Impact of Congnitive and Behavioral Biases on Trade Performance: Empirical Evidence from the Emerging Economy

Abstract

The purpose of this study is to highlight and fully understand the impact of behavioral and cognitive biases on the trade performance of individual investors trading on the Pakistan Stock Exchange. This study contends with the assumption of the rationality of the efficient market hypothesis, traditional finance's most prominent theory that has been extensively studied. According to the behavioral finance paradigm, investors are humans and are susceptible to a variety of demographic, emotional, social, and psychological factors such as greed and fear. According to heuristics and prospect theory, investors have a variety of behavioral and psychological biases when making investment decisions and do not adhere strictly to financial theories. The research has a quantitative and deductive approach with an explanatory research design. Individual investors who trade on the Pakistan Stock Exchange constitute the study's population. The sample size for the study was 600 respondents, selected through stratified random sampling techniques and confirmed by Gpower software. The analysis was done with SMART-PLS and SPSS. The results revealed that anchoring, availability bias, stock fundamentals, availability bias, mental accounting, and gambler's fallacy have a significant and positive impact on individual investor performance in terms of trading. Findings support the evidence that Pakistan's investors are not perfectly rational. Instead, behavioral factors are associated with their investment decisions, which makes them bounded and rational. Thus, for the purpose of investment analysis, investors must consider not only the fundamental theories and models of traditional finance but also behavioral factors during investment decisions, which may enhance trade performance. The findings provide empirical support for the applicability of heuristics and prospect theory in the particular context of Pakistan.