Abstract
Investors who choose to invest or divest their funds abruptly contribute to the instability of the stock market. In such a volatile market when one investor chooses to invest in companies in spite of unstable prices, others decide not to invest. What individual indifference factors might predict opposing investment decisions such as these? Finance Literature proves that heuristics are significantly related to risky decision making and but there have been no studies to explore whether locus of control plays a role in behavioral finance. The present study has been undertaken to investigate whether locus of control predicts hot-come effect and its converse gambler’s fallacy, when making personal investment decisions. The study has also analyzed investment experience as a possible determinant of hot-outcome or gambler’s fallacy heuristics. The collective effect of an individual’s locus of control and investment experience on investment decisions has been predicted using structural equation modeling. The present study has been done in the Kingdom of Saudi Arabia where 144 investors with prior investment experience and 124 new investors completed the Rotter’s (1954) LOC and the adopted version of an Investment Survey Questionnaire. Results suggest that hot-outcome heuristic, trend length, trend valence and prior investment experience are factors that influence personal financial decision making. Results affirm that novice investors tend to utilize the hot-outcome heuristic regardless of the reference groups, while experienced investors from both reference groups apply gambler’s fallacy heuristics to decide on investments.
Highlights
A behavioral finance perspective or school, which is made from psychological and financial integration, believes that psychology plays an important role in financial decision
Historians who have examined the behavior of financial markets over time have challenged the assumption of rationality that underlies much of the efficient market theory
The present study aims to contribute to the burgeoning interest in behavioral finance and growing body of research questioning the impact of individual and crowd psychology on decision-making in financial markets
Summary
A behavioral finance perspective or school, which is made from psychological and financial integration, believes that psychology plays an important role in financial decision. Historians who have examined the behavior of financial markets over time have challenged the assumption of rationality that underlies much of the efficient market theory. They point to the frequency with which speculative bubbles have formed in financial markets, as investors buy into fads or get-rich-quick schemes, and the crashes with which these bubbles have ended. They suggest that there is nothing to prevent the recurrence of this phenomenon in today's financial markets. The evidence on price patterns, in the short and long term, in different months and on different weekdays suggests that there is a lot about markets that we cannot explain with a rational investor model
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