A Study on Behavioural Biases and Market Dynamics: An Empirical Study of Overconfidence and Herding Behaviour among Equity Investors in India by Using the Structural Equation Modelling (SEM)

Behavioural Finance, Overconfidence bias, Herding behaviour, Investment decision-making, Structural Equation Modeling (SEM)

In the last few decades, the traditional notion of investor rationality has given way to more behaviourally-inspired approaches in financial theory. Now a mature field, behavioural finance has revolutionised thinking and thrown out a big challenge to conventional wisdom, as it has brought to light the effects of psychological biases on financial decision making. Of these overconfidence and herding is recognised as two key behaviours that have a significant influence on investor behaviour, especially in emerging markets like India.

In this study, the authors empirically analyse the effect of overconfidence and herding on investment decision making and market dynamics. The study is quantitative in nature as the primary data will be collected through a structured questionnaire from the Equity Investors of the selected areas in India. The results indicate that overconfidence (β = 0.44) and herding (β = 0.38) have significant positive effects on the investment decisions as revealed by the sample of 100 retail investors and SEM analysis. Construct validity was ensured by designing the measurement instrument based on validated scales from the literature in behavioural finance that was generated in the previous studies. The advantage of SEM is that it can be used to estimate both direct and indirect relationships among latent variables in the same model.

The findings show that overconfidence leads to excessive trading and risk taking, while herding behaviour leads to conformity-driven trading and risk taking. Further, the relationship between behavioural biases and the market dynamics is notably mediated by investment decision-making. The study adds to the methodological body of knowledge by using SEM to estimate both direct and indirect effects of behaviour in an integrated framework. Together, these behaviours lead to price differences, market volatility and price deviations from fundamental values. The research has a significant contribution to the behavioural finance literature as it offers empirical data on the Indian case and has practical implications on investors, policy-makers, and financial educators who want to facilitate more informed and rational investment behaviour.