CHAPTER ONE

1.0 INTRODUCTION

1.1 Background of the Problem

There are two frameworks of the human thoughts that assist, explain why people accept
negative selections. The first is the short wondering part of the mind that makes use of
intellectual shortcuts, additionally known as heuristics, to determine. This framework works
hastily and therefore depends on assumptions and little concept. The second system, which is
the highest and greater methodical one, is utilized to determine nicely thought out picks and
takes an effortful mental interest. Choices are made after cautious thought of accessible data.
According to Kahneman's study choices are dependent on feelings that prompt adverse
outcomes (Yu, 2016).

Behavioral finance is relied on the prospect that not all decision makers act rationally, always
(Joo & Durri, 2015). Financial specialists should know about the distinctive behavioral biases
inherent within them and deliberately work towards maintaining a strategic distance from
them, thus upgrading their efficiency. Some normal mistakes made by investors are offering
too early while booking benefits, holding their stocks for too long while incurring losses,
purchasing overrated stocks in light of market assessments and positive assessment by even
those who do not matter (Parikh, 2011). According to Parikh (2011) being able to join with
the emotional indiscipline and efficaciously mange it is crucial to avoid irrationality.

Behavioral finance examines the psychological aspect of the basic decision making and clears
up the unreasonableness investors are exposed to in investment decisions. Frequently,
investors stray from adjusted and reasonable choices towards the preferences adjusted to their
social tendencies. Such tendencies impact the financial specialists‟ discernment of the
financial venture (Kumar & Goyal, 2015). Behavioral finance considers how emotional
elements changes among people decision making process (Chira, Adams & Thornton, 2011).
The mental reality known as bias and its essence in human decision making provides the
extra understanding regarding the matter of investor irrationality and widens their goals and
objectives (Chira et al., 2011)
Behavioral Finance is the study of the influence of psychology on decision making in finance
related issue (Kimeu, Anyango & Rotich, 2016).Proponents of behavioral finance ideology
state that investment decisions are characterized by emotional factors such as
endowment ,loss aversion, regret aversion and mental accounting, herding behavior and
cognitive factors including overconfidence, gamblers fallacy and, hindsight biases.

Awour (2017) defines investment as the available capital in the wide array of investment
options that are at the disposal of an individual investor. These decisions’ are made with
various objectives in mind, and these including ensuring safety of the principal amount, high
liquidity, earning higher returns and tax minimization. Different types of investors exist in the
capital markets, and they differ in their investment characteristics such as risk, liquidity and
security requirements.

There are various types of investors, namely: conservative investors whom invest in low risk
investments’ as they fear indulging in high-risk ventures where the probability of losing the
principal amount and all the returns, are quite high. Such investors’ mainly invests in cash
forms of investments’ such as mutual funds, money market securities’, and certificates of
deposits, treasury bills and savings accounts. Secondly, moderate investors have a higher risk
appetite as compared to conservative investors, and invest in a mix of cash, real estate and
bonds. Lastly, we have the aggressive investors with a very high-risk appetite. They are often
involved in the stock market trading, invest in high-risk real estate business and believe that
higher risk means higher returns.

Investment decisions involve the determination of which security or asset to invest in, how
much to invest, when to invest and the investment period. Different investment alternatives
differ in their risk and return profiles, and depending on the risk appetite of the investor, one
can invest in shares, bonds, marketable securities or other securities traded on the Nairobi
Security Exchange (Awuor, 2017).
Behavioral Influence and Investment Decisions
Behavioral subject of finance views buyers’ as irrational economic agents whose picks are
motivated via sentiments, emotions, fantasies, moods and feelings. Investors’ have an
emotional and personal courting’s with their assets .This explains why a few shoppers’ keep
onto shares even though their fees and the associated returns are falling .Behavioral finance
for this reason offer to provide a cause of, why actual traders’ conduct deviates from that
predicted from a rational economic agent. It is for that reason, combines cognitive and
behavioral psychology with traditional finance precept.

