Literature Review

Over confidence and investment decision

“Overconfidence is the tendency for people to overestimate their knowledge, abilities and the
precision of their information” (Bhandari & Deaves, 2006, p. 5).Over confidence has widely
studied in previous literature of economic and psychology in different methods(Fellner& Krügel,
2012). Over confidence is the mental ability of a person that has been found in financial experts
through deep research(Daniel et al, 1998).Overconfidence tends to be stronger when correct
judgments are hard to form, such as when uncertainty is high (Hirshleifer,
2015).“Overconfidence makes an overestimation of the financial specialist’s specialized
information and its capacity to control the instability, thinking little of dangers or risk of
failure.Overconfidence bias was measured by four factors: self-control, market knowledge, stock
selection ability, and specific skill” (Malik, Munir&Surwar, 2017). Over confidence occur when
the confidence is more than its accuracy(Bar-Hillel, 2001; Moore & Healy, 2008), so due to this
definition it concludes that over confidence has negatively related to individual accuracy
(Michailova, Mačiulis & Tvaronavičienė, 2017).
Past researches and experiments find that the most of the investors or traders’ overconfidence
reduces their welfare (Barber & Odean, 2001; Biais et al., 2005; Kirchler & Maciejovsky, 2002;
Nöth& Weber, 2003). This is because the investors are mostly active in trading and due to this
kind of behavior they face the losses in investment (Barber & Odean, 2001; Glaser et al.,
2004).“Overconfidence is a cognitive bias that is extremely relevant in managerial decision-
making and has been shown to affect behavior on financial markets” (Cesarini, Sandewall, &
Johannesson, 2006).Overconfidence leads investors to witness surprises, sometimes positive and
sometimes negative, making the financial market inefficient based on their wrong forecasts
because of their trap with overconfidence(Shefrin HM, Thaler RH,1988). So we conclude from
all these past researches that overconfidence bias have positive effect on investment decision and
the overconfident investors take better decisions in investment.

H1: overconfidence is positively related to investment decisions.

Risk aversion and investment decision

Risk aversion is the level of risk that individuals do not want to accept. Determining this level,
whether expressed as risk aversion or risk tolerance, is very important for behavioralfinance
research. Risk aversion will influence and determine risky investment intention and risk
investment intention will also influence and determine risk choices(Selim Aren and Hatice
Nayman Hamamci, 2019).

H2: Risk aversion is negatively related to investment decision

Risk perception as a mediator between over confidence and investment

decision
Overconfidence is a concept that is borrowed from psychology. It manifests itself in the
following forms: miscalibration of probabilities,better-than-average effect, illusion of control and
unrealistic optimism. We are mainly interested inthe first two types of overconfidence.
Manystudies analyze the roleplayedby overconfidencein the behavior of investors. These studies
clearlydemonstrate that overconfidence can lead to excessive trading in financial markets
(Odean, 1999, Barber and Odean, 2001, Barber and Odean, 2002 and Glaser and Weber, 2007).
In the domain of financial markets, Glaser et al. [18] demonstrate that people have a tendency to
underestimate the future volatility of stock returns. Finance professionals are largely
overconfident in both the general and professional domains.
The second measure of overconfidence is the better than-average effect. It hints at the fact that
people believe they are above average and that individuals have unrealistically positive
perceptions of themselves [14,47]. The errors made by the professionals are related to the length
of their confidence intervals. Risk perception and overconfidence strongly impact the risk-taking
behavior of professionals [11]. Decision-makers exhibiting overconfidence, treat their
assumptions as facts. They may not see the Uncertainty associated with conclusions stemming
from those assumptions. They, therefore, may inaccurately conclude that a certain action is not
risky. The overconfidence bias lowers an individual’s perception of the riskiness of a strategy
[7,40].

H3: Risk perception mediates the relationship between overconfidence and investment decision.

Risk perception as a mediator between risk aversion and investment decision

Loss aversion means that transformation from reference points may be esteemed differently
depending on whether they are gains or losses; in exacting, people are extra sensitive to losses as
compared to gains. In this regard, this theory predicts that the complete level of the change in
demand due to a loss is greater than the equivalent impact of an equal gain [32]. Loss aversion
refers to the fact that people are likely to be extra sensitive to decrease in their wealth than to
increase [48]. The rationality of investors has been a main statement in the majority of theories
of finance. Financial theorist of the traditional finance often assumes that an investor’s decisions
are rationalbecause they are on the base of sound financial knowledge, details and information.
While behavioral finance states that the nature of Human is irrational based on traditions, belief
and norms, the divergence of human beings from it proves it to be imperfect in the decision
making [49]. Psychological biases always affect the decisions of the investors. Froot and Dabora
[17] have found that same shares and securities have different prices due to different nature of
human beings and the emotions they include in their decision making.

H4: Risk perception mediates the relationship between risk aversion and investment decision.

Financial literacy as a moderator between overconfidence and investment

decisions
Financial knowledge and skills in managing personal finance are essential in everyday life.
Krishna, Rofaida, and Sari (2010) explain that financial literacy helps individuals to avoid
financial problems.
Financial Literacy according to the Financial Services Authority (2013) is a series of processes
or activities to increase the knowledge, confidence and skill of consumers and the wider
community so that they are able to manage finances better. According to Kim (2001) in Sabri
(2011) financial literacy is the basic knowledge that people need to survive in modern society.
This basic knowledge involves knowing and understanding the complex principles of spending,
saving, and investing. Meanwhile, according toLusardi & Mitchell (2007) describes financial
literacy is the knowledge that someone has about financialinstruments, including, one's
knowledge about savings or saving, insurance ori insurance, investment and other financial
instruments. Financial Literacy can be interpreted as financial knowledge, with the aim of
Sachieving prosperity. From the above understanding, it can be concluded that financial literacy
is a person's ability to know finance in general, where the knowledge includes savings,
investments, debt, insurance and other financial instruments.

H5: Financial literacy positively moderates the relationship between behavioral biases and
investment decision.