Behavioural biases in relation to financial literacy

Abstract

Financial literacy consists of a person`s knowledge and understanding of different financial topics as well as the ability to manage one`s own personal finances and investments in an effective manner. It involves the capacity to be able to take suitable decisions, relating to personal finances, such as paying a loan, retirement planning and investing. When it comes to financial markets and investments, there is the Efficient Market Hypothesis which assumes that all investors are rational human beings. However, different studies have shown that human nature is not always rational. In fact, people tend to fall prey to different behavioural biases when they are making investment decisions. Despite the numerous studies that have been conducted regarding financial literacy and behavioural biases, not much research has gone into the relationship between them. This lack of information together with the fact that behavioural biases are not a familiar topic in Malta, gave rise to the need of this research study. This research will be carried out in order to investigate whether there is a relationship between financial literacy and behavioural biases. The main research question of this dissertation will therefore be: “Is there a relationship between the level of financial literacy of an investor and the level of behavioural biases?” After the data is collected, multiple regressions are run using SPSS. The findings showed that males have a higher level of overoptimism and confirmation biases when compared to females. Married investors have a higher level of overconfidence and a lower level of home bias than single investors. Investors with medium/high investment experience are more overconfident than investors with low experience. Investors with low experience are statistically more prone to confirmation, framing, loss aversion and home bias than investors with medium to high investment experience. Investors with a high level of self-assessed financial literacy are significantly found to be more loss averse than investors with a low self-assessment. It is also found that there is a significant negative relationship between the level of financial literacy and the level of home bias. Therefore, as the level of financial literacy increases, the level of home bias decreases.