HUMANOID PSYCHOLOGICAL SENTIMENTS AND

ENIGMA OF INVESTMENT

NAMES AND ROLL NUMBER:

Muntaha Maryam Fa-2020-BBA(hons)-085 8C

Aroob Akram FA-2020-BBA(hons)-105 8C

Rabiya Shahid FA2020-BBA(hons)-137 8B

SUBJECT:
Behaviour Finance

SUBITTED TO:
Sir Mazhar Farid
 ACKNOWLEDGEMENT

We would like to extend our heartfelt thanks and appreciation to everyone who
supported us during our whole semester. The advice, knowledge, and
encouragement were crucial in making this work both successful and
rewarding.

First and foremost, we want to express our sincere gratitude to our teacher, for
their unwavering support and guidance throughout the whole semester. Their
deep understanding of the finance industry, along with their patience and
willingness to share their expertise, significantly shaped our learning
experience. We are thankful for the opportunities they provided us to work on
various projects and for their constructive feedback, which helped us improve
our skills.

We also owe a debt of gratitude to all my classmates at Lahore Garrison

University who contributed to our growth and development. The experience
and knowledge we have gained will undoubtedly shape our future endeavors in
the finance industry. The support and wisdom have been invaluable to us, and
we are eager to apply the knowledge and skills we have acquired.

Thank you once again to everyone at Lahore Garrison University, especially Sir
Mazhar Farid for making the us an enriching and memorable experience.

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Table of Contents
1. INTRODUCTION ............................................................................................. 4
2. LITERATURE REVIEW................................................................................. 6
3. METHODOLOGY............................................................................................ 7
4. DATA ANALYSIS ............................................................................................ 8
5. EMPERICAL FINDINGS ................................................................................ 9
6. ANALYSIS AND CONCLUSION ................................................................... 9
7. LIMITATIONS: .............................................................................................. 11
8. REFERENCE .................................................................................................. 11

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 1. INTRODUCTION

People always have to make decisions—some big, others not so much. The majority of
judgments are made without considering pertinent facts, depending instead on an individual's
intuition and knowledge. This is particularly true when making financial decisions. Since human
emotions are rife with inconsistencies and often exceed reason, investing can be an emotional
rollercoaster and mentally taxing experience. The argument about what constitutes normal or
acceptable behavior in people only serves to increase the difficulty of choosing investments.
Aside from the actions of individual and institutional investors, the stock market is usually as
unpredictable as human nature. Political and economic activity are frequently intermingled,
which can put a person in a confusing situation. The three most crucial factors to take into
account while making an investment are how, where, and why. The process of investing is often
difficult.

Expected utility (EU) is the foundation of the idea of investor rationality (Von Neumann and
Morgenstern, 1944). The fundamental idea is to leverage market informal efficiency to enhance
an investor's wealth's utility. Agent rationality is the fundamental cornerstone of all
contemporary finance theories and models. Muth (1961) used the phrase "rational expectancy" to
characterize the process by which the result is decided. Standard finance and its theories operate
under the premise that since financial markets are efficient and investors are rational, corporate
decision-making should be straightforward. Well-known models that highlight the significance
of rationality and develop the idea that individual investors are rational and risk averse,
preferring low risk and a specific amount of return, are Markowitz's Modern Portfolio Theory
(MPT) from 1952 and Fama's EMH from 1970.

Benjamin Graham famously said, "An investor's biggest problem, and possibly their worst
enemy, is likely to be themselves." There have been a number of abnormalities found, but the
theories of conventional finance have not been able to provide adequate explanations for these
anomalies, suggesting that the EMH is not always reliable. Even with the aid of asset pricing
models, such as the four-factor model of Carhart (1997), the three-factor model of Fama and
French (1993, 1996), and the capital asset pricing model (CAPM) (Sharpe, 1964), it is
impossible to quantify the unexpected behavior of the market participant.According to Fama and
French (1997), regulations can temporarily prolong market anomalies, but over time, knowledge
changes cause anomalies to disappear. Baker and Nofsinger (2010) claim that the persistence of
several market oddities that lead to inefficiency may be explained by the "limit to arbitrage" and
"noise trader risk."Pompian and Wood (2006) expounded on this point in their book Behavioral
Finance and Wealth Management, showing how market abnormalities refute the EMH. Financial
anomalies are essentially cross-sectional in nature, with occasionally inexplicable effects.