Arthur (2014) conducted a study to determine the effect of behavioral biases on investment
decisions of individuals at the NSE. The study targeted 30 individuals reached through
questionnaires, and the data collected, analyzed through descriptive statistics and multiple
correlation analysis. The study revealed that investor decisions are influenced by the illusion
of control bias, representativeness, herd instincts, cognitive dissonance and hindsight biases.
However, other behavioral factors such as self-attribution, risk aversion, over optimism and
loss aversion did show to have no influence on individual investors’ decisions.

Kengatharan (2014) identified market prospect, herding and heuristics as the factors that
influence individual investment decisions at the Colombo Stock Exchange. His study further
revealed that overconfidence has a negative impact on investment decisions while anchoring
has a positive influence on investment decisions and herding has a negative influence on
investment decisions. According to the study, regret aversion, loss aversion, herding and the
speed of buying and selling of securities have no impact on the performance of investments.

Decisions of both shifting significance and greatness are made each day. Individuals and
associations’ are inclined to settling on wrong choices and subsequently can be destroying.
Impaired decisions can be as a result of deficient data, Kahneman (2011) contradicts by
agreeing that the mind of the decision maker can be influenced by obtaining various
information. Regardless of whether the data is precise, it can in any case result in awful
decisions because of specific tendencies that are already present in the decision maker’s
mind. Such inclinations are alluded as intellectual predisposition and reliably damage the
decisions makers capacity to settle on a sound decision (Kahneman, 2011).

Ayaz and Study (2014), decision making are a critical, yet dangerous endeavor since poor
choices are normally the reason behind business disappointments. Awful decisions start with
wrong data where the upsides and downsides post execution of the choice are not
satisfactorily considered (Snowden & Boone, 2007). There are solutions on how to overcome
these issues, such as, how one perceives a problem, reframing the options in different ways
and analyzing how decision maker’s thinking might differ for each alternative (Hammond,
Keeney & Raiffa, 2006).
Chandra (2008) argued that effective decision making in the stock market requires an
understanding of human nature in a global perspective on top of financial skills and as such
cognitive psychology should be given importance in the process of decision-making .As a
result of the bull market from 2004 to 2007 that occurred in the United States and the
subsequent financial crisis, there has been a lot of fresh focus on the irrational investor thus
studying irrational investor behavior has become important (Aiyar, 2012).

Kafayat (2014) argues that decision makers search for pleasing, instead of flawless
arrangements’. Through empirical evidence, Kafayat (2014) proposes that these add to the
accompanying investment related attributes such as excessive stock price instability and rises
in costs, follow the leader or herding instincts among investors, mis-estimating of the risk or
loss selling, winning investments too soon and offering losing investments past the point of
no return or the risk of loss, differing preferences among investors for cash dividends, belief
in the value of time expansion (that hazard lessens with time), popular investments earning
poorer than expected returns, investors mixing up "great" organizations for "good"
investments, asset prices appearing to over-or under respond to new market , individual
investors holding insufficiently widened portfolios and a prevalent short-run and second rate
long-run execution of initial public offerings . Because of the inadequately expanded
portfolio the financial specialists suffer misfortunes both in present moment and long-haul
periods. This happens in light of the fact that the investor encounters particular inclinations
and select portfolios that they acknowledge are favorable (Nyankundi, 2017).

1.2 Statement of the problem

Economic theory asserts that financial specialists are rational, and that they are objective in
the decision-making process. However, different authors who have investigated investor
behavior state that heuristic driven biases and emotions cloud the investors’ judgment, and
often negate the rules of rational economic decision making. Investors are irrational, and are
enormously affected by social factors that present predispositions in their choices.

Kahneman and Tversky (1979) stated that human behavior does not always depend on a
logical base as stipulated by conventional financial theories and may move away from
rational behaviors in time. It is known that there are many great factors limiting, and directing
individual investors who invest in financial markets and restraining them from behaving
rationally (Camerer, 1995; Loewenstein, 1999). Behavioral finance focuses on the social and
psychological determinants of investment decision making.

