FOLLOWING THE CROWD OR MAKING INFORMED CHOICES? THE IMPACT OF HEURISTIC AND PROSPECT BIASES ON PORTFOLIO MANAGEMENT AND PERFORMANCE: EVIDENCE FROM PAKISTAN'S STOCK MARKET DOWNTURN IN 2022

Abstract

The study aims to examine the influence of heuristic and prospect theory biases on the portfolio management and performance (PMP) of individual investors in Pakistan, a country that has experienced significant market fluctuations due to a deep debt crisis, currency devaluation, political instability, and a shortage of foreign reserves. Data was collected from 400 individual investors trading on the Pakistan Stock Exchange. The data revealed that PMP is positively and significantly influenced by regret aversion, loss aversion, overconfidence, anchoring bias, and mental accounting, while availability bias and the gambler's fallacy have insignificant impacts. The study suggests that investors with higher levels of these biases are more likely to achieve better PMP, and using mental accounting strategies may improve PMP. However, overconfidence may also lead to excessive risk-taking and lower performance in certain cases. Regret aversion may lead to suboptimal investment decisions in some cases. The study recommends the investors should consider the potential risks associated with overconfidence and regret aversion. By understanding these biases, they can make more informed and objective investment decisions that lead to better PMP. A major significance of this paper is it examines the prominent heuristic and prospect behavioral factors that affect portfolio formation and performance of individual investors in Pakistan.