Kuhn (1970) first used the term "anomaly," and the empirical results of anomalies seem to
capture the flux of asset price behavior. The topic of whether academics were drawn to
numerical peculiarities remains unanswered as the current literature on anomalies frequently
disappears. Nonetheless, if investors have had consistent excess returns, markets are efficient,
and estimate models accurately determine a company's value, then there is a problem that has to
be looked into. Price fluctuation should be unforeseeable in an information-efficient market, yet

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unusual returns are discovered after pragmatic results, which strongly refutes the information-
efficiency of financial markets.

The concept of behavioural finance was fully created in the 1920s when Selden (2012) presented
his conclusions concerning the psychology of the stock market, where mental attitude has a big
influence on stocks. Later, researchers discovered that a crucial factor in financial decision-
making is the human mind. According to Kahneman and Tversky's prospect theory (1979),
people make judgements based more on the potential value of potential losses and gains than on
the actual result. Traditional financial views were seriously questioned in the 1990s, which led to
the rise of the behavioural school of thought. Investor irrationality has been proven in a number
of scholarly finance publications (Shiller, 2000; Duran and Caginalp, 2007; Mittal, 2019).

Ritter (2003) focused on behavioural finance as a developing field in wealthy nations, but there
wasn't much helpful research on developing economies. Important areas with research gaps are
also highlighted for future investigation. A low literacy rate, a lack of access to accurate
information, inadequate financial policies and poor implementation, a lack of trust—all of which
are present in Pakistan—and other factors contribute to the irrationality of investors in emerging
markets. It has been established via numerous studies (Mustafa and Nishat, 2007; Shaikh, 2016;
Chishti et al., 2016; Habibah et al., 2017) that Pakistan suffers from informational inefficiency.

Over the past thirty years, there have been a number of notable modifications to the Pakistan
Stock Exchange (PSX). This shift has been facilitated by deregulation, foreign investment,
mostly from China via the China Pakistan Economic Corridor (CPEC), privatisation, and other
factors. However, Pakistan's economy suffered greatly as a result of the Panama Papers
controversy. In addition to the potential for "boom and bust," Pakistan's economy aims to
provide a variety of securities offers for trading and investing, and the PSX has created a
significant opportunity for study in the field of investment management.

Investor decisions are a major factor in establishing the market trends problem. Investigating the
behavioural elements that significantly affect PSX investors is now crucial. In order to help retail
investors understand how to make decisions about their investments, this analysis focuses on the
share investment behaviour. It is difficult for security organisations and investors to forecast
recommendations that accurately reflect the underlying worth of companies in the PSX.

Compared to industrialised nations, behavioural finance is not as well understood or applied in

developing nations. This study will assist policy makers in taking behavioural finance into
consideration. Lastly, this paper will give participants and scholars a fair chance to comprehend
the theoretical and practical significance of behavioral finance in the PSX.

This study presents alternate theories to those in earlier research, covers a wide variety of
behavioural finance topics, and fully indicates the element of irrational behaviour of individual
investors in Pakistan. Additionally, by clarifying herding variables with pertinent sub-factors, the
study discusses prospect and heuristic variables together with their sub-factors. Among the stated
goals are, in the first place, potential behavioural factors influencing investors' personal financial
decisions made in the PSX. Secondly, an investigation is conducted into the effects of
behavioural components on speculative choices and execution speculators on the PSX. Third, the

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suggestions for improving behaviour and reducing losses in speculative returns through personal
financial decision-making. Fourth, the ultimate goal is to lay the groundwork for next
behavioural finance research in Pakistan.

