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Financial literacy and Pakistan stock

behavioural biases of exchange

individual investors:
empirical evidence of 261
Pakistan stock exchange Received 4 March 2019
Revised 19 May 2019
Nosheen Rasool and Safi Ullah Accepted 20 May 2019

Department of Commerce & Finance, GC University, Lahore, Pakistan

Abstract
Purpose – Financial literacy is a crucial element of financial decision-making, exerting significant
inRuence on the behaviour of individual investors, while making budgetary, house financing, stock
investing and retirement planning decisions. So, the purpose of this research is to determine the
relationship between financial literacy and behavioural biases of individual investors in Pakistan.
Design/methodology/approach – In this research paper, a sample of 300 observations was
obtained through questionnaires from individual investors residing in Lahore and invested in Pakistan
Stock Exchange. The data obtained, was passed through Cronbach’s Alpha and Exploratory Factor
Analysis (EFA). The hypothesis developed for the research was tested by Pearson’s Chi-square and
Ordinal Regression Analysis.
Findings – The hypothesis testing of the research concluded that there is a negative association between
financial literacy and behavioural biases of individual investors. So, it means; with an increase in level of
financial literacy, the likelihood of investor facing behavioural biases reduces. It also appeared that male
respondents have more financial literacy than female respondents
Originality/value – Previous studies in the field of finance, identified different factors causing the
financial behaviour of individual investor of Pakistan, and also focused on level of financial literacy in
Pakistan, but these studies have not emphasized the crucial relationship between financial literacy and
behavioural biases of individual investors. Thus, the unique empirical analysis developed in this paper has
accentuated the financial literacy as a factor that mitigates behavioural biases of individual investor.
Keywords Behavioural finance, Financial literacy, Behavioural biases, Financial decision-making,
Individual investor
Paper type Research paper

1. Introduction and literature review

According to Lusardi and Mitchelli (2007), the importance of financial literacy has
developed widely, with the escalating complication of financial products and the growing
significance of financial selection, made by households. During recent years, the advent of
innovative financial products and instruments has encouraged individual investors to
participate actively in financial markets (Calvet et al., 2004). However, these
financial products

