The Effect of Behavioral Finance on Stock Investment Decisions

Behavioral Finance

Behavioral finance was defined as the study of the influence of psychology on the behavior of financial practitioners and the subsequent effect on markets which help to explain why and how markets might be inefficient. The work of Kahneman & Tversky revealed that people do not employ statistical methods in their decision-making, but they rely on a limited number of heuristic principles in their decision-making. Kahneman & Tversky are considered the fathers of behavioral finance. Since the 1960s they have published about 200 papers and articles, most of them were related to the concepts of behavioral finance.

Islam was more specific in defining behavioral finance by underlining the buying and selling decisions regarding stock market investors. According to Gachter et al. behavioral finance is the better understanding of the investment decisions that affects market prices which relate to human and social cognitive and emotional biases. Ritter also defined behavioral finance as behavioral factors affecting individuals' decision-making. According to Appiah & McMahon, behavioral finance is the study of how financial practitioners act and interact on financial information and the subsequent effects on markets. Pompain argued that behavioral finance tackles the behavioral factors that affect financial decisions.

Alrabadi et al. conducted a study that investigates the existence of behavioral biases in Amman Stock Exchange and their effect on investment performance from investor's point of view. In specific, the effects of overconfidence bias, familiarity bias, loss aversion bias, disposition bias, availability bias, representativeness bias, confirmation bias, and herding bias are investigated.

The researcher Al-Abdallah conducted a study titles "How behavioral biases affect investment decision".

This study investigates the effect of behavioral biases on investment decision in Amman Stock Exchange. In specific, the effects of overconfidence bias, familiarity bias, loss aversion bias, disposition bias, availability bias, representativeness bias, confirmation bias, and herding bias are investigated.

The importance of studying such topic comes from the consequences that these behavioral biases could have on the investors' gains and losses and on the stock market as a whole.

This study investigates the effect of behavioral biases on investment decision for 236 investors in Amman Stock Exchange. In fact we focus on eight well-known behavioral biases that are found to affect investment decisions in other developed and emerging stock markets. These biases are overconfidence bias, familiarity bias, loss aversion bias, disposition bias, availability bias, representativeness bias, herding bias, and confirmation bias. To the best of author's knowledge, this is the first study in Jordan that tackles such important topic.