Behavioral Factors Influencing Investment Decision-Making Mistakes: The Roles of Overconfidence, Representativeness, Loss Aversion, and Mental Accounting

Abstract

Purpose - This paper explores how four major behavioral biases, namely Overconfidence Bias (OB), Representativeness Bias (RB), Loss Aversion (LA), and Mental Accounting (MA), affect Mistakes in Investment Decision-Making (MIDM) in the Bangladesh stock market.

Methodology - The research design was quantitative. Utilizing primary data from 301 active investors, the study employs linear regression analysis to explore the relationship between these biases and MIDM. The results reveal that OB, LA, and MA significantly influence MIDM, while RB has an insignificant impact. MIDM accounts for 63.7% of the variation in OB, RB, LA, and MA: MIDM = α + β₁OB + β₂RB + β₃LA + β₄MA + e.

Findings - As the results demonstrate, the effect of OB, LA, and MA on MIDM is statistically significant and positive, whereas the effect of RB is insignificant (T = 0.282, p = 0.778). In particular, the predictive power of MA was the highest (T = 5.420, p < 0.001), then the predictive power of LA (T = 3.318, p < 0.001) and OB (T = 2.075, p = 0.038). The model attained an adjusted R2 of 0.637, thus showing that the four biases together account for about 64 percent of the variance in errors when making investment decisions. Correlation analysis further proved high positive links between MIDM and LA (r = 0.740), MA (r = 0.769), and OB (r = 0.684), and all VIF values were within the acceptable limit (1-5), which indicated that the model was stable and there was no multicollinearity.

Implications and Value - The results challenge the rationality principle of classical finance theory (EMH and EUT) and emphasize the prevailing role of cognitive and emotional biases in investor behavior. In practice, the research shows that investor education programs, financial literacy projects, and policy interventions to minimize the effects of overconfidence, loss aversion, and mental accounting among market participants are urgently required. Regulators, educational institutions, and financial advisors must focus on educating investors to develop critical thinking and analytical skills, thereby reducing systematic decision-making errors and creating more efficient capital markets.