Role of Investor Biases and Risk in Investment Decision-Making: An Empirical Study

Abstract

This study investigates how behavioural biases and financial risk propensity shape investment decision-making among stock-market investors in South India. Drawing on behavioural finance and prospect theory, the analysis distinguishes six recurring biases—overconfidence, herding, anchoring, loss aversion, the disposition effect, and representativeness—and positions financial risk propensity as a behavioural mechanism through which these biases influence market decisions. A cross-sectional survey was conducted among 438 active individual investors drawn from Kerala, Tamil Nadu, Karnataka, Telangana, and Andhra Pradesh. The measurement instrument contained 34 scale items and was assessed through confirmatory factor analysis before testing the structural relationships with covariance-based structural equation modelling. Loss aversion emerged as the most pronounced bias, followed by overconfidence and anchoring. The measurement model demonstrated satisfactory reliability, convergent validity, and discriminant validity. The structural model showed that overconfidence, herding, anchoring, loss aversion, and representativeness significantly affected financial risk propensity, whereas the disposition effect did not produce an independent effect on risk propensity. Financial risk propensity, in turn, exerted a strong positive influence on investment decision-making. Direct effects from overconfidence, herding, anchoring, loss aversion, and the disposition effect to investment decision-making were significant; representativeness operated primarily through risk propensity. Bootstrapped mediation results confirmed that financial risk propensity partially transmitted the effects of overconfidence, herding, anchoring, and loss aversion and fully transmitted the effect of representativeness. The findings demonstrate that investor decision-making is not adequately explained by bias identification alone: the behavioural consequences of a bias depend materially on how the investor processes financial risk. The study contributes an integrated bias-risk-decision framework for emerging-market retail investors and offers implications for investor education, advisory profiling, brokerage communication, and behavioural risk management.