Individual Investors’ Learning Behavior and Its Impact on Their Herd Bias: An Integrated Analysis in the Context of Stock Trading

Kalugala Shantha

doi:10.3390/su11051448

Abstract

The efficient functioning of capital markets ensures that information on companies’ sustainable development endeavors is fully and instantly incorporated into stock prices, which facilitates them in raising capital requirements at a lower cost. It, however, is impaired when market participants are inclined to behavioral biases. The Adaptive Market Hypothesis predicts that such behavioral biases are evolutionary. In that sense, market participants are capable of learning their behavioral mistakes and adapting to market conditions over time. Based on this perspective, this paper aims to explore how learning occurs within individual investors to reduce their herd bias. The data was collected by distributing a web-based self-administrated questionnaire to a sample of 1000 individual investors of the Colombo Stock Exchange, who were randomly selected during a period from March to August 2018. A total of 189 responses were received, which were analyzed using the structural equation modelling technique to test the hypotheses of the theoretical model. The results show that learning takes place when investors cognitively evaluate past trading experiences, which is induced by their desire for learning, and, consequently, reduces their herd bias. However, as the model predicts, strengthening this cognitive reflection from the relationship with the investment advisor and social learning among investors through their peer-relationships appear to be absent due to uncertain market conditions prevailed during the study period and dominance of unsophisticated investors in the market. From these findings, this paper concludes that the cognitive reflection of past experiences and the nature of the trading environment determine the extent of learning within individual investors.

Highlights

The concept of sustainable development has become an integral aspect of a company’s strategic planning process
Supporting the herding literature, the results reveal that, in the presence of uncertain market conditions, herd bias tends to exaggerate among investors through the effect of their peer-relationships
It extends the previous studies of Shantha [8] and Xiaofang and Shantha [10] by providing empirical evidence on factors that ground for the declining herd behavior in the market

Summary

Introduction

The concept of sustainable development has become an integral aspect of a company’s strategic planning process. It has become a guiding principle when formulating business policies and strategies in striving to achieve its objectives. When concerning the financing side, capital markets should promote sustainable development by facilitating companies to raise capital at a lower cost to finance their endeavor to become sustainable. Waygood [2] highlights that this role is currently impaired due to inefficiencies of capital markets which, from the sustainable development viewpoint, indicate the inability of the markets to recognize and reward companies’ right conducts to become sustainable. Waygood [2] further emphasizes that the failure of the investors’ predictive power is the main reason of market inefficiency

Objectives

Methods

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Discussion

Conclusion