© Nosheen Rasool and Safi Ullah. Pblished in the Journal of Economics, Finance and
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JEFAS are substantially complex instruments, which require the investors to be financially literate
25,50 for optimal investment selection and emerging investment avenues. By following this
phenomenon, financial literacy has attained the huge attention of researchers globally. The
recent research of Lusardi and Mitchell (2014), highlighted the appropriate improvement
methods that have been carried out around the world and concentrated particularly on
access to financial understanding and financial literacy. Clark et al. (2017) defined
262 financial literacy as
[.. .] the public understanding and information that covers financial services, administration of
the financial investments, and various perspectives that appear to be most crucial for the
cognizance of household investors, so there would be no asymmetrical information problems
associated to the various financial terms – i.e. the interest rates risks, inRation.
Zucchi (2018) argued that not only developing countries have financial literacy problems,
but the investors, from highly developed financial markets, have also faced financial
losses due to ineffective planning, and the inability to identify market uncertainties and
risk associated with it. The depiction of these Raws can be highlighted during the financial
crises of 2008 (Klapper et al., 2013).
The actual importance of the financial literacy was raised during the financial crises of
2008 (Klapper et al., 2013). On one side, the global financial crisis 2008, well-known as
the subprime mortgage crisis, was the main cause to bring the need for financial
understanding in front of market players. The other reason was the two key issues that
contributed to the financial literacy’s importance (Agnew et al., 2007). Firstly, the wide
range of financial products, which were mostly complex and not comparable, raised the
necessity of understanding financial problems (Mandell and Klein, 2009). On the other
hand, previous change in social security, all around the world, necessitated individuals to
actively participate in their financial management (Aren and Aydemir, 2014).
One of the crucial assumptions, observed in financial crisis, was irrationality (Friedman
and Kraus, 2011) among the financial behaviour of investors due to lack of financial
knowledge, which has been highlighted particularly in the field of behavioural finance. In
traditional financial theories, it is assumed that financial markets and its participants are
rational in decision-making (Ackert, 2014), such as modern portfolio theory by Markowitz
(1999), capital asset pricing model by Sharpe (1977), and two factor or three-factor model
by Fama and French (Womack and Zhang, 2003). In contrast, Barberis and Thaler (2003)
argued that behavioural finance is a relatively modern financial subject, seeks to
summarize the combination of behaviour and cognitive factors that inRuences irrational
financial decisions. It is also based on the exceptional idea that the majority or at least a
significant minority of investors are inRuenced by their behavioural biases, which leads to
less rational or fully irrational decision-making. These biases are empirically
acknowledged under cognitive psychological theories; one of them is “Prospect Theory”
proposed by Kahneman and Tversky (1979) that shows the patterns of decision-making
and portfolio selection in risk prevailing situations.
Many types of research on financial literacy have been exercised globally, on behalf of
different countries, to scrutinize financial literacy. The Global financial survey conducted by
World Bank Financial Governance Consumer Protection in Financial Services Program
(“Report on the Key Findings of the Survey prepared for the World Bank”, 2010) studied
the improvement levels of consumer protection and financial literacy, thereby, supporting
investor confidence in the financial areas.
President’s Advisory Council on Financial Literacy (PACFL) clarified financial
education as the ability of an individual to devour learning and financial skills to
oversee financial
assets competently for monetary welfare. PACFL also clarified financial skills as a
capacity to make utilization of investor’s intelligence and aptitudes to successfully oversee Pakistan stock
and productively manage monetary assets over a lifetime to accomplish budgetary welfare exchange
(Schwab et al., 2008).
The study of Awais et al. (2016) stated that some of the households lacked the most
common observable information while taking crucial financial decisions for their well-
being. However, Reich and Berman (2015) raised various questions about the extent of the
effectiveness and inRuence of financial learning on financial literacy. Thus, Sayinzoga et 263
al. (2016) highlighted the contradiction that exists between the efficiency of financial
education in enlightening financial literacy and its ultimate inRuence on investor’s short-
term and long-term behaviour. Moreover, Sundarasen et al. (2016) expressed that
financial literacy accelerates the efficiency of cash Row management, credit risk
management, saving and investment with higher extent.
To discover the measures of financial literacy, Remund (2010) inspected the majority
of the measures of financial literacy and recognized the absence of typical measures, for
clarifying and estimating financial education and demonstrated financial literacy as a
degree to which one has the capacity to comprehend common and crucial financial ideas.
Whereas, Fernandes et al. (2014) measured the relationship between financial literacy
and financial education in association with financial behaviours by using meta-analysis.
Volpe et al. (1996) measured investment knowledge by forming 10 multiple choice
questions (Ergün, 2018). Hilgert et al. (2003) evaluated the level of financial literacy by
using 28 true/false financial skills questions with investment, spending, saving, cash
inRow and outRow and other macro factors as variables. Furthermore, Clark et al.
(2017) empirically evaluated financial knowledge from 3 questions on Portfolio
Diversification, Real and nominal interest rates, and the time value of money.
In Pakistan, the project named Access to Finance Survey 2008, conducted by Fin-Mark
Trust in support with the State Bank of Pakistan was the initial step towards financial
literacy measuring financial knowledge and patterns of household investment. This study
concluded that only 14 per cent of the experimental population formally participated in the
stock markets, while the other 40 per cent were not part of any formal or informal
financial activities. It also concluded that a higher level of education, as well as a higher
level of income, is the biggest source of enhancement in accessing broad financial
education.
In some cases, understanding behavioural finance, in an ostensible sense, directly
highlights the relationship between financial education and different characteristics of
financial behaviour (Ates et al., 2016). A survey, conducted on Turkish monetary clients
on their acquiring behaviour, suggested that financial clients with a higher degree of
financial education are rather more anticipated to use their credit cards in a suf ficient and
educated way (Sevim et al., 2012).
Previous studies, such as modern portfolio theory, have shown that investors are risk-
averse, which means that among two investment alternatives, the investor will choose the
one with lower risk (Calvo-Silvosa et al., 2017). To choose optimal investment portfolio,
which occupies the efficient parts of the risk-return spectrum, another term introduced in
modern portfolio theory known as “Efficient Frontier”, also named as “Markowitz Bullet”
(Lee and Yoo, 2017). The financial economists Fama and French (1993) mentioned the
need for efficient market theory named “Efficient Capital Markets”.
As shown by Ritter (2003), behavioural factors are dependent on attitudes just as
human judgment procedures have been dependent on several cognitive illusions and
biases. Those illusions are distributed in two categories:
(1) biases produced from heuristic judgment procedure; and
JEFAS (2) illusions, embedded in the implementation of mental structures, categorized in the
25,50 prospect theory (Bakar and Yi, 2016).