This research will assist Pakistani individual investors in their decision-making process, while
also incorporating information that may be beneficial to a wider range of investors.
Understanding the psychology of individual investors who contribute a significant amount of
money to stock exchanges will be beneficial for policymakers, asset management firms, finance
companies, the mutual fund industry, and hedge fund managers. Emerging economies with
economic conditions comparable to Pakistan's will also benefit from this knowledge.

2. LITERATURE REVIEW
This literature review looks at easily readable research on the topic. The first section of the
review discusses the important variables, their sub-variables, and their influence on investment
decisions. Information is covered extensively because it is the basis for all business decisions and
is of utmost importance. The heuristic variables, prospect variables, market variables, and
herding variable—as well as their sub-variables—are covered in the next session. The study's
aims are outlined in the third part, which contains the hypotheses that were derived from the
literature review.

Minimising risk and maximising positive return is the critical point of convergence of previous
composition on financial markets (Fama, 1965; Lintner, 1965). The traditional approach came
first and was centred on evaluating financial statements. The second is contemporary finance,
sometimes known as new classical finance, which placed emphasis on the asset pricing process's
rational economic behaviour and maintained that markets are always efficient and that sporadic
market abnormalities are eventually corrected by arbitragers. In their 2019 study, Delcey and
Sergi examined two standard methods in contemporary financial economics: Efficient market
hypothesis (EMH) and rational expectation theory. Neoclassical finance, defined by Statman
(1999) as "standard finance," is based on the arbitrage principles of Modigliani and Miller (1958)
and Markowitz (1952)'s portfolio optimisation theory. The option-pricing theory of Black,
Scholes, and Merton (Black and Scholes, 1973) and the capital asset pricing theory of Sharpe,
Lintner, and Black (Fama and French, 2004) were also examined because "it uses a minimum of
tools to build a unified theory intended to answer all the questions of finance."

Information has long been central to finance literature (Von Hayek, 1937; Stigler, 1961;
Grossman and Stiglitz, 1980; Sargent, 2013; Graf-Vlachy, 2019), and it has a direct impact on
market speculators' impulses. The effects of advertising highlights on investor energy were
categorised by Waweru et al. (2008) and included cost changes, showcase data, historical stock
designs, client tilt, and an overreaction to changes in the value of basic stocks. In spite of its
complexities, Bogle (2017) examined information as the foundation of any organisation, taking
into account factors including expediency, data flow, exogenous information asymmetry, and
historical instances. Financial specialists cannot possibly distribute information with the quality,
quantity, and repeatability of exuberant nature while maintaining Simon's limited objectivity
(Caparrelli et al., 2004). Information congruity, accuracy, dependability, and clarity have a

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strong influence. Arand et al. (2015) examined the advice of substantial value when selling
stocks in their specialised reports. Samuelson (1965), who contended that the rivalry between
rational agents with no regard for basic values can explain the unpredictability of price
differences, is initially credited by the efficient EMH. Fama (1965) then provided the definition
of a "efficient market" based on information. In macroeconomics, the EMH has three roles.

First, according to Delcey and Sergi (2019), "it gave the theoretical standard of general
equilibrium macroeconomic model without financial friction; second, it reinforced the rationale
of the behaviour of money in general equilibrium in macroeconomic models." Though it is
thought to be the most dubious theory in financial economics, the academic community and
practitioners have consistently given the Efficient Market theory (EMH) some thought during the
preceding decades. The development of investment methods, such as the investigation of
proficiency requests and the importance of capital markets, is altering the observational
levelheadedness and noteworthiness of the EMH. The EMH is regarded as one of the most
important recommendations in financial matters. Even after countless studies, academic theories
remain fascinatingly modest and remarkably easy to reject since it is still challenging to come to
a consensus on whether or not markets are efficient. In 2006, Antweiler and Frank examined if
the EMH was just partially accurate.