As a rule, financial specialists don’t know about their wrong practices. If investors are aware
of their psychological biases by knowing their own identity, they can settle their financial
decisions in a more conscious way. Thus, this way of thinking reduces their perception
failures and increases the quality of their decisions. In the event that an investor realizes
himself better, so he can acquire more, or he can maintain his wealth (Zweig, 2011).

Using behavioral economics, we can appreciate how these mix-ups rise, why they persevere,
and what should be possible to limit them. Investment decisions have a great impact on the
economy as a whole yet scholars world over have applied traditional finance models to
explain the issues that influence the decision-making process with less emphasis on
behavioral aspects inherent in the decision makers‟ environment (Barber & Odean, 2012). It
is on this basis that this study will seek to determine behavioral biases influencing individual
investors when making investment decision on the Nairobi Securities Exchange.

Wamae (2013) examined herding, prospecting, and risk aversion and anchoring. She found
out that all the factors affect investment decisions, with herding having the most impact,
followed by prospecting, anchoring and finally the risk aversion factor has the least impact.
Bashir, Rasheed, Raftar, Fatima and Maqsood (2013) studied behavioral biases, including
overconfidence, confirmation, illusion of control, loss aversion, mental accounting, status quo
and excessive optimism on investors‟ financial decision making. Results revealed that
overconfidence, illusion of control, confirmation biases and excessive optimism had an
impact on investors’ decision making. While loss aversion and mental accounting biases had
a positive influence but no impact on investors‟ decision making.

Shikuku (2014) studied the effect of behavioral factors on the choices of individual investors
at the NSE. Questionnaires were issued to 63 individual investors, and further data collection
supplemented through interviews. Correlation analysis and descriptive statistics were used in
data analysis. Herding ,loss aversion ,price changes, regret aversion, market information,
overconfidence, past stock trends and anchoring were found to greatly influence investment
decisions, while mental accounting was revealed to least influence individual investor
behavior.

Islamoglu, Apan and Ayvali (2015) identified social factors such as the trading frequency of
the investor, media and social interaction that affect individual investors’ decisions.
Tabassum,Sultan and Pardhasaradhi (2012) surveyed the factors that influence Indian
individual equity investors in decision making and investment behavior. Out of 40 attributes,
forty-two percent of the respondents stated that their investment decisions were influenced by
accounting information, while thirty-two percent said their influence was majorly from
financial and personal needs. The remaining percentages were influenced by
recommendations, company information and the image of the company.

Islamoglu et al. (2015), Tabassum et al. (2012) identifies media focus on the stock market,
government policy, political stability, investors risk tolerance, referrals by family members’
and co-workers and accounting information as the factors that affect individual investor’s
decisions.

Ongoing exploration demonstrates that the normal financial specialist settles on choices
dependent on feelings, not rationale, most investors purchase high on hypothesis and sell low
in frenzy mode. The main reasons for the variance are the tendency for the average investor
to sell after a stock price has fallen a long way and then buy back into the market after it has
already raised a large amount. Effectively the average investor is buying high and selling low,
and thus making losses. In addition, the investors go for lesser risky investment avenues so
that at least their principal amount is safe and they stay at breakeven point (Kumar & Kumari,
2017).

Panic selling by foreign investors’ is said to have occurred at the NSE following the
announcement of the 2017 August election results, and the annulment of the 2017 elections
by the supreme court on 1 September 2017. In line with the trading rules, NSE had to halt
trading for some hours, after the price of the NSE 20 share index fell by more than 5%. One
of the local dailies revealed that the NSE lost about fifty billion shillings within ten minutes
of the Supreme Court declaration. Political vulnerability during election results in economic
uncertainty, and this leads to an increase in an individual financial specialist hazard
avoidance level that means panicky selling.
Behavioral finance has been studied by various scholars and rich literature exists in this field.
However, most of these studies that have been conducted on behavioral factors affecting
individual investment decision have focused on investors’ who are conversant on how the
capital market works and have enough experience when making investment decisions, hence
forcing the less experienced investors’ to rely on financial analysts, family members,
colleagues, peers and financial reports when making investment decisions. In addition,
existence of financial behavioral traps has a major influence on investors when making a
decision such as being hasty, escape from regret, greed and escape from loss. Decision
making is a complex and challenging process, whereby various factors influence investors
differently due to age, sex, education level, experience and culture. The research gap cited in
existing literature was the basis of the study, providing a basis for mechanisms that can be put
in place to become aware of behavioral biases inherent within investors’ and how they can
work towards minimizing the negative effects of these biases on decision making.

