Journal of Positive School Psychology http://journalppw.

com
2022, Vol. 6, No. 3, 6685–6697

Examining the Role of Behavioural Biases in Financial Decisions: A

Literature Review

Vishal Sharma Rajesh Kumar*

Himachal Pradesh University Business Himachal Pradesh University Business
School, Shimla School, Shimla
Himachal Pradesh University, Shimla, India Himachal Pradesh University, Shimla, India
Email: [email protected] Email: [email protected]

Abstract
Aim of the study: The study's main objective is to identify the behavioural biases in the
available literature on behavioural finance and study their role in financial decision-
making. The study also highlights the significant gaps for future research in behavioural
finance.
Methods: The study has used a seven-step methodology to identify behavioural biases
and their role in financial decisions and find significant gaps for future research. Articles
available in the behavioural finance literature have been used for the study. The study has
used 70 articles from various databases, ranging from 1970 to 2021.
Results: The study found 17 common behavioural biases that influence the financial
decisions of individuals. These behavioural biases include both cognitive and emotional
biases. Behavioural biases have a significant influence on the various aspects of financial
decisions. The study concluded that behavioural biases could not be ignored when
making financial decisions due to significant influence. Understanding and awareness of
these behavioural biases can enhance individuals' overall financial well-being.
Original value: The study contributes to the literature by identifying the common
behavioural biases and their role in financial decisions and found gaps for further
research. The study's findings can be used to study the behavioural biases in further
research.
Keywords: Behavioural biases; Behavioural finance; financial behaviour; cognitive
biases; emotional biases; financial decisions
1. Introduction from various other disciplines such as
psychology, sociology, and finance (Ritika &
Financial markets have evolved over a period, Kishor, 2020). Kahneman & Tversky (1979)
and available information is also becoming proposed prospect theory that explains
complex because now individuals have a people’s behaviour while valuing gains and
choice to choose from various options in the losses. This theory states that people give
financial markets (Sahi, 2017). In traditional different-different weights to the profits and
finance, it was assumed that human beings are losses of the same value. According to Simon
rational, and they take decisions only after (1979), humans have a limited capacity to
analysing the best possible information process all the information, and it is not
available (Mittal, 2019). Fama (1970) possible to take full rational decisions.
proposed the efficient market hypothesis Humans make more satisfying decisions than
which states that markets are efficient, and rational decisions, known as bounded
prices reflect all the available information. rationality. This leads to psychological errors
This rationality of individual decisions was in financial decisions as well. The role of
challenged in the late 20th century, and behavioural biases cannot be ignored when it
behavioural finance emerged as a field of comes to decisions related to finances (Singh
study. Behavioural finance is an & Jain, 2021). Behavioural biases are some
interdisciplinary approach that derives its roots irrational beliefs that affect the decision-

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making process of a human being. Due to Awareness of these behavioural biases helps
behavioural biases, humans commit errors as individuals and financial planners better
these biases alter the capacity of human beings understand financial matters and make sound
in the decision-making process (Bagde et decisions.
al.,2021). The financial decisions of 2. Rationale and objectives of the study
individuals are affected by two kinds of
behavioural biases, errors due to faulty Financial decisions are crucial in human life
reasoning, known as cognitive biases and because they affect almost all areas of life.
mistakes due to emotions, known as emotional Every day humans make financial decisions
biases (Sahi, 2013). related to investments, debt, spending, long
Cognitive biases such as conservatism bias, term financial planning that affects their
confirmation bias, representative bias, overall financial well-being. Humans try to be
anchoring and adjustment bias, availability rational in their decisions, but the emotional
bias, self-attribution bias, ambiguity-aversion part of the human mind also plays an essential
bias, herding bias, mental accounting bias and part in decision making. Human psychology
emotional biases such as loss aversion bias, has an essential role in the decisions making of
overconfidence bias, self-control bias, status individuals, so it is essential to be aware of the
quo bias, regret aversion bias (Ritika & biases that affect financial decisions. The main
Kishor, 2020) can influence the financial objective of this study is to identify the
decisions of individuals. These behavioural behavioural biases and how they affect the
biases affect investment-related decisions and financial decisions of individuals with the help
other financial matters like debt, insurance of a literature review. The study also
planning and retirement planning. Behavioural highlights the significant gaps in behavioural
biases have a significant influence on buying finance for future research.
insurance, and it influences the chance of 3.
wrongly calculating risk, which increases the Research Methodology:
likelihood of underinsurance (Pithhan and
Witte, 2021). Long-term financial decisions This research is based on the secondary data
require much complex information and time to available in the literature. Secondary data was
analyse all the dimensions of financial collected through articles published in
decisions. Individuals prefer to use shortcuts to academic journals to study behavioural biases.
make long term financial decisions like The studies related to behavioural biases and
retirement planning. Due to behavioural biases their role in financial decisions have been
such as lack of self-control, people explored in the behavioural finance literature,
overestimate their financial knowledge while which ranges from 1970 to 2021. The articles
taking decisions related to retirement planning have been collected from databases such as
which results in errors and lower returns over a Emerald, Elsevier, Google Scholar, Semantic
more extended period (Trehan& Sinha, 2020). Scholar, JSTOR, Taylor and Francis and
Individual needs appropriate financial Science Direct. The keywords are identified
planning to be stress-free from the side of and used in search of databases are
finances. Still, people see financial planning as behavioural biases, cognitive biases, emotional
overwhelming, scary, and intimidating because biases, heuristics, financial decisions, and
of psychological beliefs, impacting their financial planning. Only those articles are
overall economic well-being (Baker, 2015). selected in the study that is specifically related
Financial decision making is a complex to the study of behavioural biases. The seven-
process but necessary. These decisions require step methodology has been used in the study is
much seriousness from the side of individuals. as follows:
To ensure that financial decisions are correct
and as per the needs and goals of individuals,
understanding behavioural biases is essential.