Overconfidence leads to the overestimation of knowledge and abilities (DeBondt and Thaler,
1985). When making investing decisions, heedless heuristics might lead to disastrous
consequences. According to Baker et al. (2002), speculators' negligence resulted in
underestimating of a hazard and improperly extended portfolios. Many researchers have
examined the critical effect of presumptuousness on an individual's dynamic, including Poppian
and Wood (2006), Moore and Healy (2008), Bakar and Yi (2016), and Viviani et al. (2018). It is
an intellectual heuristic inclination where there is inappropriate confidence in institutional
thinking and psychological capacities.

Investors assess the likelihood of an outcome based on how quickly the outcome comes to mind,
according to Tversky and Kahneman (1974). This cognitive bias is known as availability bias, or
mental shortcut, and it arises when quickly obtainable knowledge serves as the foundation. The
impact of the availability heuristic on market decision-making was examined by Kudryavtsev et
al. (2013). The outcomes showed that behavioural biases had a significant impact on investors.
According to Bian et al. (2014), the ranking of individual investors is significantly impacted by
availability bias. According to Kovic and Kristiansen (2019), an unreasonable expectation of
future outcomes is heavily reliant on past outcomes.

Kovic and Kristiansen (2019) investigated the gambler's fallacy—the irrational conviction that
all opinions impacting sequence order outcome probabilities form the gambler's fallacy—and if
it is an unreasonable conviction when future outcomes are precisely determined according to
prior results.

3. METHODOLOGY
The investigational methods utilised to gather and distribute information are explained in this
section along with their exploration structure. It starts by outlining why this research is
acceptable, and it then uses the respondents' conclusion and the specified examination process to

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construct a generalised agent test. Descriptive statistics and factor analysis are among the
programmes included in the statistical package for the social sciences that are used to acquire the
findings. The framework for data collection and analysis is provided by research design (Bryman
and Bell, 2007). Cross-sectional structure is useful in understanding the typical practices of
specific financial specialists. Test configurations were typically used to analyse the relationship
between elements, and examinations were generally used to look into and make sense of a
particular problem (Saunders et al., 2009).In this manner, a cross-sectional plan was favored for
the purposes of the study.

The target audience consists of PSX individual stock investors. The PSX is the aggregate term
for the demutualization processes of the three stock exchanges.During the selection process, 500
surveys were distributed. Stock brokerage houses provided a list of individual stock investors,
and personal connections were also used. Surveys that were conducted in person were still used
as part of the procedure to increase the response rate. Three Pakistani stock exchanges received
printed copies of the polls. Because printed versions were favoured and local reactions were
unfavourable, the usage of messages was purposefully avoided. Out of the 471 surveys that were
sent in, 19 of them tended to have ambiguous responses; just ten of the respondents did not
respond. Because of this, the response rate was stable and stayed around 92.2%.

A modified poll that included a wide range of questions regarding the impact of the PSX on
Pakistan's market value was developed in order to examine the effect on the decisions made by
individual investors. The polls' sub-factors were the primary considerations. In this analysis,
three free factors with sub-factors were used. The first is corporate disclosure, which was derived
from a previous study by Nagy and Obenberger (1994) and comprised four components, each
estimated on a four-point Likert scale (a 5 least powerful to d 5 typically persuasive). One of the
examination's disadvantageous variables was the solitary dynamic, which is rated on a four-point
Likert scale (from 5 strongly disagree to 5 strongly agree). Muhammad and Ismail defended the
solitary dynamic measurement scale (2009).

