of
traditional finance to make it more realistic approach of studying investment decisions.Without this
knowledge of stock markets will be incomplete (Hayat, Bukhari, & Ghufran, 2006).

1.2 Problem statement

Following the appalling events adjoining the replete of the tentative technology fizz in 2000 and the
real estate bubble in 2008, work is being carried out to explain the activities of financial markets, one
of the leading of which is in the area of behavioral finance (Singh,S, 2012). It is important to analyze
decision behaviors at stock markets to marginalize the market performance for economic stability.
Kengatharan,N & Kengatharan,L (2014) say , investment decision making requires the problem be
analyzed in the light of psychological reasoning. The investment decisions are constitutionalists of the
market behavior and performance therefore it is necessary to identify those psychological biases to
have an insight of the investors mind.Among these biases heuristics and risk aversion are important and
are the main focus of the study.
The Purpose of this study is to find out the relationship between certain behavioral biases such as
heuristics, Risk aversion and investment decision making of investors at Islamabad Stock Market
.
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1.3Aim of the study
Aim of this study is to describe how investment decision making is affected by heuristic biases and
Risk aversion of investors in a particular environment of Islamabad Stock exchange to facilitate further
research for measuring the stock exchange performance .

1.4Research objective
This study attempts to understand and provide a reasonable justification for the investors decisions,
influenced by behavioral factors such as heuristics and risk aversion who are at Islamabad Stock
Market.

1.5

Research question

What is influence of heuristics and risk aversion on the decision making of Islamabad Stock Market
Investors ?

1.6 Limitations of the study

This research is conducted in Islamabad; it is only concerned with this specific region because
reasons behind behavioral biases vary all over the world so this research may not serve as

legitimate work in other parts of the world.

May not be authentic, due to lack of finance.
The research is not broader, due to lack of time.

2 PROPOSED THEORETICAL/CONCEPTUAL FRAMEWORK

Framework serves as a foundation on which entire research project is based . It is a logically
developed , described , elaborated and graphically presented network of association among the
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dependent and independent variables deemed relevant to the problem situation and identified through
such processes as interviews , observations and literature surveys .

2.1Decision Making (Literature & Arguments)

The dependent variable used in the study is Decision making. It is the study of identifying and selecting
alternative choices available to the decision maker based on the values and preferences of the him/her
(Harris ,1980).
Tversky and Kaheman (1979) worked on developing interdepending linkage of psychology and
investment decision making. Investors are influenced by their behaviors and psychological triggers for
making their investment decisions (Statman M. , 1995) .Later Researches shown that investment
decision making varies from region to region (Srivastava (2012). Baghdabab et al (2011) worked on
Malaysian stock markets and concluded that investors are investment decision making is an emotional
process rather a rational one. Kenneth A. Kim and John R. Nofsinger (2003) studied investment
behaviors of Japanese investors and concluded that investors make blunders in their choices .They
invest in risky stocks with low incomes due to their emotional drives. Hence Each researcher from
different regions is different in his/her findings , this is how Behavioral theories were exploited to
indicate factors that influence the investors decision making (Sohani , 2012).
Several researchers on investors decision making took Cognitive Dissonance theory as base of their
research which is related to investors psychology. Cognitive dissonance is the state of mind when a
person has mental conflict with already taken decision. If the ultimate outcome is of regret the decision
maker blames others for such a misfortune , however rational approach would differ (Festinger 1957).
Traditional finance suggests that investment must be done rationally but if the investors are taking
decisions emotionally they may face regret and the Cognitive dissonance is taken as base of this new
aspect (Lucy F. Ackert et al; 2003). Cognitive psychology proposes that human decision making can be
classified on the basis of heuristic frames of making judgements and convenient frames of decision
processes explained by Prospect Theory which is a descriptive categorization of how people make
decisions in specific circumstances such a uncertainty and risk. (Kahneman and Tversky 1979).

2.2 Heuristics (Literature & Arguments)

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Heuristics are referred as rules of thumb , people use in making their decisions ,The form decisions
without analyzing the options completely and rationally. Heuristics are known as the cognitive
processes that overview the alternatives with being less attentive (Payne & Bettman, 2004). These
biases are representation, overconfidence and anchoring and adjustment (Keren & Teigen, 2004).
Heuristics suggest that investors tend to make decisions quickly on the basis of known actions and do
not bother going deeply for analyzing the market situations (Zeeshan ,2013).

