MRR 04 2016 0091

Management Research Review
Institutional investor behavioral biases: syntheses of theory and evidence

Zamri Ahmad Haslindar Ibrahim Jasman Tuyon
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Zamri Ahmad Haslindar Ibrahim Jasman Tuyon , (2017)," Institutional investor behavioral biases: syntheses of theory and
evidence ", Management Research Review, Vol. 40 Iss 5 pp. -
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Institutional Investor Behavioral Biases: Syntheses of Theory and Evidence
1. Introduction
Practical investment and academic studies have acknowledged the existence of investment
behavioral biases that lead to irrational decision making. These biases in investing encompass many
types, and are still not well understood. Investor irrational behavior is real and its effects to
financial and economic systems are pervasive if no efforts are taken to acknowledge and mitigate
them. Despite its significance, the theoretical underpinning of irrational behavior remains vague and
this has been neglected in academic, practice and policy discourse. In academic finance inquiry,
empirical evidence of behavior irregularity reflected in financial markets has increasingly
challenged the validity of many modern finance theories and models. Attention to this issue is
important but remains challenging because modern and behavioral finance paradigms are divided in
perspectives with regards to theoretical foundation of investor and market behaviors. Modern
finance paradigm has defended the assumption of rationality and market efficiency as the correct
theoretical basis describing the approximate behavior for investor and the market. On the other
hand, behavioral finance paradigm believes that investor behavior is bounded rational and
collectively forms inefficient markets.
Behavioral finance postulates that as human being, retail and institutional investors commit
some elements of irrationality in their decision making. This human irrationality is biologically,
psychologically, and sociologically embedded in normal human being. Given the above problems in
focus, the objective of this paper is to examine the evidence of various classes of behavioral biases
among fund managers, which is the largest and important segment of institutional investors in
financial markets. We focus solely on survey-based evidence to understand and describe the
behavior from the individual level data. This review will provide information to scholars,
practitioners, and regulators on the origin, causes, and effects of institutional investors irrational
behaviors and suggests possible future actions.
This paper provides two insights. First, it proposes an alternative theoretical underpinning
through theoretical triangulation of psychological, sociological and biological perspectives in
understanding the origin, causes and effects of institutional investor irrational behaviors. Second, it
draws a conceptual framework based on syntheses of theories and empirical evidence in
understanding the origin of institutional investors’ irrational behaviors, their influence on irrational
investment management strategies, and impact on fund investment performance. This inquiry is
organized as follow. Section 2 establishes the theoretical perspectives and evidences on investors
and market behaviors. Section 3, provides syntheses of the fund managers biases compiled from
survey-based research worldwide. Section 4, proposed the theoretical conceptualization and
modeling of fund managers irrational behaviors’ origin, causes and effects. Finally, Section 5
concludes and suggests scholars, practitioners and regulators on the next course of actions.
2. Literature Review
2.1 Behavioral finance theoretical perspectives
Approximation of human behavior is the cornerstone in understanding the reality of financial

markets functioning (Shiller, 1999). In particular, investor behaviour determine asses prices through
demand and supply forces, and consequently determine the financial market behaviours. Currently,
two schools of thought, namely modern finance and behavioral finance, provide a different
theoretical conceptualization of the finance worldviews. Figure 1 illustrates the interconnections
1
between investor, asset prices, and market behaviours in financial systems together with the two
school of thought theoretical perspectives. To keep our discussion focus, we briefly introduce the
financial worldview from the lenses of behavioral finance. The modern finance theoretical
perspectives are described in Miller (1999), while the behavioral finance historical development is
well explained in Ritter (2003), Baker and Nofsinger (2010), Statman (2014), and Thaler (2016).
Efficient market hypothesis Adaptive market hypothesis

