Abstract
Individual investors trading at the Colombo Stock Exchange (CSE), Sri Lanka, behave irrationally despite objective finance models available for them to refer in making rational decisions. Therefore this paper examines the irrationality by testing whether behavioural finance factors (BF), stock broker’s recommendations (SBR) as a contextual factor, and individual investor’s existing knowledge of the stock market (EK) as a demographic factor affect individual investor’s investment performance (IP). Heuristic behaviour, prospect behaviour and market factors were conceptualised as independent variables of the study whereas SBR and EK act as moderators on the relationship between BF and IP. Data of 221 individual investors of CSE during first half of 2019 were analyzed using structural models to draw empirical evidence to test hypotheses of the study. Results of the study reveal that market information and past stock trends as market factors have a significant bearing on investment decision making, which ultimately affect IP, while the aggregate effect of BF upholds a significant impact on IP. The results expose some novel findings such as: investors receive inferior financial returns when imitating other investors’ trading behaviour whilst trading on SBR; receive lower returns once trading on market factors whilst resuming SBR; and receive mediocre returns when EK is affirmative whilst following other investors’ decisions; and suffer losses when trading on market factors whilst exploiting EK. The findings imply that the stock brokers should not merely consider the output of objective finance models, but market wide herding, market manipulations, market factors and EK in investment recommendations.
Highlights
The stock market is a popular and a more effective channel for trade unlike any other type of investment due to its high liquidity (Jaswani, 2008)
The present study found that individual investor’s existing knowledge of the stock market and stock broker’s recommendations dampen the relationship between behavioural finance factors and individual investor’s investment performance
Individual investors trading on the Colombo Stock Exchange (CSE) behave irrationally
Summary
The stock market is a popular and a more effective channel for trade unlike any other type of investment due to its high liquidity (Jaswani, 2008). Traditional finance theories: Capital Asset Pricing Model (Sharpe, 1964; Lintner, 1965; Black, 1972), Dividend Discount Model (Gordon & Shapiro,1956; Gordon, 1959; Gordon, 1962) and Markowitz Mean-variance Portfolio Theory (Markowitz, 1959) are backed by logical reasoning. This logic is questioned by many other scholars (Kahneman & Tversky, 1974; Kahneman & Tversky, 1979; Waweru, Munyoki & Uliana, 2008; Gounaris & Prout, 2009) as such logic is found to be less realistic. Thereby, the quest to understand what finance truly is has to move beyond conventional finance theories
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