Behavioral Biases in the Decision Making of Individual Investors

In earlier research, it has been discovered that contrary to the assumptions and theories of conventional finance, many irrational behaviors related to investment judgment occur in real life. In this paper, we have made an extensive review of various behavioral biases that affect investment decision making of the individual investors. Extant research indicates that individual investor makes his/her investment decision under the influence of some combination of behavioral biases, which mainly include disposition effect, mental accounting, investors' overconfidence, representativeness, narrow framing, aversion to ambiguity, anchoring, availability bias, and regret aversion. Under the influence of some such biases or combination of the same, individual investors often make irrational investment decisions. And therefore, individual investors, in aggregate, earn poor long-run returns. These aspects have been highlighted in this paper. Potential solutions to mitigate the adverse impact of behavioral biases on decision making of individual investors have also been discussed. Finally, future research direction relevant to such an area has been indicated in this paper.IntroductionConventional finance theories are based on the assumptions that people act rationally and consider all available information in their decisions related to investments (Dedu et al., 2012). According to Somil (2007), principles of maximization, self-interest and consistent choice commonly underpin the rational economic factor. Over the last few decades, it has been discovered that contrary to the assumptions and theories of conventional finance, many irrational behaviors related to investment judgment occur in real life. The theory of rational investor has been opposed by neoclassical economic theory which proposes that every investor or every person has limited access to information and an individual is bounded by external constraints and one's own behavior. In fact, individual investors make mental shortcuts in the process of investment decision making. According to Behavioral Finance (BF) approach, several psychological biases influence decision making of both individual investors and institutional investors.A large body of empirical research indicates that real individual investors behave differently from one another. A number of previous studies (e.g., Glaser and Weber, 2004; Lehenkari and Perttunen, 2004; Massa and Simonov, 2005; Brown et al., 2006; Fogel and Berry, 2006; Lim, 2006; Chen et al., 2007; Campbell and Sharpe, 2009; Kliger and Kudryavtsev, 2010; Talpsepp, 2011; Chandra and Kumar, 2012; and Hon-Snir and Cohen, 2012) investigated behavioral biases that generally occur in decision making of the investors. The findings of such studies clearly indicate that each specific study focused only on one or a few behavioral biases. And that's why the literature appeared scattered. Of course, such studies enable us to develop a fair understanding of manifestations of various behavioral biases and their likely impact on investment decisions of the investors in one or other situation. But, in reality, a number of behavioral biases in aggregate influence the investment decisions. The review of such biases may help develop a better understanding of the issues concerning the behavior of the individual investors. Such observations trigger the interest of the authors of this paper to carry out a qualitative review of the phenomena under reference. A broader view of the various biases that influence investors' investment attitudes and tendencies, may enable individual investors to broaden their concept and to evolve better investment strategies, and the same may enhance the level of expertise of the investment professionals. In this paper, we have made a review of various behavioral biases that affect investment decision making of the individual investors. Irrational decision-making tendencies of individual investors, as revealed in earlier research, have been particularly highlighted. …