(EMH) Market (AMH)
behaviour
Behavioral Finance
Modern Finance
Equilibrium/Static/Linear Asset prices Disequilibrium/

behaviour
Dynamics/Nonlinear
Rational hypothesis Investors Bounded rational

behaviour hypothesis
Figure 1. Theoretical perspectives of financial market functioning (Tuyon and Ahmad, 2016)
Notes: This figure illustrates the systems of financial markets that can be organized into three layers namely; investor
behaviour, asset price behaviour, and market behaviour. The investor’s behaviour is the basic elements in the financial
systems that will determine the asset prices and market behaviour.
Behavioural finance offers an alternative theoretical perpective of financial market functioning (i.e.
investor, asset prices, and market behaviors) based on positive philosophical views, which does not
assume full rationality of market players. The current theoretical foundations for investor behaviors
in the behavioural finance paradigm are the bounded rationality theory of Simon (1955) and
prospect theory of Kahneman and Tversky (1979) drawn from the field of psychology. In
psychology perspective, irrationality on the part of human decision is a basic human nature (Ellis,
1976). This is substantiated with extensive experimental evidences from cognitive psychology on
the systematic heuristics and biases that arise from people’s beliefs and preferences (Tversky and
Kahneman, 1986).
Guided by the above theoretical assumption on human behavior, asset prices and market
behavior, which are the product of collective actions of market players, are dynamic and adaptive in
nature. Human behaviour biases are impacting asset prices through supply and demand interactions
which sometimes leads the market to be inefficient (Schneider and Lappen, 2000; Ritter, 2003).
These provide support to the adaptive market efficiency hypothesis of Lo (2004; 2005) as a
representative theory for financial market behavior. Based on the behavioural finance paradigm, the
complexity and dynamism of investors and market behaviours are best reflected and acknowledged
in a complex system (Jacobs and Levy, 1989; Mitroi and Oproiu, 2014) supported by
interdisciplinary theories. As such, it is important to synchronize investors, asset prices and market
in the dynamic systems ruled by real human behavior. In the following sections, the discussion will
focus on forces determining investor behavioral biases.
2.2 Interdisciplinary insights on investor and market behaviors
Empirical evidences from the field of psychology, sociology and biology conclude that investors’
behaviors are shaped collectively by internal and external forces namely psychological, sociological
and biological factors.
Psychological factors are decision-making biases that are produced internally by individuals
through the two systems of human thinking namely the dual cognitive-affective process
(Kahneman, 2003; Carmerer, Loewenstein and Prelec, 2005). These thinking systems are claimed
2
to induce errors in individual decision-making. Specifically, cognitive system produces errors that
are collectively known as cognitive heuristics or the tendency to use rules of thumb in decision-
making process to simplify complex decision situations (De Bondt, 1998; Fuller, 1998; Das and
Teng, 1999). Whereas, biases in decision-making produced by affective system are sentiment or
feelings, emotion, and mood (see Lowenstein, Hsee, Weber and Welch, 2001; Ackert, Church and
Deaves, 2003; Lucey and Dowling, 2005; Grable and Roszkowski, 2008; Shu, 2010; Dow, 2011;).
The sociological factors are external forces that induce decision-making biases on part of
individual as a result of social influence in the social networks (see Zafirovski, 2000; Shiller, 2002;
Fligstein and Dauter, 2007; Frith and Singer, 2008; Baddeley, 2010; Carruthers and Kim, 2011;
Fenzl and Pelzmann, 2012; Seyfert, 2012). These evidences are consistent with earlier prediction by
Keynes (1937) that social interaction influences individual decisions by way of believing what
others think and following what others do. From the field of ecology, ecologists coined that the
financial institutions, ranging from large institutional investors to investment banks, have important
social and ecological impacts at a global level through their investment decisions (Galaz et. al.
2015). The relevant of social factors in influencing individual decision is postulated in many
sociology-based theory. The theory of social preferences suggesting that individual sole motivation
is not entirely for self-interest as asumed in modern economics paradigm. Instead, this theory argue
that the society is made of a fair (concern for others) and selfish individuals. Thus, individual
motivation and interaction between fair and selfish group are influence decision making with
important economic consequences (Sobel 2005; Fehr and Schmidt, 2006). The theory of social
mood (Nofsinger, 2005) hypothesises that social mood determines the types of decisions made by
consumers, investors, and corporate managers alike. Culture-based theory postulates that culture
can affect finance through three channels. First, the values that are predominant in a country depend
on its culture. Second, culture affects institutions practice. Third, culture affects how resources are
allocated in an economy (Stulz and Williamson, 2003). In behavioral finance application, Statman
(2008) argues cultural differences may influence investor behavior that matters in understanding