The most significant cognitive bias is heuristics. Heuristics are characterized as the rule of
thumb, which resolves the basic decision-making problems, particularly in complicated
and problematic conditions (Ritter, 2003), by decreasing the unpredictability of evaluating
264
probabilities and anticipating values of simpler judgments (Reason, 1990). Tversky and
Kahneman (1974) are the ones, who initially focused on heuristics and recognized three
heuristics to be specific representativeness, availability bias and anchoring (Tversky and
Kahneman, 1974). Waweru et al. (2008), likewise, list two elements named Gambler’s
fallacy and Overconfidence into heuristic theory (Waweru et al., 2008).
Modern finance perspective indicated that investors do not always act irrationally, and
they contribute their funds by examining the risk and reward and face a lot of
psychological and sentiment biases (Kahneman and Tversky, 2013). Kahneman and
Tversky (1979) defined prospect theory as a substitute to standard models, which gives a
superior image of practical behaviour. Prospect theory depicted few perspectives
inRuencing decision-making behaviour including regret aversion, loss aversion, and
mental accounting (Waweru et al., 2008). Regret aversion is a feeling that happens after
individuals commit errors (Fogel and Berry, 2006). Loss aversion states the distinctive
level of perceptual biases that individuals face from comparative size profits and losses
(Barberis and Thaler, 2003), whereas, mental accounting is defined as “the procedure by
which individuals consider and assess their Financial events” (Barberis and Huang, 2001).
De Bondt and Thaler (1985) expressed, about financial market factors, that they can be
inRuenced by individual investor’s conduct in the method of behavioural finance. Waweru
et al. (2008) recognized the components of the market that affect an individual’s
decision- making, which are price Ructuation, available market information, prior patterns
of stocks, consumer inclination, over-response to value changes and essentials of principal
stocks. Barber and Odean (2013) underscored that investment holders are affected by
occasions in the securities exchange that attract them.
Whereas, the herding effect, observed in the stock market, is recognized as the
propensity of investor’s practices to track other’s activities (Tan et al., 2008). In the
viewpoint of behavioural finance, herding bias inRuences some enthusiastic biases,
including similarity, congruity and intellectual clash, the home bias and chitchat
(Kallinterakis et al., 2010). Waweru et al. (2008) concluded that purchasing and
offering choices of investors are fundamentally affected by other’s selection, and herding
behaviour encourages investors to have a feeling of regret avoidance for their choices.
By the review of the above studies, it has cleared that without financial literacy, it is
impossible to make decisions about complicated investment avenues and it is extremely
difficult to mitigate the behavioural biases faced by investors. However, to find the true
relationship between financial literacy and behavioural biases of individual investors, this
paper aims to contribute towards the importance of financial literacy and depicts the
empirical evidence on this relationship in the context of Lahore. So precisely, this research
paper is focused on measuring basic financial literacy, identifying the possible behavioural
biases and determining the relationship between financial literacy and behavioural biases
of individual investors at Lahore.
This paper is structured as follows: Section 2 describes the data collection. Section 3
discusses the empirical strategy. Section 4 shows the analysis and results. Finally, Section
5 provides conclusions and recommendations (see Figure 1).
2. Data
This research is entirely based on primary data that was collected by using a descriptive Pakistan stock
survey technique. Primary data was taken because it provides accurate as well as real time exchange
data that has not been used previously. For data collection, structured questionnaires were
prepared and provided to groups of institutions located in Lahore. These questionnaires
were filled by individual investors, who have invested in shares, bonds, etc.
The structured questionnaire consisted of three parts: The first part was intended to
collect some basic demographical information about investors and their preferred 265
investment avenue. This part included gender, age, area of specialization, sources of
financial information, average income level, preferred investment avenue and frequency
of information. The second part of the questionnaire was proposed to obtain the level of
financial literacy, among the individual investors. This part was developed by using 20-
items on the financial knowledge scale; produced by Knoll and Houts (2012) and 10-items
on the financial sophistication scale of Lusardi and Mitchell (2014). To measure the
financial literacy of individual investors at Lahore, different items were selected from
both scales in a modified manner, as shown in Table 1.
This part consisted of multiple statements and different financial concepts were
summarised in the following way: numeracy, interest compounding, inRation, time value
of money, money illusion, investing, diversification of risk, debt management, retirement
saving, housing, life insurance and annuity. Finally, the third part included 29 statements,
which were intended to measure the level of behavioural biases. All these statements were
measured by using the five-point Likert scale.
These questionnaires were entered into SPSS by coding each question’s answer with a
numeric value and considered each question as a variable and then all biased
questionnaires were removed due to their missing values and illogical ratings.

RESEARCH
INTRODUCTION LITERATURE REVIEW
METHODOLOGY:

DATA ANALYSIS,
CONCLUSIONS AND
RESULTS AND
RECOMMENDATIONS
INTERPRETATION:

Figure 1.
Source: Own elaboration
Structure of study

Financial literacy items Options Measurements

Numeracy, interest compounding, inRation, money

illusion, debt management More than or Ordinal
Time value of money, investing, diversification of risk, less than, measure
increase or Nominal Table
decrease
1.
True/False,
retirement saving, housing, life insurance Different classes measure Measurement scale of
financial literacy
Source: Own elaboration items
JEFAS According to statistics obtained from the Central Depository Company (CDC) of Pakistan,
25,50 the number of retail investor’s sub-accounts is 245,975 as of June 2018, whereas the total
investors from Lahore represent 40 per cent of overall individual investors. The sample
size was obtained by using the following formula:

