ISSN (Print): 2788-8320 ISSN (Online): 2788-8339

ASSESSMENT OF INVESTORS' INVESTMENT BEHAVIOUR: MEDIATING EFFECT

OF RISK TOLERANCE: A CASE OF PAKISTAN STOCK EXCHANGE

Waqas Patras1, Akhtar Rasool2 & Muhammad Idrees3

1MS Scholar, Hailey College of Commerce, Lahore, Punjab, Pakistan
2Lecturer in commerce/ Assistant Director Colleges Bhakkar District, Pakistan
3Assistant Accountant, Chaudhary Enterprises Manufacturer & Exporter, Punjab, Pakistan

KEYWORDS ABSTRACT
Investment This study aims to investigate the role of risk tolerance as a mediator in the
Behavior, Market investment choices of retail investors on Pakistan Stock Exchange. Research
Factors, addresses criticisms of the descriptive theories in behavioral economics and
Organizational emphasizes the importance of understanding factors that impact consumers'
Factors, Personal financial decisions for a more efficient and stable financial system. The study
Factors, Risk
Tolerance
analyzes organizational, personal, and market factors to determine relative
significance. Sample for this study consists of individual investors actively
trading on Pakistan Stock Exchange. The findings indicate that individual
investors' investment behavior is mainly swayed by market factors, personal
characteristics, and organizational context. Study findings hold value for
various stakeholders, including investors, brokerage companies, managers,
and government officials. By utilizing these findings to inform their decision-
making processes, these stakeholders can make more informed choices. Thus,
understanding the role of risk tolerance and the influence of different factors
contributes to development of a stronger and more knowledgeable financial
system.

2023 Journal of Social Research Development

Correspondence Waqas Patras
Email: [email protected]
DOI https://doi.org/10.53664/JSRD/04-02-2023-07-305-315

INTRODUCTION
The volatility and uncertainty in the financial market result in significant fluctuations in turnover.
These fluctuations are primarily caused by human behavior, which has been a subject of concern for
some time. Thus, investment returns often fall short of expectations (Huang, Tang & Zhang, 2020).
The investors, being human, sometimes make irrational decisions influenced by emotions and social
factors, as shown by research. The decision-making process is influenced by cognitive and emotional

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aspects. This phenomenon is explained by the emerging field of Behavioral Finance, which suggests
that psychological factors play role in decision-making (Rafay & Mustafa, 2023). The importance
of institutional and individual investors in Pakistan's stock market should not be underestimated
(Ahmad, 2017). Although institutional investors have larger portfolios compared to retail investors,
understanding retail investors is vital as they have disproportionate impact when shared (Khurshid
& Ahmad, 2023). Those studying financial markets often assume that the institutional investors are
better informed and actively counteract excessive interest of retail investors. This leads to insight
that retail investors are either poorly educated or torn between conflicting desires and outcomes
(Hussain & Rasheed, 2023).

Retail investors face additional challenges compared to fund managers when making investment
choices, as they lack comprehensive knowledge and official data, resulting in illogical and hasty
decisions (Lu, 2010). The behavioral finance suggests that many investors are risk-averse and easily
influenced by others' opinions, leading to biases in their investment decisions (Hussain & Rasheed,
2023). Impact of psychological and emotional factors can result in irrational investment behavior
among individual investors. Making informed investment decisions requires factual information,
logical thinking, and proper data analysis (Mirzazadeh, Yazdani, Khanmo & Dastnaee, 2023). Due
to lack of knowledge in balancing expected returns with risk tolerance, individual investors often
make poor investment decisions and fail to achieve their financial goals. To understand functioning
and volatility of stock market, it is crucial to consider the role of human nature (Rafay & Mustafa,
2023). Understanding how different demographic groups of investors are influenced by behavioral
aspects is essential for gaining insights into investor behavior. In this connection, extent of investors'
past experiences in making investment decisions and their exposure to different market conditions.
Although, the impact of behavioral biases upon investment choices has been extensively studied in
the advanced economies, only limited research is available for the emerging nations like Pakistan
(Khurshid & Ahmad, 2023).

According to Hudson, Yan and Zhang (2020), Pakistani investors often make decisions based upon
crowd behavior. Moreover, cultural differences, values, infrastructure of financial markets, financial
literacy, and education levels necessitate separate studies for developing countries, as research
conducted in industrialized nations cannot be directly extrapolated (Hussain & Rasheed, 2023).
The risk tolerance refers to an investor's willingness to take on risk or uncertainty in their investment
choices. It plays crucial role in shaping investment behavior and act as mediator between various
factors and investment decisions (Khurshid & Ahmad, 2023). The financial objectives investors aim
to achieve over their investments, such as capital growth, income generation, or risk mitigation. The
aim of this research is to examine intermediary function of risk tolerance in relation to investment
decisions made by retail investors in the Pakistan Stock Exchange. The level of knowledge investors
possesses about investment strategies, financial markets and instruments. Organizational, individual,
and market factors was extensively analyzed to determine their relative importance. The investors,
brokerage firms, management, corporate governance, and governments can benefit from this study
by gaining valued knowledge that can lead to informed and effective decision-making, ultimately
contributing to stable market.