individual in different culture investment decision-making process.
The biological origin of human irrationality has been explained in Ellis (1976), while
individual financial risk tolerance based on biological perspective has been provided by Harlow and
Brown (1990). The main idea is that biological and psychological traits influence the formation of
preferences and decision-making process. Harlow and Brown (1990) also highlighted that
personality characteristics such as sensation seeking and extroversion as well as various
components of the complex set of human neurochemical systems influence the individual financial
risk tolerance. Based on this theoretical premise, Murphy (2012) provides the underlying biological
explanations for time-varying risk aversion and temporal changes in expectations. The basic
premise is that the brain states which are induced by internally produced biological chemicals,
could explain investor irrational behaviors that cause mispricing and inefficiency of the markets. In
his paper, Murphy discusses how variations in testosterone and cortisol influence irrational risk
taking behaviors especially for males. In a wider perspective, Professor Paul J. Zak and his
collaborators discuss many aspects of the neurobiology origin of individual decision and collective
actions (see http://www.neuroeconomicstudies.org/published-works).
Motivated by biology-based theory (the theory of evolution) and evidence, Farmer and Lo
(1996) put forward a new view of financial market functioning from a biological perspective. In
particular, within an evolutionary biology conceptual framework, they postulated that the markets,
instruments, and investors are interacting and dynamically evolving. This is due to the assumption
made on part of the financial agents that are believe to be competing and adapting, but not
necessarily in optimal ways. Later, Lo (2004; 2005) formalizes the AMH as an alternative theory
for financial market functioning. Recently, extending the biological perspective, the neuroscience
3
theories have been capitalised to inform the neural and cognitive origin of investor behavior under
the neurofinance research pillar (see – Sahi, 2012; Frydman and Camerer, 2016).
Based on these interdisciplinary literature reviews, the possible list of behavioral heuristics
and biases are many and unclear. This claim is in line with Fuller (1998) who states no taxonomy
existed for classifying behavioral biases currently exist in behavioral finance. Nonetheless, we
argue that based on these evidences, the behavioral biases can be systematically categorized by
those which are induced by psychological, sociological and biological forces.
2.3 Institutional investors and their investment behavior.
Financial market behavior is aggregates of investors’ behaviors of institutional and retail individual
investors (Tuckett and Taffler, 2012). Institutional investors are the main actors in financial markets
(Gonnard, Kim and Ynesta, 2008). Institutional investors are defined as asset management
companies like investment funds, insurance companies, pension funds, and other forms of
institutional savings that principally work for their customers as agents (Suto and Toshino, 2005).
Although the characteristics of institutional investors are not uniform throughout the world,
generally they have four common features according to Midgley and Burns (1977). First, they are
intermediaries that do investment on behalf of others. Second, they have large amount of funds for
investment. Third, they are only few and could act in concert to influence the market. Fourth, they
tend to have a net inflow of funds readily available for investment.
Since the institutional investors are the most dominant players in financial markets,
understanding their behavior is important in understanding the asset prices innovation and market
behavior in general. They are expected to be rational and to act professionally. Nonetheless, there
are many issues of irrationality of institutional investors (Menkhoff, 2002; Montier, 2002; Suto and
Toshino, 2005;) and some have blamed them for creating excessive volatility that distort financial
markets stability and directly destabilizing the economy (Menkhoff, 2002). However, to date, the
real behavior of fund managers has been largely ignored in finance academic literature (Tuckett and
Taffler, 2012). Addressing these issues is important for academician, practitioners, and regulators.
Academically, modern finance assumes institutional investors are always rational actors,
who off-set irrational wave by retail investors through rational arbitrage activities. This will ensure
the financial market to be always operationally and informationally efficient. However, there are a
few problems related to this assumption. First, there is growing evidence challenging the validity of
this assumption. Second, there is evidence of irrationality of institutional investors behavior as well,
that leads some to believe that lay people and experts are alike (Akerlof and Shiller, 2009; Garling,
Kirchler, Lweis and Raaij, 2009). Third, any evidences of irrationality and inefficiency in financial
markets bring challenges to the completeness of agency theory and corporate governance theory,
which have been based on full rationality assumption.
In practical investment perspective, the practices of fund management based on modern