z 2 ^p 1 — ^p
266 n=
e2
where the level of confidence was 95 per cent, sampling proportion (p) was observed as
50 per cent, and the margin of error was equal to 5.6 per cent. The calculation revealed the
approximate sample size of 300 observations.
Thus, a sample of 300 was obtained from the individual investors at Lahore and it was
suitable enough to ensure the significance of the relationship between financial literacy
and behavioural factors of individual investors. During the research, the area of data
collection was confined to the capital market of Lahore, as it was not possible to gather
data from the entire population of Pakistan, due to some associated barriers such as lack of
time, extensive cost and massive exertion in data collection.
Furthermore, our study implemented a Multi-Stage sampling technique. At the first
stage, the capital market was bifurcated into different groups of institutions which act as
market players, such as corporations, institutions, investment banks and public accounting
firms and randomly selected three groups of institutions, i.e. private banks, brokerage
firms and listed companies and each group was individually called as strata, as shown in
Figure 2. In the second stage of sampling, investors were randomly selected from each
group of institutions. The questionnaires were equally allocated among these groups and it
was assured that the individuals have done recently some real-time investment in Pakistan
Stock Exchange.

3. Empirical strategy
In this research, behavioural biases are taken as the dependent variable, which included
representativeness, overconfidence, anchoring, gambler’s fallacy, availability bias, loss
aversion, regret aversion, mental accounting, and herding bias. The questions related to
these biases contain 29 statements, measured using the ordinal five-Point Likert Scale
(Strongly disagree to Strongly Agree).

Sample distribution
140
120
120
100
100 90

80

60

40
Figure 2.
20
Sample distribution
among different 0
Stock Brckers Private Bankers Listed Company
professions
Source: Sample data collected by author
To conform to the structure of our research, financial literacy is taken as the independent
variable. This variable was first measured by using 21 statements of financial literacy and Pakistan stock
each correct response was given with 1 score. By summing up, the new variable was exchange
generated and named as the financial literacy score. The average score obtained was
12.30. The score obtained above 12 was considered as investors with high financial
literacy, whereas the score below 12 was considered as investors with a low literacy rate.
To reduce the hidden effect of confounding variables, demographics are used as a
control variable in the regression model. These variables include gender, age group, 267
educational level, area of specialization, source of financial information, average income,
preferred investment avenue and frequency of information. Each variable is used as a
categorical variable. Furthermore, the ordinal regression model is used to check the
relationship between financial literacy and behavioural biases of individual investors, this
regression is repeated for every bias. The regression model is shown as follows:

y (Behavioral Bias) = b0 + b1(Fliteracy_Score) + b2(Gender) + b3(Age group)

+ b4(Edu) + b5(Specialization) + b6(Income) +
b7(Info_Source)
+ b8(Pref _Investment) + b9(Freq_Info) + ei

The dependent variable y is formed by coding the values of behavioural biases with
numeric values. Similarly, demographic variables are recoded as follows: gender variable
has a value of 1 if male and 0 otherwise, age group has a value of 1 if below age of 35 and
0 otherwise, educational background has a value of 1 if graduate or postgraduate and 0
otherwise, area of specialization has a value of 1 if business related and 0 otherwise,
average income has a value of 1 if below Rs 60,000 and 0 otherwise, Info source has a
value of 1 if from parents or friends and 0 otherwise, preferred investment has a value of 1
if it is shares or bonds and 0 otherwise, and frequency of information has a value of 1 if
less than month and 0 otherwise.
Different statistical methods are used to verify the reliability of data such as descriptive
statistics, factor analysis and reliability test using Cronbach’s Alpha as the most preferred
reliability instrument. The linear regression model is also used in the analysis to detect
Multicollinearity with help of collinearity statistics that show tolerance level and Variance
InRating Factor (VIF). This process used ANOVA tests to ensure that the model fits on
our sample appropriately with the significant value of F-test. T-value and P-value are
used to check the significance level of Beta-Coefficients at the Confidence Interval of 95
per cent.
Hypothesis statements were formed for each of the dependent variables. The
hypothesis testing was based on main and sub-hypothesis. However, the main hypothesis
of the research is: The increases in the level of financial literacy reduces the
likelihood of occurrence of behavioural biases affecting individual investor’s
decision-making.