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LITERATURE REVIEW
A wide range of variables are influencing investors' choices in stock buying. Parveen, Satti, Subhan,
and Jamil (2020) conducted research in Pakistan to recognize how representational bias, heuristics,
and overconfidence affect investor behavior. The study revealed that these factors have significant
impact on stock selection choices of Pakistani investors. Another study focused on the relationship
between financial education and success of Chinese investors (Jiang, Liao, Wang, & Xiang, 2020).
The findings indicated that financially knowledgeable retail investors give more consideration to
their investment decisions, which can potentially enhance their wealth. Huang, Tang, and Zhang
(2020) found that the investors' investment decisions are highly influenced by their search for the
information about different investment opportunities. In United Kingdom, separate research was
conducted to investigate how herd behavior influences the choices made by mutual fund investors.
The findings indicated that herding has a major impact on investors' choices (Hudson et al., 2020).
Similarly, the recent study focused upon how Arab women invest their money and found that the
confidence, risk tolerance, herding, and financial knowledge significantly impact women investors'
behavior (Salem, 2019). According to Ahmad (2017), organizational and market aspects have most
influence on investors' choices.

Azam and Kumar (2011) conducted study upon the factors that affect investors' decisions and found
that macroeconomic variables, such as growth rate of earnings per share, foreign direct investment,
and gross domestic product, significantly influence companies' share prices on the KSE (Caracas
Stock Exchange). Financial statements play crucial role in informing the stakeholders and investors
about a company's financial health, thereby heavily influencing investors' choices (Hillenbrand &
Schmelzer, 2017). Various academics have studied the characteristics of investors' personalities and
found that issues in their relationships with other investors and firms greatly influence the investor
behavior (Bucciol & Zarri, 2017). Aytaç, Coqueret, and Mandou (2017) conducted research on herd
mentality and outlook of wine investors. Babatunde and Razali (2016) led research suggesting that
investors should consider company's dividend, predict rate of return, and financial stability when
making investment decisions. Company culture can also influence investor behavior (Chang & Lin,
2015). Levinson and Peng (2007) examined that how different cultures influence Americans' and
Chinese individuals' approaches to money, revealing cross-cultural differences in biases associated
with framing and ethical caliber.

Hossain and Nasrin (2012) conducted research in Bangladesh and identified 8-influential factors
affecting investor retention. A study by Hoffmann, Post, and Pennings (2015) found that high-risk
investors are increasingly investing in stocks to maximize their profits. Ahmad (2017) found that
investors rely more on the advice of financial advisors and friends rather than family members when
making investment decisions. Moreover, investment choices are positively related to one's comfort
level with risk. Stock market data is frequently utilized by investors, and the actions of traders can
be impacted by changes in stock prices (Waweru, Munyoki, & Uliana, 2008). According to Shafi's
(2014) research, news coverage & involvement of government officials play vital role in investment
decision-making. Religious convictions can significantly influence investors' actions (Lein, Turk, &
Weill, 2017). Merika (2016) found that market movements during the survey period had impact on

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economy, emphasizing importance of understanding the country's financial and economic situation
for making better investment decisions. Maini (2017) validated that market pricing volatility plays
crucial role in individual investors' choices, particularly at Tehran Stock Exchange, where political
and psychological elements heavily influence decisions due to a lack of information objectivity and
financial professionals.

Mahfudh (2016) conducted study at Nairobi Securities Exchange and found significant correlation
between investors' levels of financial literacy and their investment decisions. Muhammad and Khan
(2018) used samples of the students, professors, and people with expertise in investing to explore the
association between financial literacy and desire to invest. Another study focused on relationship
between financial education and success of Chinese investors (Jiang, Liao, Wang, & Xiang, 2020).
Behavioral finance, which encompasses various approaches, offers insights into how people make
financial decisions (Mak & IP, 2017). In the Pakistani stock market, the traders are susceptible to
representativeness bias, as indicated by research conducted by Irshad et al. (2016). Risk tolerance
refers to an investor's willingness to take on risk or uncertainty in their investment choices. It plays
crucial role in shaping the investment behavior and act as a mediator between various factors and
investment decisions (Khurshid & Ahmad, 2023). Hussain et al. (2017) identified three heuristics
that expectedly influence investors' decisions, with higher-educated and more experienced investors
being less susceptible to these heuristics. Scholars used mixed-methods approach to test prospect
theory in Pakistan stock market, considering multiple factors that influence investment decisions of
Pakistani retail investors.

