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CHAPTER TWO

Effects of Behavioral Biases in Investment Decision-Making among young professionals in

the Nairobi County, Kenya.

Elvis Odhiambo Kouko

24/09484

KCA University

Dr. Peter Maina Njuguna

BCOM

26th February 2026

2.1 Introduction

This chapter gives a literature review of the literature that applies to behavioral biases and

how it affects the decision-making process of investors. The review is structured according to

major topics in behavioral finance, such as theoretical approaches to it, empirical data, and gaps

in the available knowledge. Behavioral finance contradicts the classical view of investors as

being fully rational by emphasizing the systematic role of psychological aspects of financial

decision making like overconfidence, loss aversion and herding effects.

This chapter reviews the concept of foundational theories on the issue as well as the

recent empirical research on the dynamics of underlying mechanisms by which such biases

exhibit themselves and influence investment behaviors. It also addresses the context of emerging

markets especially the Nairobi County in order to point out how cultural, technological and

regulatory aspects can affect the behavior of the investors. Lastly, a conceptual framework is

created according to which the study is going to be conducted and the relationships between the

independent variables (behavioral biases) and the dependent one (investment decision-making)

are determined, along with the possible moderating factors, including financial literacy.

2.2 Theoretical Perspectives

Behavioral finance offers the theoretical basis of cognition and emotional biases on

investing choices. The key theories that will be applicable in the present study are:

2.2.1 Prospect Theory

According to Prospect Theory formulated by Feather (2021), people do not necessarily

assess their future gains and losses but in terms of their relation to a certain point. The theory

describes the aversion to loss, where the psychological effects of losses is about 2 times the

corresponding effect of the gains of the same amount. This causes investors to make decisions
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which would prevent any losses even at the cost of future gains like retaining losing stocks

longer than is advisable.

2.2.2 The Biases of the Heuristics and Cognition.

Heuristics are the short-cuts that investors have in their minds to make decisions that are

simple to make in times of uncertainty. Although they are effective in terms of efficiency, they

may cause foreseeable errors. As an illustration, overconfidence will lead investors to overrate

their market-moving ability, that will lead to excessive trading and under-diversification (Liu et

al., 2022). Herding behavior is the process of following the act of others and often disregarding

basic information due to the fear or not wanting to be out of the crowd as well as thinking that the

crowd might know more about something.

2.2.3 Mental Accounting and the Nudge Theory.

Özkan & Özkan, (2020) came up with mental accounting that explains why people tend to treat

money in different ways depending on its origin or purpose. This has the potential of affecting

investment allocation decisions that are not in line with the classical finance principles. The

Nudge Theory by Thaler also postulates that even minor alterations in the packaging of options

may cause an investor to act in anticipated manners, which may be subject to interventions in

behavioral terms.

All these theoretical views explain why investors do not follow rational models and give

a guideline on the analysis of the impact of overconfidence, loss aversion and herding on

investment choices in the Nairobi County.

2.3 Empirical Literature

A number of studies have examined the impact of bias in behavior during investment

behavior in both developed and emerging markets:

2.3.1 International Evidence

In a study by Pym Tansuchat and Yunng Thaicharo (2025), cognitive biases in Thailand

were investigated and discovered that overconfidence has a significant effect on affecting the

frequency of trading and at the same time, lessening the diversification of the portfolios. Loss

aversion contributed to risk-seeking behavior in cases of losses to investors and herding had an

impact on investors to invest with the mob in a direction that goes against the market fundamentals.

Equally, Mahapatra & Mishra (2020) discovered that the mental accounting and framing effects

had a significant influence on the investment allocation decisions made in the Indian stock market.

2.3.2 African and Kenyan Context

In Kenya, Jain (2025), found out that young urban investors engaged in digital trading

platforms exhibited the tendencies of speculative trading and panic selling, which is an indication

of overconfidence and herding biases. Ease of transactions and peer influence like the emergence

of mobile money platforms like M-Pesa have made money more accessible to everyone but also

increased the behavioral biases. Although these studies give a clue on the behavior of investors,

few studies have empirically established the relationship between financial literacy and behavioral

bias susceptibility in the Nairobi retail investment market.

2.3.3 Summary of Findings

In these studies, overconfidence has contributed to over trading, loss aversion has

impacted on the risk-taking and holding behavior, and herding behavior has contributed to

imitating market trends. Although the theoretical and practical evidences are based on

international studies, the empirical research on young professionals in Nairobi is not that

extensive and thus conducting a context-specific analysis is necessary.

2.4 Knowledge Gap

Even with the increasing literature, there are still a number of gaps:

1. Context-Specific Evidence: The majority of the behavioral finance researches are

implemented in advanced markets. Empirical studies have not been done to determine the

impacts of overconfidence, loss aversion, and herding in decision making by young professional

investors in Nairobi County.