4. Data analysis and results

According to the data collected, the majority of respondents were males that represent
77.77 per cent of the total sample. The age variable was valued by four age brackets:
below 25 years, 25-35 years, 35-50 years and above 50 years. The result shows that 112
respondents were below 25 years old, 107 respondents were between 25 and 35 years old,
moreover, 88 of the respondents were between 35 and 50 years old, whereas only 3
respondents were 50 years old. The outcomes showed that 69 respondents belonged to
postgraduate, 127 respondents belonged to the university, whereas 101 from college, 1
from secondary and 2 from primary education. However, 98 respondents earned below
Rs 30,000, 126 of them
JEFAS earned between Rs 30,000 to Rs 60,000, 58 of them earned between Rs 60,000 to Rs
25,50 100,000 while the remaining 18 earned above Rs 100,000.
The scales of financial literacy and different factors of behavioural biases are tested
using Cronbach’s alpha to ensure that variables are reliable for further use. According to
Cronbach’s alpha, the financial literacy score is reliable at 0.725, whereas behavioural biases
268 are reliable at 0.863. However, the overall outcome is shown in Table 2. This result
describes higher internal consistency among variables.
Factor analysis is used to explain the variance or covariance among the observed
variables, and to identify the set of variables also called dimensions. In our research,
Exploratory Factor Analysis is used to identify the factors based on variables of financial
literacy and behavioural biases (2nd and 3rd part of the questionnaire). To make the factor
analysis reliable for the data, Kaiser-Meyer Olkin (KMO) and Bartlett’s Test of Sphericity
are used to check the sample precision. The result of this experiment is shown in Table 3.
Another technique was used to describe the total variance explained, which must be
greater than 50% (Ali et al., 2006). However, in our case, it was 61.50 per cent, which has
shown the factors to be retained until the last factor.
As specified earlier, financial literacy is measured by financial knowledge scale
containing 21 statements, which was developed by modifying 20 items on the financial
literacy scale presented by Knoll and Houts (2012) and 10 items on the financial
sophistication scale of Lusardi and Mitchell (2014). According to the data, more than 50
per cent of respondents answered correctly, more than 25 per cent answered incorrectly,
whereas more than 20 per cent did not know about the financial literacy items. In financial
literacy items, numeracy is responded correctly at the highest rate of 65.5%, whereas an
annuity is answered correctly at the lowest rate of 49.7 per cent within all items. The
response rate is shown in Table 4.
Another analysis is conducted to check the relation between financial literacy and
demographic variables. In this analysis, financial literacy is bifurcated into two parts, i.e.
high financial literacy and low financial literacy. High financial literacy represents a
literacy score of 12 and higher, whereas low financial literacy represents a literacy score
of 11 and

Scale Cronbach’s a No. of items

Financial literacy scale 0.725 21
Behavioural biases scale 0.863 29
Table 2. Overall 0.767 50
Overall reliability
test analysis Source: Author calculations based on primary
data

KMO and Bartlett’s Test

Kaiser-Meyer-Olkin Measure of Sampling Adequacy 0.858

Bartlett’s Test of Sphericity
Approx. x 2 1824.510
Df 435
Table 3. Sig. 0.000
Factor analysis
results Source: Author calculations based on primary data
 Pakistan stock
Items Correct response (%) Incorrect response (%) Do not know
(%) exchange
Numeracy 65.5 23.2 11.3
Interest compounding 59.4 28.4 12.3
InRation 51.9 24.2 13.9
Time value of money 59.4 28.4 12.3
Money illusion 57.7 24.8 13.9
Investing 60.69 25.35 13.96
269
Diversification of risk 58.4 32 9.7
Debt management 53.2 26.8 20
Retirement savings 57.25 19.85 24.2
Housing 59.35 24.2 16.45
Life insurance 51.75 24.85 23.4 Table
Annuity 49.7 28.1 22.3 4. Financial
Source: Author calculations based on primary data, literacy response
SPSS rate

lower. The T-value of each relationship is significant at 2 or higher as a rule of thumb. In our
case, only two demographics have a significant relationship with financial literacy.
Analysis of behavioural biases is the second crucial part of research because it
oscillates among individual investors at an extensive level. To measure the bias level of
the individual investor, factors with an average of more than 3 are presumed to have
biasness in their investment decisions. However, this study indicated that with an increase
in financial literacy, the likelihood of biasness in investment decisions reduces. The
highest level of biasness is detected in gambler’s fallacy with an average of 3.50, whereas
the lowest level of biasness is shown by self-attribution bias with an average of 3.04. The
mean values of behavioural biases are shown in Table 5. All factors have more than 3
levels of biasness, this depicts that individuals face a high level of behavioural biases
while participating in investment avenues.
As control variables have a crucial role in our regression analysis, it is mandatory to
figure out the sole impact of demographic variables on behavioural factors. According to