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6687 Journal of Positive School Psychology

Figure 1
Seven step methodology used by researcher

Research objectives

Search of keywords in database

Identified articles
Selection of articles

Identified behavioural biase and their role

Theoretical model proposed

Future scope of research

Table 1
Year-wise classification of articles used in the study
Year of Publication No. of Articles
1970 1
1979 1
1985 1
1988 1
1991 1
1994 1
1995 1
1998 2
1999 1
2001 2
2003 1
2005 4
2006 3
2007 2
2009 1
2010 2
2011 3
2012 2
2013 4
2014 2
2015 5
2016 3
2017 3
2018 6
2019 7
2020 3
2021 7
Total 70

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Table 2
Variable wise classification of articles used in the study
Behavioural biases No of Articles
Confirmation bias 3
Conservatism bias 3
Representativeness bias 5
Availability bias 6
Anchoring bias 3
Hindsight bias 4
Self-attribution bias 5
Herding bias 6
Mental accounting 8
Ambiguity aversion bias 3
Disposition effect 7
Framing bias 4
Loss aversion bias 4
Self-control bias 6
Overconfidence bias 6
Status quo bias 6
Regret aversion bias 4

Table 3
Top five articlesby citation score
Title Author Journal Citations
Prospect theory: An Kahneman & Econometrica 71435
analysis of decision Tversky, 1979
under risk
Efficient capital Fama, 1970 The Journal of Finance 33179
markets: A review of
theory and empirical
work
Mental accounting and Thaler, 1985 Marketing Science 8209
consumer choice
The endowment effect, Kahneman et Journal of Economic 7093
loss aversion, and status al., 1991 Perspectives
quo bias
Status quo bias in Samuelson Journal of Risk and 6598
decision making &Zeckhauser, Uncertainty
1988

4. Review of literature 2013). Jones et al. (2001) stated that if the

information is presented sequentially rather
4.1 Confirmation bias: In confirmation bias, than simultaneously, people represent a strong
people select only those ideas that validate preference for existing information, reflecting
their existing beliefs and ignore those that that confirmation bias is due to the sequential
disapprove of them (Ritika & Kishore, presentation of information rather than the
2020). People actively search for information sequential processing of information.
that confirms their existing beliefs and
viewpoints, allowing them to believe that 4.2 Conservatism bias: This bias refers to the
others share similar viewpoints(Sahi et al., tendency of people not to update their prior

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6689 Journal of Positive School Psychology