It was recommended to employ a comparatively large sample size because larger sample sizes
were more conclusive and because investors' time, money, and effort are more valuable when the
conclusion and sample size are more solid (Saunders et al., 2009). 500 questionnaires were thus
distributed to certain financial investors who were selected by the use of specified arbitrary
testing. According to Bryman and Bell (2007), defined testing ensures that the sample was
distributed among a representative subset of the population. The summary was divided into three
sections: unique information about personal data, behaviour aspects that influence investment
decisions, and investment execution. Nominal and ordinal estimations were used to collect the
individual data (Ghauri and Gronhaug, 2010).

4. DATA ANALYSIS
From the outset, the collected data were appropriately maintained and reviewed; the information
was streamlined by eliminating the overview that had undesirable aspects, such as an excessive
number of missing characteristics or irrational assessments. Subsequently, quantitative methods
were employed to achieve the assessment objectives and identify potential relationships between
the latent factors. These methods comprised two parts: an estimation model at the most basic
level of confirmatory factor analysis (CFA) and a fundamental demonstration using a multi-slide

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show (Schreiber et al., 2006). The structural equation model (SEM) is used in this assessment to
determine which social components are covered by the Cronbach's alpha test and the previous
iteration of the EFA. In the end, SEM was used to test H3 while the data was being examined.

5. EMPERICAL FINDINGS
The study investigated the influence of social and behavioral factors on individual investment
decisions within the Pakistan Stock Exchange (PSX). A total of 500 surveys were distributed to
investors, with 471 responses received, resulting in a high response rate of 94.2%. The questions
aimed to explore the degrees of social factors and investment decision-making were coded
accordingly: questions 12 to 35 as P1 to P24 for social factors, and questions 36 to 38 as I1 to I3
for investment decision-making evaluation.

Reliability and data suitability were assessed using Cronbach’s alpha and exploratory factor
analysis (EFA). The Kaiser-Meyer-Olkin (KMO) value was 0.728, indicating adequate sampling,
and Bartlett’s test of sphericity was significant (p < 0.000), confirming the data's suitability for
factor analysis. Cronbach’s alpha values exceeded 0.6, validating the reliability of the variables.

The factor analysis identified several key components influencing investment decisions. Four
herding variables (P21 to P24) showed strong factor loadings ranging from 0.762 to 0.889,
indicating a significant influence of herding behavior. Prospect variables, which included risk
aversion and portfolio management behaviors, had moderate factor loadings between 0.508 and
0.732. Market factors, such as monitoring stock prices and considering past trends, had high
factor loadings from 0.790 to 0.797, emphasizing their importance. Heuristic factors, including
overconfidence and anchoring biases, showed loadings from 0.609 to 0.809. Investment
performance factors (Y1 to Y3) demonstrated adequate reliability with loadings between 0.679
and 0.695.

Structural equation modeling (SEM) further analyzed the relationships between these factors.
Heuristic practices, such as overconfidence and gambler’s fallacy, had a strong positive impact
on investment decision-making, with a regression coefficient of 0.68 (p < 0.000). Herding
practices positively influenced investment execution (regression coefficient 0.11, p = 0.03).
Conversely, prospect practices, characterized by loss aversion and regret aversion, negatively
affected investment decision-making (regression coefficient -0.12, p = 0.05).

6. ANALYSIS AND CONCLUSION

Overall, the study revealed that heuristic and herding behaviors positively impact investment
decisions and performance, while prospect behaviors have a negative effect. Market factors
influence investment decisions but do not significantly affect investor performance. These
findings suggest that refining heuristic and herding practices could enhance investment
decisions, whereas The analysis of individual investors in the Pakistan Stock Exchange (PSX)
provided valuable insights into the influence of various behavioral factors on investment
decision-making. It was found that overconfidence had a moderate effect on investors' decisions.
This finding can be attributed to the evolving nature of Pakistan's security advertisements, which
display varying trends that might affect investors' confidence levels. Similarly, anchoring also
had a moderate impact on the ability of investors to predict future stock prices, indicating that

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while investors rely on current prices to forecast future movements, their predictions are not
always accurate.