RESEARCH METHODOLOGY
This study employed quantitative methods to investigate the relationship between behavioral
characteristics and the investment decisions of individual Pakistan Stock Exchange (PSX) investors.
The population under investigation consisted of the private individuals who had engaged in PSX
transactions. The sample was derived from individuals actively trading on the PSX in the Lahore
stock exchange area, using convenience and snowball sampling methods. Total 350 questionnaires
were distributed to investors, resulting in 311 usable responses. The sample selection was guided by
item-rate theory. To assess individuals' investment behavior, the modified questionnaire was used,
consisting of two distinct dimensions. The first section examined the behavioral biases of individual
investors, focusing on the impact of accounting data, firm image, firm culture, individual investor
financial requirements, consultation, self-image, market data and uncertainty, risk tolerance, and
investment decisions. Second section gathered essential demographic information, including age,
gender, salary, and years of work experience. A revised questionnaire was designed to correspond
with the five behavioral bases of individual investors outlined by DAS (2012) and Hussein, Hassan,
and Tamimi (2006). This questionnaire incorporated insights from relevant literature sources to
evaluate investors' fundamental decision-making. Various data analysis tools and methodologies
were employed to ensure the accuracy of collected data. The analysis included reliability analysis,
descriptive statistics, correlation, and regression. The IBM's SPSS statistical package was utilized to
analyze the data for this study.

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RESULTS OF STUDY
Table 1 Frequency Analysis
Variable Frequency Percent
Gender
Male 210 67.52
Female 101 32.48
Age of Respondents
20-30 88 28.29
31-40 112 36.01
41-50 85 27.33
51-above 26 8.37
Table 1a Frequency Analysis
Variable Frequency Percent
Education
Bachelor Degree 19 6.10
Master 203 65.27
MS 55 17.68
Doctorate 20 6.44
Diploma 14 4.51
Investment Experience
< 10 years 163 52.41
11 – 15 years 92 29.58
> 16 -25 years 39 12.54
> 25 years 17 5.46
The demographic profile of the respondents is illustrated in Table 1 & 1a. The results indicate that a
significant proportion of the participants are male, comprising 67.52% of total sample. Moreover,
the table illustrates that a significant proportion of the participants belonged to the age group of 31
to 40 years (36.01%), with the majority holding a Master's degree (65.27%). The findings indicate
that a majority of the participants (52.41%) possess less than 10 years of investment experience) in
the present study.
Measurement Model for Lower-Order Construct
According to Yamamoto et al. (2014), outer factor loading represents how much item contributes to
the formation of each latent variable. The minimum requirement for the outer loading is 0.7, so the
researcher excluded all those items whose outer loading is less than 0.7. Table 2 shows the construct
reliability of the variables which clearly state that all the variables are reliable for further analysis
in the present research.
Table 2 Construct Reliability
C-Alpha RHO_A CR AVE
Investors Behavior 0.809 0.815 0.869 0.572
Market Factors 0.832 0.824 0.831 0.714

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Organizational Factors 0.804 0.807 0.706 0.569

Personal Factors 0.713 0.715 0.785 0.556
Risk Tolerance 0.878 0.886 0.902 0.585

The average variance extracted uses for purpose of analyzing construct validity. As per Alarcón et
al. (2015), it should be more than 0.5. Table 3 represents AVE of lower-order construct that is almost
more than 0.5. VIF is normally used by the researcher for the purpose of analyzing multicollinearity
of items. VIF should be less than five that shows no multicollinearity amid indicators. Table 3 shows
VIF table of the measurement model.
Table 3 Average Variance Extracted (AVE)
Average Variance Extracted (AVE)
Investors Behavior 1.68
Market Factors 1.91
Organizational Factors 1.63
Personal Factors 1.39
Risk Tolerance 1.66

Table shows the results of HTMT for purpose of checking discriminant validity between constructs.
The figures of HTMT should be less than 0.9, and if it is more than 0.9, it means the data do not have
discriminant validity.
Table 4 Construct Validity (HTMT)
Investors Market Organization Personal Risk
Behavior Factors Factors Factors Tolerance
Investors Behavior
Market Factors 0.194
Organizational Factors 0.558 0.797
Personal Factors 0.208 0.177 0.364
Risk Tolerance 0.275 0.423 0.443 0.383

The discriminant validity using Fornel and Larcker. This is achieved by comparing the square root
of each Average Variance Extracted (AVE) in the diagonal with the correlation coefficients (off-
diagonal) for each construct in the relevant rows and columns. In summary, the measurement model
demonstrates the desired acceptable discriminant validity, thereby supporting the distinctiveness
of the constructs.
Table 5 Discriminant Validity_ Fornell Larcker Criterion
Investors Market Organization Personal Risk
Behavior Factors Factors Factors Tolerance
Investors Behavior 0.756
Market Factors 0.936 0.845
Organizational Factors 0.423 0.496 0.685
Personal Factors 0.813 0.829 0.836 0.746
Risk Tolerance 0.229 0.293 0.703 0.607 0.696