finance paradigm have been challenged. First, in the presence of behavioral biases on part of
institutional investors’ thinking, behavior, and action, this provides evidences that they contradict
their role as shareholders (Suto and Toshino, 2005) as predicted by agency theory. Second, there is
a need of corporate governance to address the negative effect of behavioral biases as highlighted by
some scholars. In this regard, Suto and Toshino (2005) argued that institutional investors who
underperform in corporate governance, distort corporate evaluation and neglect their long-term
fiduciary roles entrusted to them as an agent. They also noted that “there is still a large gap between
awareness and action” (Suto and Toshino, 2005, p. 476) with regards to enhancing corporate
governance to address behavioral biases in investment institutions.
4
In regulatory perspective, these behavioral finance perspectives should have been taken into
account and incorporated in policy making to ensure fair and transparent practices in investment
activities in financial markets by all parties. However, because the policy makers are also guided by
modern finance and economics thought, this has not yet been the case. We should have learned
from many historical evidence of financial crisis caused by irrational behavior of institutional
investors. To address market inefficiency, Li (2008) highlighted the needs for organizational and
institutional framework to be fair, transparent and efficient in disclosing and distributing
information. This requires the need to strengthen the laws in financial markets.
2.4 Evidence on institutional investors’ behavioral biases
In search of the existing empirical evidence, a purposive literature review has been employed. In
particular, we review the possible lists of behavioral biases reflected by institutional investors by
relying on past studies that have been conducted using survey method. This is intended to control
for possible biasness in opinion due to different research methodology used. Most impotantly, direct
survey of institutional investors provides the best and real measures of their behaviours (Frank,
2007). With this objectives in mind, we did not cover a bulk of complementary perspectives
provided under the experimental methodology approach which are generally conducted on non-real
institutional investors in lab experimental setting.
In doing so, we retrieved all possible existing papers from various journal databases (i.e. EBSCO
host, Emerald, Google Scholar, Science Direct, SAGE Knowledge, Scopus, Springer Link, World
Scientific, Wiley Online) and reference to behavioral finance books. The search on these literatures
is performed in early 2015. We used the following key words in our search “behavioral finance,
irrational behaviour, behavioral biases, institutional investors, fund managers, survey-based”. All
identified articles are further manually screened for content suitability. Finally, we managed to
identify more than 30 relevant papers related specifically to survey of fund managers’ behavioral
biases covering 19 countries. The retrieved relevant literature is summarized in Table 1.
Table 1: Summary of studies on institutional investor behavioral biases