Behavioural factors Questions Mean values

Representativeness 1, 2 3.34
Overconfidence 3, 4 3.31
Anchoring 5, 6 3.41
Gambler’s fallacy 7 3.50
Availability bias 8, 9 3.31
Loss aversion 10, 11 3.15
Regret aversion 12, 13 3.06
Mental accounting 14, 15 3.24
Hindsight bias 16 3.15
Illusion of Control 17 3.08
Self-attribution bias 18 3.04
Cognitive dissonance 19 3.06
Market bias 20, 21, 22, 23, 24, 25 3.21 Table 5. Types
Herding bias 26, 27, 28, 29 of behavioural factors and their
3.11
mean values
Source: Author calculations based on primary data
JEFAS results, gender significant relationship between representativeness, overconfidence and
25,50 illusion of control, age group is significant with loss aversion and market factors bias,
education level is significant with representativeness, market factor and cognitive
dissonance, average income is significant with regret aversion, market factors and
overconfidence, whereas source of financial information have significant relation with
270 majority of behavioural biases, i.e. overconfidence, availability bias, loss aversion, regret
aversion, mental accounting, market factors.
This is the most central part of our research, in which ordinal regression analysis is
conducted for each one of the behavioural biases. The analysis and its results entirely
comply with the research hypothesis that has been articulated in Research Methodology.
The results of ordinal regression model are shown in Tables 6-16.
Analysis initiates with the ANOVA tests to ensure that the model fits on our sample
appropriately by applying a linear regression model. The ANOVA table is used to ensure
the value of the F-test significance. Multicollinearity is detected with the help of
collinearity statistics that show tolerance level and Variance InRating Factor (VIF).
Durbin-Watson test is used for autocorrelation, which is always between 0 and 4. Breusch-
Pagan-Godfrey test is used for heteroskedasticity that is in our case significant at 1% for
all biases. T-value and P-value are used to check the significance level of Beta-
Coefficients at the Confidence Interval of 95 per cent.
The analysis of data by using the Ordinal Regression model showed diverse outcomes.
In that part of the analysis, we dropped some behavioural biases due to insignificant
results, which included self-attribution bias, regret aversion and mental accounting. The
remaining variables were taken in analysing the relationship between financial literacy and
behavioural biases. The regression analysis showed that there is a negative association
between financial literacy and behavioural biases and 10 out of 14 behavioural factors
including representativeness, overconfidence, availability bias, loss aversion bias,
hindsight bias, the illusion of control, cognitive dissonance, herd behaviour bias and
market bias had a significant relationship with financial literacy. However, the R-square
of the regression is

x 2 38.430
p = 0.000 Estimate Std. error Wald Sig.
Explained variable
Representativeness = 1 —3.612 1.629 4.914 0.027
Representativeness = 2 —2.349 1.619 2.106 0.147
Explanatory variable
Financial literacy score —0.151 0.035 18.427 0.000***
Gender —0.498 0.262 3.626 0.057*
Age group —0.830 0.259 10.241 0.001***
Education 0.199 0.290 0.468 0.494
Area of specialization 0.105 0.442 0.056 0.813
Average income 0.132 0.286 0.215 0.643
Main source of information 0.172 0.249 0.479 0.489
Table 6. Preferred investment —0.073 0.266 0.075 0.784
Results of ordinal Frequency of information 0.862 1.138 0.574 0.449
regression for
representativeness Notes: ***p # 0.01; *p # 0.10
Source: Author calculations based on primary data
 Pakistan stock
x 2 36.780
p = 0.000 Estimate Std. error Wald Sig. exchange
Explained variable
Overconfidence = 1 —1.419 1.626 0.761 0.383
Overconfidence = 2 —0.187 1.622 0.013 0.908

Financial literacy score

Explanatory variable
—0.157 0.035 19.818 0.000***
271
Gender —0.325 0.257 1.606 0.205
Age group —0.140 0.269 0.272 0.602
Education 0.055 0.286 0.037 0.848
Area of specialization 0.467 0.470 0.985 0.321
Average income 0.155 0.287 0.291 0.590
Main source of information 0.510 0.249 4.188 0.041**
Preferred investment 0.583 0.280 4.334 0.037**
Frequency of information 0.498 1.141 0.190 0.663 Table
7. Results of
Notes: ***p # 0.01; **p # 0.05 ordinal
Source: Author calculations based on primary regression for
data overconfidence

x 2 14.994
P = 0.091 Estimate Std. error Wald Sig.
Explained variable
Anchoring = 1 12.098 1.179 105.346 0.000***
Anchoring = 2 12.949 1.172 122.052 0.000***
Explanatory variable
Financial literacy score —0.085 0.036 5.610 0.018**
Gender —0.074 0.261 0.080 0.777
Age group —0.163 0.275 0.352 0.553
Education —0.294 0.291 1.017 0.313
Area of specialization 0.019 0.461 0.002 0.967
Average income —0.292 0.282 1.070 0.301
Main source of information 0.353 0.256 1.898 0.168
Preferred investment 0.303 0.285 1.136 0.286
Frequency of information 14.955 0.000 . . Table
8. Results of
Notes: ***p # 0.01; **p # 0.05 ordinal
Source: Author calculations based on primary data regression for
anchoring bias

slightly lower which means that various other factors have a significant impact on
behavioural biases of the individual investor.