An effective investment relies upon the assurance on the determination of psychological

biases as well as financial knowledge on the lowering of those biases. It is impossible that
people choose with no predisposition. However, the determination of those biases and
investment rules can enable the decrease of the predisposition. This study, therefore, seeks to
fill this gap. To achieve this, the study will examine the behavioral biases influencing
investment decisions made by USIU students.

1.3 General Objective of the study

The main objective of the study is to examine the influence of behavioral biases influencing
individual investments decisions by university students’ a case study of USIU.

1.4 Research Objectives

Particularly, this study sought to:

1.4.1 To determine the effect of overconfidence behavior on individual investors’ decision
making in the Nairobi Securities Exchange.
1.4.2 To determine the effect of anchoring behavior on individual investors’ decision making
in the Nairobi Securities Exchange.
1.4.3 To determine the effect of herding behavior on individual investor’s decision making in
the Nairobi Securities Exchange.

1.5 Significance of the study

The beneficiaries of this research are:

1.5.1 Investors
This study will help investors have a clear understanding of behavioral factors that do affect
their investment decisions, hence, will be able to minimize or avoid illusions influencing their
decisions when making an investment by drafting ideal strategies.

1.5.2 Researchers and scholars

This research will also help other individuals to evaluate their decision making process and
lower biases that may influence them hence make improvements where necessary. This
research paper will be available online for easy access by scholars and researchers.

1.5.3 Regulatory Authorities

Policy makers will be able to formulate better policies that remove the negative effects of the
behavioral factors identified in this study, during the policy formulation process, which as a
result leads to successful investment.

1.6 Scope of the Study

The focal point of this study is on student investors based in the United State International
University –Africa.

1.7 Definition of Terms

1.7.1 Behavioral Finance

Behavioral finance is the study of the influence of psychology on decision making in finance
related issues (Kimeu [Link], 2016). Proponents of the behavioral finance ideology state that
investment decisions are characterized by emotional factors such as endowment, loss
aversion, regret aversion and mental accounting, herding behavior and cognitive elements
consisting of overconfidence, gamblers fallacy and hindsight biases.

1.7.2 Investment
Thangamani (2014) defines investment as the act of putting money into something with the
expectation of returns or profits or growth in the worth of the funds employed. Funds are
committed on a long-term venture, with the expectation of future reward. Economists view
investments as the growth in capital stock, which are the goods and services used in the
production of other goods and services. This could mean an increase in inventory, machinery,
plant and buildings owned by the company.

1.7.3 Decision making

Decision making includes the processes and steps for analysis of various options (Anum and
Ameer, 2017). Every investor is keen on the kind of investment they want to venture into
because this indicates commitment of resources and funds in order to gain in the future.

1.7.4 Behavioral bias

Behavioral bias refers to the tendency of decision making which the outcomes in
unreasonable irrational financial decisions brought about by wrong cognitive reasoning or
thinking influenced by feelings (Pompian, 2012).

1.7.5 Overconfidence

Subash (2012) defines overconfidence as the unjustified faith in one’s own cognitive abilities,
predictive abilities and judgment and reasoning process.

1.7.6 Anchoring

According to Sapadin (2013) anchoring is a cognitive bias that impacts one to depend too
intensely on the first piece of information they get.

1.7.7 Herding

Herding is the tendency of people to mimic a group behavior when individually a different
course of action was to be pursued.
1.8 Chapter Summary

The section has given a background of the thesis by featuring a portion of the past of the
previous research on behavioral finance. In doing so the section briefly stated implications for
the practice of investment decision making, the contention that psychological forces hinder
decision makers from acting in a rational manner.
In section 2 a detailed theoretical survey is given on the impacts of behavioral biases on
investment decision making. It also, outlines the conceptual framework utilized in this study.