H1: Heuristics significantly positively impact on Investors Decision Making .

2.3 Overconfidence ( Literature & Arguments )

Overconfidence in its simplest way could be defined as an inopportune belief toward a witnessed
reasoning, judgment and the person's cognitive abilities (Sadi, Ghalibaf, Rostami, Gholipour, &
Gholipour, 2011). A narrow interval of confidence in the judgments is called Predication
Overconfidence while if they investors are very sure about their judgments this is known as
Certainty Overconfidence. The investors who are having Prediction overconfidence usually ignore
risks while the other category of investors trade excessively (Pompian, Behavioral Finance and Wealth
Management, 2006). As a result of excessive trade investors receive low returns on their investments
(Odean, 2002). Because they exaggerate themselves in the perspective of knowledge and controlling
the market happenings while ignore the risk factor (Nofsinger, 2002).An other reason behind
overconfidence bias is that investors think they can predict the market accurately (Shefrin, 2000)

H2: The Overconfidence Bias significantly positively impacts on Investors Decision Making .

2.4 Representativeness ( Literature & Arguments)

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The representativeness heuristic is used when making judgments about the probability of an event
under uncertainty (Kahneman and Tversky 1972). The have defined Representativeness as "the degree
to which (an event) (i) is similar in essential characteristics to its parent population, and (ii) reflects the
salient features of the process by which it is generated. Relying on Representativeness enhances the
chances of a wrong decision as if something is more representative does not mean is actually more
reliable. This behavioral bias is more frequently put into use by investors because of its easy
computation (Kahneman and Tversky,1982) . The people misjudge its capability to make exact future
predictions (Fortune, Erica E. & Goodie, Adam S , 2012).
H3: The Representativeness Bias significantly positively impacts on Investors Decision Making .

2.5 Anchoring and Adjustment ( Literature & Arguments )

The anchoring effect signifies adjustment of a persons judgement on the basis of already available
information or an anchor ( Lichtenstein & Slovic, 1971; Tversky & Kahneman, 1974; Wilson,
Houston, Etling, & Brekke, 1996). It is a cognitive bias which suggests that investors rely excessively
on the first hand information provided (the "anchor") in decision making process. After that Anchor ,
other judgments , higher or lower, are made by moving up or down , back or forth from it , in this
process of adjusting the estimates away from the anchor, a biased approach is developed (Pompian ,
2006). The anchoring heuristic plays its role always in overall human decisions and has various
dynamics including estimations of probabilities (Plous, 1989; Tversky n& Kahneman, 1974),
communications (Neale & Bazerman, 1991; Ritov, 1996), judicial decisions (Chapman & Bornstein,
1996), historical studies (Chapman & Johnson, 1999; Jacowitz & Kahnman, 1995; Wilson, Houston,
Etling, & Brekke, 1996). Trainings and specializations (Northcraft & Neale, 1987) estimations of
monetary benefits (Chapman & Johnson, 1999; Wilson, Houston, Etling, & Brekke, 1996; Wright &
Anderson, 1989) and many other real world problems (Northcraft & Neale, 1987; Cervone & Peak,
1986).
H4: The Anchoring and Adjustment Bias significantly positively impacts on Investors Decision
Making .

2.6 Risk Aversion (Literature & Arguments)

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Among other independent variables is Risk Aversion . Risk-aversion is defined as the priority of a
certain outcome over a highly rewarded uncertain outcome (Kahneman, D., & Tverksy, A, 1984). The impact
of risk aversion as a decisive part of investment decision making has been recognized as the Investors
are risk averse (von Neumann and Morgenstern, 1947; Sitkin and Weingart, 1995 and Weber et al,
2002). Risky investments are often neglected by such investors (Pennings and Smidts, 2000; Shum and
Faig, 2006). The investors make risk averse decisions usually but claim that they make rational
decisions (von Neumann and Morgenstern, 1947). In Prospect Theory Kahneman and Tversky,(1979)
asserted that investors reflect several risk management patterns in different cases. Usually they are risk
averse when expect certain gains while they become risk takers when to avoid expected losses. Some
researchers of risky behaviors found risk aversion plays a vital role in decision making under uncertain
circumstances (Sitkin and Weingart, 1995; Weber et al, 2002).

