Behavioral Biases and the Rationality in Stock Market Investments; Evidence from Sri Lanka

Abstract

Prospect theory and its evolution, the behavioural finance, suggests that investment decisions could deviate from rationality. This study aims to investigate behavioural biases that influence the investment decisions of stock market investors in Sri Lanka. We have collected the primary data from 250 active investors of the Colombo Stock Exchange. We have used the Structural Equation Modelling technique to test our hypotheses. We find that overconfidence bias and herding bias significantly influence the investment decisions of stock market investors in Sri Lanka. Moreover, familiarity bias, availability bias, confirmation bias, and disposition bias are found to be significant at 10%. We find no evidence to support the influence of representative bias and loss aversion bias. Our study has important implications for investors and regulators. Investors in the stock market should be aware of the possible behavioural biases that may hinder their investment decisions. Further, the regulators should closely monitor the stock market movements to minimize market manipulations initiated by a few who capitalize on the investment biases such as herding and overconfidence for their personal advantage.