Interestingly, although the gambler’s fallacy was identified as a strong factor among PSX
investors, its actual impact on decision-making was minimal. This suggests that while investors
might believe they can predict the market's direction based on past events, this belief does not
significantly influence their investment choices. This finding underscores the variability in
investor certainty within the Pakistani market, where investor confidence ranges from very high
to quite reasonable.

Among the prospect factors examined, mental accounting had the highest impact on investor
behavior. This factor led investors to treat each component of their investment portfolio
independently, rather than considering the portfolio as a whole. Such behavior can lead to
inefficiencies and inconsistencies in decision-making, as investors may overlook the
interconnections between different investments. This aligns with the observations made by
Rockenbach (2004), who noted that treating investments in isolation can lead to suboptimal
decision-making. Loss aversion, another prospect factor, also had a significant impact on
investors. This effect manifested as increased risk aversion following adverse outcomes, making
investors more cautious about taking risks in the future, which echoes the findings of Hair et al.
(1998).

Regret aversion exhibited a moderate impact on investor decision-making. This indicates that the
fear of regretting a decision can moderately influence investors' choices, making them more
cautious. Herding factors also had a moderate influence on investment decisions in the PSX,
suggesting that investors are somewhat influenced by the actions of their peers. However, this
study did not fully support the findings of Farber et al. (2006) and Tran (2007), who claimed that
herding had a significant impact on the Pakistan securities exchange.

Furthermore, the study revealed that return rates often did not meet investor expectations. Many
investors felt that their stock investment returns were lower than the average return on
comparable investments, as noted by Barberis and Thaler (2003). This dissatisfaction with return
rates was further compounded by the difficulty investors faced in coping with losses after
previous gains, aligning with the findings of Barberis et al. (2001).

The study's methodology involved organizing all participant responses into a comprehensive
analysis, ensuring that the research goals were met and hypotheses tested. Five behavioral factors
were identified as influencing individual investment decisions in the PSX: herding, market
factors, prospect factors, overconfidence bias, and anchoring-capacity bias. Herding included
following the decisions of other investors regarding buying and selling stocks. The analysis
provided a holistic view of how these behavioral elements affect investment decisions and
performance in the PSX.

Unlike previous studies in Pakistan, which primarily focused on traditional financial theories,
this research utilized behavioral finance to examine investment decisions. It stands out as one of
the few studies to explore the full range of social elements affecting Pakistani individual
investors, rather than focusing on a limited set of behavioral factors.

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In conclusion, the study found that overconfidence positively impacted investor performance.
Pakistani investors generally showed responsiveness but also exhibited uncertainty in specific
situations. While overconfidence can be beneficial in enhancing investment performance, it also
poses risks by leading investors to underestimate the dangers associated with dynamic stock
investments. Therefore, a balanced approach that leverages confidence in innovative and
appropriate ways is recommended for investors to improve their performance. mitigating the
adverse effects of prospect behaviors could lead to better investment outcomes.

7. LIMITATIONS:
The study acknowledges several limitations despite its substantial sample size of 500
respondents affiliated with the Pakistan Stock Exchange (PSX). It suggests that while the
sample size met statistical requirements, future studies should consider larger samples to
better represent the complexities of the Pakistan financial exchange. Generalizations beyond
the sample's affiliations were deemed inadequate despite the use of random testing methods.
Additionally, the study notes a relative unfamiliarity among Pakistani financial experts with
social money and its assessments. Despite these limitations, the research was notable for
integrating behavioral finance theories with estimations in Pakistan, suggesting opportunities
for future studies to validate findings with broader respondent bases and delve deeper into
behavioral influences on institutional investor decisions within the PSX.

8. REFERENCE:
Chishti, M. F., Bashir, R., Mancinelli, T., & Hussain, R. T. (2023). Humanoid psychological sentiments
and enigma of investment. Journal of Economic and Administrative Sciences, 39(4), 1260-1276

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