Explaining the Disposition Bias among Investors : The Mediatory Role of Personality, Financial Literacy, Behavioral Bias and Risk Tolerance

Investors are frequently subjected to cognitive error. They often sell stocks that have increased in value, while keeping stocks that have dropped in value. We proposed a theoretical framework explaining what factors affect this disposition bias and how. According to the proposed theory, Disposition bias is affected by risk tolerance, financial literacy, and behavioral biases. Lower risk tolerance and low financial literacy can aggravate disposition bias. Similarly, those who are more prone to behavioral biases like Anchoring, Loss Aversion, Overconfidence, and Representativeness, also have a higher tendency of Disposition bias. We also proposed that personality factors such as Superego, Parsimony, Orderliness, and Obstinacy also influence both the level of financial literacy as well as behavioral biases that in turn affect disposition bias. Empirical validity was established by conducted a survey using a close-ended questionnaire. Data was collected from 182 investors trading through 3 brokerage firms in Karachi. Confirmatory factor analysis and structured equation modeling were used for analysis. The results suggested that financial literacy significantly affects all behavioral biases (except Representativeness) as well as Disposition Bias. Higher financial literacy will tend to show less disposition bias and they better can make portfolio decisions. Similarly, risk tolerance also affects disposition biases as risk-averse investors will tend to show more disposition bias. Among the behavioral factors, Anchoring, overconfidence, and loss aversion affect disposition biases. Overconfidence also seems to affect risk tolerance. Personality traits like superego and parsimony seem to affect almost all the behavioral biases. Similarly, superego and parsimony have an effect on risk tolerance. Similarly, Superego and obstinacy affected financial literacy. This finding will help investors to better manage their portfolio by mitigating these biases