Impact of Psychological Traits on Rationality of Individual Investors

Abstract

Over the years it has been noted that investors suffer from number of biases that affect their rationality while they take investment decisions and as such it is must for stakeholders to have an idea of these biases. Thus the objective of this paper is to explore the factors which affect the investors’ rational behavior in the stock market decisions. The authors have designed well-structured questionnaire to empirically investigate the presence of psychological traits in the individual investors’ financial decisions. Deduction approach of research has been used in present study because the main objective of the study is to identify the psychological traits that influence the decision making of individual investors, which are already out there, without inferring and building theory. Based on the data collected from 303 respondents and by applying Exploratory Factor Analysis (EFA), the study could identify the five main psychological traits including the newly identified bias i.e. “faith” that have substantial influence on the rationality of investors. Further, the results of regression analysis reveal that faith, heuristics, confirmation, pessimism, over-confidence and optimism and herd behavior are statistically significant psychological traits and all these variables collectively explain the 35 per cent variation in rational behaviour of investors. Finally, this study asserts that there is an urgent need to have the unified theory of behavioural finance and standard finance, the emphasis of which should be in identifying portfolio anomalies that can be explained by various psychological traits in individual investors for bringing greater efficiency in our stock markets.