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Assessment of Structural Model

Table 6 Path Coefficients
OS SM SD TS PV
Market Factors -> Investors Behavior 0.459 0.446 0.074 6.209 0.000
Market Factors -> Risk Tolerance 0.452 0.442 0.078 5.818 0.000
Organizational Factors -> Investors Behavior 0.447 0.469 0.042 11.192 0.000
Organizational Factors -> Risk Tolerance 0.351 0.366 0.086 4.085 0.000
Personal Factors -> Investors Behavior 0.899 0.906 0.077 11.631 0.000
Personal Factors -> Risk Tolerance 0.688 0.666 0.152 4.523 0.000
Risk Tolerance -> Investors Behavior 0.422 0.419 0.023 10.272 0.000

Table 6 shows results extracted from PLS-SEM for purpose of showing the significance regarding
impact of exogenous variables on endogenous variables. Table shows that variables have significant
impact on endogenous variables. The researcher accepts H1 as behavioral biases affect investment
decisions at 0.1 level of significance.
Table 7 Mediation Analysis (Risk Tolerance)
OS SM SD TS PV
Market Factors -> Risk Tolerance -> Investors Behavior 0.055 0.053 0.015 3.649 0.000
Organizational Factors -> Risk Tolerance -> IB 0.043 0.042 0.009 4.559 0.000
Personal Factors -> Risk Tolerance -> Investors Behavior 0.084 0.081 0.028 2.974 0.003

Table 7 shows mediation analysis through the path coefficients. The results show that risk tolerance
plays its role as mediator variable between all exogenous variables (Personal, organizational and
market factors) & endogenous variables that are investment behavior. Based upon these results, the
researcher accepted the research hypothesis H2 .
Figure 1 Structural Equational Modeling

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DISCUSSION
This research reveals that individual investors in Pakistan are influenced by the market variables,
organizational factors, and personal factors. These findings are consistent with the previous studies
conducted by Chandra and Kumar (2011). Also, Sara (2017) observed that political, environmental,
innovative social, and legal issues play a role in the decision-making of private investors in the JSX.
Further support for this theory comes from the discussion of Malaysian investor behavior by Chong
and Lai (2011). The research conducted in this study emphasizes that profit/return is a crucial factor
for individual investors in Pakistan, which aligns with the findings of Azam and Kumar (2011) and
Tanha and Halid (2011) in their research on PSX and KSX, respectively. The influence of personal
bias as a significant element is reflected in investors' preconceived notions that certain firms offer
superior returns on ad hoc basis. This finding is consistent with a similar study conducted by Hussein
and Hassan (2006) on the stock market in the United Arab Emirates. However, the present study's
findings do not align with certain previous studies. Researchers Sultana and Pardhasaradhi (2010)
and Chou, Huang and Hsu (2010) studying Taiwanese investors that personal investing experience
can alter one's perception of risk. Thus, these studies indicate that the firm's organizational aspect
significantly impacts investor behavior. Furthermore, results suggest that investor decision-making
is heavily influenced by the market knowledge and uncertainty, as indicated by the state of market
variables (Chang & Lin, 2015).
CONCLUSION & IMPLICATIONS
This study concludes by investigating the role of risk tolerance as a mediator for retail investors on
the Pakistan Stock Exchange, thereby contributing to the comprehension of investment decisions.
By addressing criticisms of descriptive theories in behavioral economics, the research emphasizes
the significance of the understanding the factors that influence consumers' financial decisions for a
more efficient and stable financial system. The relative significance of organizational, personal, and
market factors is illuminated by their analysis. Thus, individual investors' investment behavior is
predominantly influenced by market factors, personal characteristics, and organizational context,
according to the findings as it influences of personal bias that reflected in investors' preconceived
notions for superior returns. Besides, risk tolerance emerges as an important mediator between these
variables. This emphasizes significance of contemplating a person's risk tolerance when analyzing
their investment options.
However, this research has limitations. First, research concentrates exclusively on retail investors in
the Lahore stock exchange area, which may limit the applicability of the findings to other regions
or categories of investors. In addition, study relies on self-reported data, which may contain errors or
biases. Future research could consider increasing the sample size and incorporating a variety of
investor profiles to increase the external validity of the study. In this connection, the implications of
this research for various stakeholders are noteworthy in diverse contexts. Investors can benefit from
a deeper comprehension of their risk tolerance and how it impacts their investment decisions. These
findings can be utilized by brokerage firms and administrators to modify their services, policies and
strategies to the requirements of the individual investors. In order to promote a more informed and
resilient financial system, government officials can consider integrating these insights into financial
regulations and policies.

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