H5: Risk Aversion significantly positively impact on Investors Decision Making .

2.7 Theoretical framework

H2
+ ve

Overconfidence

+ ve

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H3

H1

Decision Making

+ve

Representativeness

Heuristics

H4

+ve

Anchoring and
Adjustment

+ve

+ve

H5

Risk Aversion

The expected outcome is the verification of all hypothesis which is to be achieved by investigating behavioral
actions of investors associated with these biases as mentioned in literature .
The investors who are overconfident , overestimate the abilities to evaluate a company to be a potential
investment they trade excessively and hold undiversified portfolios .Representativeness is found in the investors
who commit errors in tracking the financial records of a company . They tend to look at successes and cant
analyze the overall companys financial position . Anchoring and Adjustment bias is identified when investors
make forecasts nearing the current level of the market , they become anchored by the economic stats of certain
companies and hence their decision becomes closer to the current level . Risk aversion causes investors holding
their investments for too long while in the case of success they sell the shares too early ( Pompian, 2006 ) .

On the basis of above clues, this research will identify these biases in the investors at Islamabad stock exchange .

3Proposed research methodology

3.1 Sample selection (size and techniques)
The sample size would be 50 investors from different backgrounds investing at Islamabad Stock
exchange and a technique of stratified random sampling will be employed.
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3.2 Population frame
The population of the study includes the individuals who invest in Islamabad stock exchange. This
covers equity fund managers of equity investment companies, investment banks, mutual funds,
insurance companies, and commercial banks.

3.4Unit of Analysis
In my research, I will ask questions about the role of behavioral biases influencing the investors
decision making .

3.5 Type of Study

The type of research is descriptive.

3.6Time horizon
In my study I will use cross-sectional data.

3.7Instrument development/selection
I will use adaption method for instruments. It means I will adopt a few part of my instrument and as
well as I develop some part myself.

3.8Proposed data collection procedures

I will use questionnaire method for collecting data from ISE. It will be easy, cost effective and also time
saving for me.

3.9Proposed data analysis techniques

I will use descriptive analysis & correlation for analyzing the data. In descriptive analysis I conclude
mean value of our data. In correlation, I will find the relation of variables among each other.

3.10 Proposed data analysis software

After collecting all data, I will analyze the data through SPSS Software.

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4. Analysis
Simple regression was conducted to investigate how well Overconfidence bias , Representativeness
bias , Anchoring and Adjustment bias and Risk aversion predict the investors decision making at ISE.
The results were statistically significant F(4.25) = 10.449. The R square was .626 which means the
62.6 variance in the decision making was explained by these biases . According to Cohen (1988) this is
the large effect. .The value of Beta was negative for Anchoring and Adjustment Bias ( B= -.322) which
means this bias affects decision making adversely rest al biases are affecting it positively and
significantly .

Model Summary

Model

Std. Error of the

Square

Estimate

R Square
a

Adjusted R

.791

.626

.566

.646

a. Predictors: (Constant), Anchoring and Adujustment Bias,

Representativeness Bias, Overconfidence Bias, Risk Aversion Bias

ANOVAb
Model
1

Sum of Squares

df

Mean Square

Regression

17.437

4.359

Residual

10.430

25

.417

Total

27.867

29

F
10.449

a. Predictors: (Constant), Anchoring and Adujustment Bias, Representativeness Bias,

Overconfidence Bias, Risk Aversion Bias
b. Dependent Variable: Investment Decision Making Bias

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Sig.
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Coefficientsa
Standardized
Unstandardized Coefficients
Model
1

Std. Error

(Constant)

.259

.553

Overconfidence Bias

.474

.125

Representativeness Bias

.560

Risk Aversion Bias

Anchoring and Adujustment

Beta

Sig.
.469

.643

.521

3.780

.001

.135

.540

4.154

.000

.362

.180

.341

2.018

.054

-.322

.164

-.319

-1.968

.060

Bias
a. Dependent Variable: Investment Decision Making Bias

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Coefficients

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