2. Financial Literacy Link: There is little research that test the moderating role of

financial literacy in the prone-ness to such biases in the emerging markets.

3. Practical Implications: Existing literature does not often offer practical suggestions to

individual investors, financial advisors and policymakers in the Kenyan setting.

The proposed research will fill these gaps by offering empirical data in Nairobi County

and evaluating the effectiveness of financial literacy in predicting investor behavioral bias

vulnerability.

2.5 Conceptual Framework

The theoretical framework of the proposed research gives a diagrammatic and theoretical

imagery of the postulated connections among behavioral biases and investment decision making

among the young professional investors in Nairobi County. It demonstrates the impact of the three

chosen biases in behavior on investment decision, namely overconfidence, loss aversion and

herding and also moderating effect of financial literacy (Ahmad & Shah, 2020). The

overconfidence, loss aversion, and herding are the independent variables in the study.

Overconfidence is the disposition of investors to believe that they are more

knowledgeable and have greater predictive skills and control over the returns of their

investments. This bias is likely to result in over-trading, over-under-diversifying and maybe bad
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financial performance as investors will be trading on an over-confident perception of their

market judgments. Loss aversion, conversely, is the fact that the psychological effect of losses is

disproportionate in comparison to the same gains. Participants in the investment industry with

loss aversion can be characterized as risk-averse when making investments that involve increases

in earnings, but risk-seeking when attempting to recover losses.

This can affect the decisions they make when it comes to investing and also impact when

and how they invest and the level of investment undertaken. Herding behavior is the mode of

people to copy the actions of the larger group in making investments without necessarily doing

the basic study or personal consideration. The bias may lead to investors following the market

trends or other popular opinions that in some cases may lead to suboptimal choice of portfolio

decisions.

The dependent variable in the research is investment decision-making, which is

operationalized in three components that are measurable including the frequency of trading, the

diversification of investment portfolios, and the risk taken by the investor. These elements both

produce the behavioral expressions of the biases and the actual effects in the portfolio of the

investor. It is theorized that increased amounts of overconfidence, loss aversion and herding will

have a direct effect on these elements of investment decision-making which will result in deviant

behavior patterns contrary to the postulations of the traditional finance theories.

The framework includes financial literacy as a moderating factor because it is assumed

that this variable can determine how the behavioral biases can be relevant to making investment

decisions. Highly financially literate investors can be in a better position to identify and address

the impacts of cognitive and emotional biases, and thus make more rational decisions and

minimize the adverse effects of overconfidence, aversion to losses, and herding. On the other
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hand, these biases may influence more investors with lower financial literacy, which may lead to

the poor trading performance and low portfolio returns.

Overall, the conceptual framework shows that behavioral biases should directly affect the

process of making investment decisions, whereas financial literacy may moderate the effect of

these biases by either increasing or decreasing the impact of the latter. This framework will help

in the empirical investigation as it will be used to design research instruments that will be used

and analysis of data will be conducted and the study will identify both the psychological and

practical aspects of the investment behavior in the context of Nairobi County.

References

Ahmad, M., & Shah, S. Z. A. (2020). Overconfidence heuristic-driven bias in investment

decision-making and performance: mediating effects of risk perception and moderating

effects of financial literacy. Journal of Economic and Administrative Sciences, 38(1), 60–

90. [Link]

Feather, N. T. (2021). Expectancy-Value approaches:present status and future directions.

Expectations and Actions, 395–420.

[Link]

value-approaches-present-status-future-directions-norman-feather

Jain, N. (2025). Decision Process of Individual Investor in Indian Capital Markets Theories and

Empirical Evidence. Journal of Marketing & Social Research, 2, 192–200. [Link]

[Link]/article/decision-process-of-individual-investor-in-indian-capital-markets-

theories-and-empirical-evidence-218/

Liu, H., Peng, L., & Tang, Y. (2022). Retail Attention, Institutional Attention. Journal of

Financial and Quantitative Analysis, 58(3), 1–34.

[Link]

analysis/article/retail-attention-institutional-

attention/C92DB27218CFED1690F116E95D0FC933

Mahapatra, M. S., & Mishra, R. (2020). Behavioral influence and financial decision of

individuals: A study on mental accounting process among Indian households. Cogent

Economics & Finance, 8(1).

[Link]
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Özkan, M., & Özkan, Ö. (2020). Financial Evaluation of Mental Accounting. Journal of

Accounting Finance and Auditing Studies (JAFAS), 6(1), 86–118.

[Link]

Pym Tansuchat, & Yunng Thaicharo. (2025). Cognitive Biases and Investment Choices:

Exploring the Psychological Determinants of Financial Decision-Making in Thailand.

Journal of Business and Economic Options, 8(1), 43–60.

[Link]