5. Conclusion
The fundamental objective of the research was to identify the extent of the relationship
between individual investor’s level of financial literacy and the level of behavioural biases in
Pakistan. The research findings were initiated with demographic variables, which
 JEFAS
25,50 x 2 9.352
P = 0.405 Estimate Std. error Wald Sig.
Explained variable
Gambler’s Fallacy = 1 —1.524 1.233 1.528 0.216
Gambler’s Fallacy = 2 —0.138 1.230 0.013 0.911
272 Explanatory variable
Financial literacy score —0.069 0.029 5.449 0.020**
Gender —0.154 0.220 0.491 0.484
Age group —0.243 0.233 1.088 0.297
Education —0.109 0.239 0.208 0.648
Area of specialization 0.291 0.382 0.580 0.446
Average income —0.186 0.244 0.580 0.446
Main source of information 0.227 0.213 1.133 0.287
Table 9. Preferred investment 0.044 0.229 0.037 0.847
Results of Frequency of information 0.094 0.703 0.018 0.894
ordinal
regression for
gambler’s fallacy Notes: **p # 0.05
Source: Author calculations based on primary
bias data

x 2 39.006
P = 0.000 Estimate Std. error Wald Sig.
Explained variable
Availability bias = 1 —4.960 1.440 11.869 0.001
Availability bias = 2 —3.682 1.425 6.671 0.010
Explanatory variable
Financial literacy score —0.170 0.036 22.865 0.000***
Gender —0.323 0.261 1.538 0.215
Age group —0.224 0.267 0.700 0.403
Education 0.349 0.293 1.419 0.234
Area of specialization 0.225 0.447 0.254 0.615
Average income —0.561 0.276 4.133 0.042**
Main source of information 0.463 0.250 3.423 0.064*
Preferred investment 0.086 0.270 0.101 0.750
Table 10. Frequency of information —1.182 0.789 2.245 0.134
Results of
ordinal
Notes: ***p # 0.01; **p # 0.05; *p # 0.10
regression for Source: Author calculations based on primary
availability bias data

concluded that male respondents have more financial literacy than female respondents and
most of them have age below 25. Based on education, most of them belonged to university
graduates, had business related specialization, and had an average income between thirty
thousand and sixty thousand. Most of the respondents use periodicals or the internet as
their main source of information and preferred shares as their investments. Based on basic
financial literacy concepts, our findings concluded that most of the respondents had high
financial literacy. On the other hand, most of the respondents had a high level of biasness
in decision making.
 x 2 20.843
Pakistan stock
P = 0.013 Estimate Std. error Wald Sig. exchange
Explained variable
Loss aversion = 1 —3.004 1.393 4.651 0.031
Loss aversion = 2 —2.003 1.386 2.088 0.148

Financial literacy score

Explanatory variable
—0.067 0.032 4.345 0.037**
273
Gender 0.487 0.239 4.149 0.042**
Age group —0.590 0.250 5.586 0.018**
Education —0.526 0.261 4.048 0.044**
Area of specialization 0.810 0.486 2.782 0.095*
Average Income —0.045 0.268 0.028 0.867
Main source of information 0.220 0.234 0.888 0.346
Preferred investment —0.194 0.251 0.599 0.439
Frequency of information —0.433 0.779 0.310 0.578 Table
11. Results of
Notes: **p # 0.05; *p # 0.10 ordinal regression
Source: Author calculations based on primary for loss
data aversion

x 2 17.162
P = 0.046 Estimate Std. error Wald Sig.
Explained variable
Hindsight bias = 1 —2.076 1.256 2.730 0.098
Hindsight bias = 2 —0.787 1.251 0.396 0.529
Explanatory variable
Financial literacy score —0.090 0.030 9.074 0.003***
Gender —0.296 0.223 1.770 0.183
Age group 0.143 0.235 0.374 0.541
Education 0.012 0.241 0.003 0.959
Area of specialization —0.492 0.386 1.623 0.203
Average income —0.150 0.246 0.373 0.542
Main source of information 0.324 0.216 2.263 0.133
Preferred investment —0.246 0.232 1.120 0.290
Frequency of information 0.355 0.730 0.236 0.627 Table
12. Results of
Notes: ***p # 0.01 ordinal
Source: Author calculations based on primary regression for
data hindsight bias