beliefs and stick with their existing beliefs. In phenomena, and it is not a unitary
financial decisions, investors may stick to phenomenon (Epley & Gilovich, 2006).
prior forecasts and underestimate the effect of
the new lousy forecast (Luo, 4.6 Hindsight bias: Hindsight bias occurs
2012). Irrespective of providing new evidence, when people think that they could easily
people hesitate to change their prior predict a particular event after an event, which
viewpoints and stick to the prior also refers to knowing it all along with
probabilities (Hoppe &Kusterer, phenomena (Roese&Vohs, 2012). Hindsight
2011). Conservativism bias depends on the bias reduces volatility estimates from the side
personality type of individuals (Moradi of investors, and it results in poor choice in the
&Mostafaei, 2013). portfolio, overtrading and poor risk
management (Biais& Weber, 2009). There are
4.3 Representative bias: Representative bias three levels of hindsight bias: inevitability,
refers to the tendency of people to give memory distortion and foresee ability (Kelman
weightage to past events while interpreting et al., 1998; Nestler et al., 2010).
future events (Busenitz, 1999). In this bias,
investors think that a company's past 4.7 Self-attribution bias: This bias refers to
performance represents future the tendency of people to give credit to success
performance (Boussaidi, 2013). Due to to their skills and put the reason for failure on
representativeness bias, investors violate external factors(Hoffmann & Post,
traditional financial theory (Toma, 2014). Self-attribution bias consists of self-
2015). Representative bias is found more in enhancing bias, the irrational tendency to take
individual investors, not in institutional credit, and self-protecting bias, which is the
investors (Chen et al., 2007). Due to this bias, irrational tendency not to take responsibility
people make extreme forecasts based on the for failure (Mishra &Metilda, 2015). Traders
available information (De Bondt& Thaler, with self-enhanced bias tend to underperform,
1994). but self-protection bias harms their
performance (Czaja& Order, 2020). Due to
4.4 Availability bias: In availability bias, self-attribution bias, investors do not learn
people rely on existing available information from their mistakes (Mahina et al., 2018). Self-
instead of examining the other possible attribution bias can deviate investors from
alternative (Javed et al., 2017). In investing, reality and is more potent than overconfidence
people make decisions based on information bias (Naveed &Taib, 2021).
that is easy to recall (Sahi et al., 2013). Salman
et al. (2021) reported the existence of 4.8 Herding bias: Herding bias refers to the
availability heuristics among investors with an tendency of people to follow the crowd by
external locus of control. During the covid 19 observing and imitating their behaviours (Yu
pandemic, availability bias was enhanced et al., 2018; Madaan& Singh, 2019). In
among investors who preferred available herding bias, rational people start behaving
information to make decisions (Kathpal et al., irrationally because they imitate the actions of
2021). Due to this bias, investors take more others while taking their financial
risk after a gain, and after a loss, they take less decisions (Kumar & Goyal, 2015). Stocks
risk (Mittal, 2019). A risky event having a show extreme volatility when masses react
significant impact on communication, vivid quickly to an event simultaneously because of
memories and coverage in media increases the the herd mentality (Javed et al.,
demand for insurance due to availability 2017). Investors having low self-confidence
heuristics (Pitthan& Witte, 2021). shows herd behaviour more often in financial
markets (Kubiley&Bayrakdaroglu,
4.5 Anchoring bias: In anchoring bias, people 2016). There is a high degree of herding bias
rely on the first piece of information they among short term investors than long term
get (Shin & Park, 2018). This bias arises due investors (Lakshmi et al., 2013).
to a lack of information and
knowledge (Kubiley&Bayrakdaroglu, 4.9 Mental accounting bias: Mental
2016). All anchoring effects among investors accounting bias refers to the tendency of
do not result from the same psychological people to give different weightage to the same
among of money based on various subjective

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 Vishal Sharma, et. al. 6690

