Effect of Demographics, Personality Traits, and Financial Literacy on Risk Tolerance and Behavioral Biases in Individual Investors of Pakistan Stock Exchange

Abstract

This study explored the effect of various factors on risk tolerance and psychological biases. Factors include personality traits (extroversion, agreeable, consciousness, neuroticism, openness to experience), and financial literacy (actual financial literacy, perceived financial literacy). Psychological biases were classified under anchor bias, availability bias, gambler fallacy, loss-averse bias, overconfidence bias, and representative bias. We further explored the moderating effects of investor’s age, investments, qualifications and experience on the relationship between risk tolerance and psychological biases. For this, a survey was conducted from 150 individual investor trading in Pakistan stock exchange by means of a close-ended questionnaire. Data were analyzed using a structural equation model and confirmatory factor analysis. Results showed a significant relation between extroversion and both availability and overconfidence bias and risk tolerance. Similarly, neuroticism has a significant relationship with availability bias. However, consciousness and openness to experience has no association with any biases. Perceive and actual financial literacy has a significant association with anchor and overconfidence bias. Actual financial literacy additionally affects availability bias. Risk tolerance also seems to affect anchor bias and gambler fallacy as expected. With regards to demographics, age and qualifications moderates the relationship between risk tolerance and anchor bias, while availability bias was moderated by investments