According to the obtained results, it is concluded that there is a strong negative

relationship between financial literacy and behavioural biases of individual investors. This
means that with an increase in the level of financial literacy, the likelihood of investors
facing behavioural biases reduces. However, Abreu and Mendes (2010) concluded that
there is a low level of financial literacy of female investors than male investors. In
contrast, Sezer and Demir (2015) claimed that there is no association between gender and
behavioural factors. It is observed that individual investors have a high level of cognitive
biases specified in this research. Among these cognitive biases, representativeness,
anchoring, and gambler’s
 JEFAS x 2 15.656
25,50 P= Estimate Std. error Wald Sig.
0.074
Explained variable
Illusion of control = 1 —1.002 1.325 0.572 0.450
Illusion of control = 2 0.133 1.323 0.010 0.920
274 Explanatory variable
Financial literacy score —0.071 0.030 5.589 0.018**
Gender —0.374 0.226 2.740 0.098*
Age group —0.091 0.237 0.149 0.700
Education —0.147 0.245 0.356 0.550
Area of specialization 0.317 0.397 0.638 0.425
Average income —0.381 0.247 2.382 0.123
Main source of information 0.297 0.219 1.847 0.174
Preferred investment 0.182 0.236 0.598 0.440
Table 13. Frequency of information 0.820 0.836 0.964 0.326
Results of
ordinal
regression for Notes: **p # 0.05; *p # 0.10
illusion of control Source: Author calculations based on primary data

x 2 = 17.781
P = 0.038 Estimate Std. error Wald Sig.
Explained variable
Cognitive dissonance = 1 —1.280 1.160 1.219 0.270
Cognitive dissonance = 2 0.184 1.157 0.025 0.874
Explanatory variable
Financial literacy score —0.049 0.029 2.836 0.092*
Gender 0.152 0.221 0.472 0.492
Age group 0.042 0.234 0.032 0.857
Education —0.348 0.146 5.687 0.017**
Area of specialization 0.310 0.384 0.651 0.420
Average income 0.088 0.246 0.129 0.720
Main source of information 0.412 0.215 3.671 0.055*
Table 14. Preferred investment 0.024 0.232 0.011 0.917
Results of ordinal Frequency of information 0.200 0.706 0.080 0.777
regression for
cognitive dissonance Notes: **p # 0.05; *p # 0.10
Source: Author calculations based on primary data

fallacy biases are highly inRuencing investor’s decision-making (Chen et al., 2004). It is
observed that anchoring bias leads investors to assign his thoughts to current experience,
and make their investment decisions upon attained experiences, despite its rationality. So
precisely, investors believe that through initial information he will outperform the market.
However, gambler’s fallacy bias provokes investors to prefer betting to speculate over the
investments (Pompian, 2011).
Based on the above facts, it is recommended that the Capital Markets Authority of
Pakistan i.e. Securities and Exchange Commission of Pakistan, should spread the
 x2 = 15.915
Pakistan stock
P = 0.069 Estimate Std. error Wald Sig. exchange
Explained variable
Herding bias = 1 —3.633 1.627 4.987 0.026
Herding bias = 2 —2.856 1.621 3.104 0.078

Financial literacy score

Explanatory variable
—0.112 0.038 8.545 0.003***
275
Gender —0.017 0.282 0.004 0.952
Age group —0.228 0.295 0.599 0.439
Education —0.377 0.313 1.454 0.228
Area of specialization —0.339 0.459 0.546 0.460
Average income 0.216 0.166 1.694 0.193
Main source of information 0.404 0.274 2.166 0.141
Preferred investment 0.253 0.166 2.324 0.127
Frequency of information —0.584 0.892 0.428 0.513 Table
15. Results of
Notes: ***p # 0.01 ordinal
Source: Author calculations based on primary regression for
data herding bias

x 2 = 18.412
P = 0.031 Estimate Std. error Wald Sig.
Explained variable
Market bias = 1 —3.585 1.447 6.138 0.013
Market bias = 2 —3.286 1.445 5.172 0.023
Explanatory variable
Financial literacy score —0.078 0.034 5.360 0.021**
Gender —0.411 0.249 2.725 0.099*
Age group —0.291 0.264 1.214 0.270
Education —0.430 0.275 2.447 0.118
Area of specialization —0.481 0.419 1.316 0.251
Average income 0.284 0.148 3.691 0.055*
Main source of information 0.336 0.244 1.899 0.168
Preferred investment 0.014 0.145 0.009 0.925
Frequency of information —0.721 0.772 0.871 0.351 Table
16. Results of
Notes: *p # 0.01; **p # 0.05 ordinal regression
Source: Author calculations based on primary for market
data bias

wide-ranging financial learning and Government funded training program that

incentivizes the individual investors. It is subsequently suggested that research on a
similar topic should be repeated at numerous areas, various institutions, and different age
groups of Pakistan, to ensure the reliability in the association between financial literacy
and behavioural biases of individual investors in numerous areas of Pakistan.
However, various behavioural factors were not adopted in this research like framing,
over-optimism, and confirmation, etc. So, it is recommended for future studies to apply
these factors and to explore more behavioural biases among different areas of Pakistan,
whereas in the field of financial literacy, we applied basic financial concepts that helped
measure
JEFAS financial literacy, so it is recommended that for more accuracy, advance financial concepts
25,50 must be used among various areas of Pakistan.

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Corresponding author
Nosheen Rasool can be contacted at: nosheen.rasool@gcu.edu.pk

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