criteria (Thaler, 1985; Bagde et al., 2021; 2021). How insurance investors act towards a
Ritter, 2003). Individuals divide their financial particular opportunity depends on how
assets and liabilities into different parts, information is presented in front of
considered mental accounts (Baker et al., them (Badge et al., 2021). The intensity of
2015). Due to mental accounting, people framing bias depends on the context, and
separate the decisions that could be individual characteristics are the main
combined (Ritter, 2003). Mental accounting determinants of framing bias (Tabesh et al.,
bias largely influences individuals' financial 2019).
planning process (Mahapatra et al.,
2016). Investor behaviour is not only 4.13 Loss aversion bias: When individuals
influenced by the opening or closing of a feel more pain in losses than pleasure at the
mental account but also by the evaluation time of gains is known as loss aversion
frequency of a mental account (Zhang & bias (Benartzi& Thaler, 1995). People show
Sussman, 2017). Besides investing, mental more sensitivity to loss than gains of the same
accounting bias also influences individuals' amount (Barberis and Huang, 2001).
budgeting and spending behaviour (Zhang & Kahneman et al. (1991) and Moshinsky&
Sussman, 2018). Hillel (2010) reported that loss aversion bias
leads to another bias called status quo bias.
4.10 Ambiguity aversion bias: Ambiguity
aversion bias refers to the tendency of people 4.14 Self-control bias: Self-control refers to
to select known information over unknown the control of people on the postponement of
and uncertain information (Baltzer et al., current consumption for the future (Riaz &
2014). When people feel incompetent, they Iqbal, 2015; Xiao & Porto, 2019). People who
display ambiguity aversion bias (Dimmock, suffer from self-control can put high debt and
2016). When investors think that there is credit outstanding on them due to lack of self-
uncertainty in investment decisions, they avoid control (Sahi, 2017). Many people lack
that decision (Pompian, 2006). adequate savings for retirement due to this
self-control bias (Baker et al., 2015; Trehan&
4.11 Disposition effect: Disposition effect Sinha, 2020). Some people do not control their
bias in financial markets refers to the tendency tendency to spend money today, so they force
of investors to sell their profitable investments themselves to save and reduce their tendency
and hold on to loss-making to save (Sahi et al., 2013).
investments (Noviamggie&Asandimitra, 2019;
Baker et al., 2015; Barber &Odean, 4.15 Overconfidence bias:
2011). This behaviour of selling winners and Overconfidence bias refers to the tendency of
holding losers is not motivated by rebalancing people to overestimate their ability while
the portfolio but due to tax motivation (Odean, making decisions related to finances (Deaves
1998). Barberis&Xiong (2009) observed that et al., 2005). Investors who credit success to
annual gains and losses are unreliable in their skills and failure to bad luck are more
predicting disposition effect, realized gains prone to overconfidence bias (Chen et al.,
and losses are more reliable than unrealized 2007). Overconfidence bias helps investors
ones. Investors who show disposition effect in trust their abilities in managing their financial
their stock portfolios reflect contradictory affairs, enabling them to feel financial
behaviour in mutual fund choices which satisfaction (Sahi, 2017). Overconfidence is a
implies that the disposition effect is less significant bias affecting the decision making
frequent when the portfolio is managed of equity investors (Jain et al.,
professionally (Bailey, 2011). Sophistication 2019). Overconfidence investors
and trading experience can eliminate the underestimate their inability, and they suffer
disposition effect (Feng &Seasholes, 2005). from the winner’s curse (Biais et al.,
2002). Overconfidence is significant among
4.12 Framing bias: When information is people who are open to
presented positively, people act positively, and experience (Kubilay&Bayrakdaroglu, 2016).
if the same information is presented
negatively, people tend to react negatively, 4.16 Status quo bias: Status quo bias refers to
known as framing bias (Kahneman and the tendency of people to maintain their
Tversky, 1979; DoNascimento Junior et al., current state (Kahneman et al.,

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6691 Journal of Positive School Psychology

1991). Individuals who suffer from status quo of the individuals largely influences it. The
bias tend to choose the same option they have study found that people make decisions based
chosen earlier, even if that option is not on their beliefs and values. People are prone to
optimal (Kempf and Ruenzi, 2006). Status quo committing errors while processing financial
bias has a significant effect on the decision information that affects their financial
making of individuals (Samuelson decision-making process.
&Zeckhauser, 1988). People who have more
experience suffer from status quo bias because The study found that the psychology of
experience controls their thoughts (Burmeister individuals influences various aspects of
& Schade, 2007). Status quo bias is also a financial decisions. It is observed from the
result of the tendency of people to avoid losses study of literature that behavioural biases
and uncertainty (Rubaltelli et al., 2005). Status significantly influence the decisions related to
quo bias does not have a significant role in the investment planning, debt planning, insurance
non-optimal portfolio choices of planning, retirement planning and spending of
individuals (Filiz et al., 2018). individuals.

4.17 Regret aversion bias: Regret aversion The study found that behavioural biases are
bias refers to giving extra weight to regret present among all individuals to certain
arising from mistakes and bad degrees. The degree of behavioural biases
decisions (Kubilay&Bayrakdaroglu, 2016). To among individuals depends on the individual
avoid the pain of mistakes, individuals tend to experiences and personality. The study found
behave irrationally (Ritika and Kishor, that behavioural biases have a significant
2020). When people suffer losses in their relationship with individuals' level of financial
investments, they hesitate to take essential satisfaction. Based on the literature review, the
investment decisions because of fear of study found that behavioural biases are divided
regret (Sahi et al., 2013). Due to regret into two parts: cognitive biases and emotional
aversion bias, people do not take decisions that biases. Cognitive biases arise due to faulty
impact their future decisions (Zahera& Bansal, reasoning of individuals during the decision-
2018). making process, and emotional biases arise
due to emotional instincts.
5. Findings and Conclusion
The study found the following common
Financial decisions of individuals are not only behavioural biases based on the literature
influenced by the level of financial literacy review:
and knowledge they have, but the psychology

Table 4
Behavioural biases
Behavioural biases Literature Support
1. Cognitive biases
1.1 Confirmation bias Ritika and Kishore (2020); Sahi et al. (2013); Jones et al.
(2001)
1.2 Conservatism bias Luo (2012); Hoppe &Kusterer (2011); Moradi &Mostafaei
(2013)

1.3 Representative bias Busenitz (1999); Boussaidi (2013); Toma (2015); Chen et al.
(2007); De Bondt& Thaler (1994)
1.4 Availability bias Javedet al. (2017); Sahi et al. (2013); Salman et al. (2021);
Kathpal et al. (2021); Mittal (2019); Pitthan& Witte (2021)

6691
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 Vishal Sharma, et. al. 6692

1.5 Anchoring bias Shin & Park (2018); Kubiley&Bayrakdaroglu (2016); Epley &
Gilovich (2006)

1.6 Hindsight bias Roese and Vohs (2012); Biais& Weber (2009); Kelman et al.
(1998); Nestler et al. (2010)
1.7 Self-attribution bias Hoffmann & Post (2014); Mishra &Metilda, (2015); Czaja&
Order (2020); Mahina et al (2018); Naveed &Taib (2021)

1.8 Herding bias Yu et al. (2018); Madaan& Singh (2019); Kumar & Goyal
(2015); Javed et al. (2017); Kubiley&Bayrakdaroglu (2016);
Lakshmi et al. (2013)

1.9 Mental accounting Thaler (1985); Bagde et al. (2021); Ritter (2003); Baker et al.
(2015); Ritter (2003); Mahapatra et al. 2016; Zhang &
Sussman (2017); Zhang & Sussman (2018)

1.10 Ambiguity aversion bias Baltzer et al. (2014); Dimmock (2016); Pompian (2006)
1.11 Disposition effect Noviamggie&Asandimitra (2019); Baker et al. (2015); Barber
&Odean (2011); Odean (1998); Barberis&Xiong (2009);
Bailey (2011);Feng &Seasholes (2005)

1.12 Framing bias Kahneman & Tversky (1979); Do Nascimento Junior et al.
(2021); Badge et al. (2021); Tabesh et al. (2019)
2. Emotional biases
2.1 Loss aversion bias Benartzi& Thaler (1995); Barberis and Huang (2001);
Kahneman et al. (1991); Moshinsky& Hillel (2010)
2.2 Self-control bias Riaz & Iqbal (2015); Xiao & Porto (2019); Sahi (2017); Baker
et al. (2015); Trehan& Sinha (2020); Sahi et al. (2013)

2.3 Overconfidence bias Deaves et al. (2010); Chen et al. (2007); Sahi (2017); Jain et al.
(2019); Biais et al. (2005); Kubilay&Bayrakdaroglu (2016)

2.4 Status quo bias Kahneman et al. (1991); Kempf&Ruenzi (2006); Samuelson
&Zeckhauser (1988); Burmeister & Schade, (2007); Rubaltelli
et al. (2005); Filiz et al. (2018)

2.5 Regret aversion bias Kubilay&Bayrakdaroglu (2016); Ritika & Kishor (2020); Sahi
et al. (2013); Zahera& Bansal (2018)

The study concluded that the psychology of Individuals cannot ignore the role of
individuals significantly influences financial behavioural biases and financial advisors and
decision making. People carry irrational understanding these behavioural biases can
beliefs known as behavioural biases, including improve the financial decision-making
cognitive and emotional biases, which play an process.
essential role in their decision-making.

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6693 Journal of Positive School Psychology

6. Proposed Model
Figure 2
Behavioural biases and financial decisions: Proposed model by the researcher

Cognitive Biases:
Confirmation bias
Conservatism bias
Representative bias
Availability bias
Anchoring bias
Hindsight bias
Self-attribution bias
Herding bias
Mental accounting
Ambiguity aversion Financial
bias Decisions
Behavioural
Biases Disposition effect
Framing bias
Hindsight bias
Emotional biases
Loss aversion bias
Self-control bias
Overconfidence
bias
Status quo bias
Regret aversion bias

The above proposed modelby the researcher 7. Contribution of the study

depicts the behavioural biases affecting
financial decision-making based on the It is evident from the study that behavioural
academic literature related to behavioural biases significantly influence the financial
biases. Behavioural biases can be categorized decision making of individuals. Understanding
into two classes: cognitive biases and the technical part of finance is not enough for
emotional biases. Cognitive biases arise due to a sound financial future; at the same time,
faulty reasoning, whereas emotional biases understanding psychology is also very
arise due to emotions and intuitive judgements important for individuals and financial
in financial decisions. advisors. The study shall help the financial
services and advisory industry to understand

6693
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 Vishal Sharma, et. al. 6694

the behavioural biases that influence the Handbook of the Economics of

financial decisions of their clients that can help Finance, 2, 1533–1570.
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Long-Standing Preference-Based
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