Behavioral biases Countries Studies
Anchoring Kenya Waweru, Munyoki and Uliana (2008)
Availability bias Kenya, Israel, Waweru, Munyoki and Uliana (2008), Kudryavstev,
Cohen and Schmidt (2013),
Confirmation bias Germany Menkhoff and Nikiforow (2009)
Disposition effect Japan, Israel, Sweden Susai and Moriyasu (2007), Kudryavstev, Cohen and
Schmidt (2013), Bodnaruk and Siminov (2014)
Emotion United States, United Kingdom, Tuckett and Taffler (2012)
Asia
Gambler’s fallacy Kenya, Israel, Waweru, Munyoki and Uliana (2008), Kudryavstev,
Cohen and Schmidt (2013),
Gut feelings Malaysia Lai, Low and Lai (2001)
Herding Japan, Germany, United States, Suto and Toshino (2005), Menkhoff, Schmidt and
Thailand, Switzerland, Italy, Brozynski (2006), Susai and Moriyasu (2007), Beckmann,
Israel, Menkhoff and Suto (2008), Lutje (2009), Menkhoff and
Nikiforow (2009), Kourtidis, Sevic and Chatzoglou
(2011), Kudryavstev, Cohen and Schmidt (2013),
Hot hand fallacy Israel Kudryavstev, Cohen and Schmidt (2013)
House money effect Germany Menkhoff and Nikiforow (2009)
Inconsistence in risk tolerance Greece, Malaysia Kourtidid, Sevic and Chatzoglou (2011), Mahat and Ali
(2012)
Loss aversion United States, Kenya Olsen (1997)
Mental accounting Kenya Waweru, Munyoki and Uliana (2008)
Optimism France Broihanne, Merli and Roger (2014)
Overconfidence Germany, Australia, Kenya, Menkhoff, Schmidt and Brozynski (2006), De Venter and
United States, Switzerland, Italy, Michayluk (2008), Waweru, Munyoki and Uliana (2008),
Thailand, Greece, France Menkhoff (2010), Kourtidid, Sevic and Chatzoglou
(2011), Broihanne, Merli and Roger (2014)
5
Reflection effect Germany Menkhoff and Nikiforow (2009)
Representativeness Kenya Waweru, Munyoki and Uliana (2008)
Sentiment India Sehgal, Sood and Raiput (2009)
Social influence Greece Kourtidid, Sevic and Chatzoglou (2011)
Use of other information Countries Studies
Company visits United Kingdom Clatworthy and Jones (2008)
Newspaper reports Saudi Arabia Al-Abdulqader, Hanna and Power (2007)
Political news Malaysia Lai, Low and Lai (2001)
Relying on analysts reports United Kingdom Clatworthy and Jones (2008)
Relying on other opinions Hong Kong, Sweden Wong and Cheung (1999), Hellman (2005)
Rumors Malaysia Lai, Low and Lai (2001)
Use of non-accounting United Kingdom, Germany Clatworthy and Jones (2008), Lutje (2009)
information
Words of mouth United States Shiller and Pound (1989)
Irrational investment Countries Studies
behavior
Excessive portfolio turnover Sweden Bodnaruk and Siminov (2014)
Home bias Germany Menkhoff and Nikiforow (2009)
Momentum trading United States, United Kingdom Richardson, Tuna and Wysocki (2010)
Winner and spotlight stocks Germany Arnswald (2001)
Self-marketing Japan Suto and Toshino (2005)

Self-monitoring Greece Kourtidid, Sevic and Chatzoglou (2011)
Short-termism Japan, Germany, United States, Suto and Toshino (2005), Lutje (2009), Menkhoff (2010)
Switzerland, Italy, Thailand
Use of technical analysis Hong Kong, Malaysia, Saudi Wong and Cheung (1999), Lai, Low and Lai (2001), Al-
Arabia, Germany, Switzerland, Abdulqader, Hanna and Power (2007), Kourtidis, Sevic
United States, Italy, Thailand, and Chatzoglou (2011), Menkhoff (2010), Richardson,
United Kingdom Tuna and Wysocki (2010)
The general findings of these studies indicate that behavioral forces are found to be significant
among institutional investors. We provide synthesis of these behavioral heuristics and biases in the
following sections.
3.1 Common behavioral biases among institutional investors
The list of investment biases that investors committed is too long (Cronqvist and Siegel, 2014) and
impossible to be summarized here. We discuss here only those reflected in the empirical papers
reviewed. They can be grouped into two broad categories as induced by psychology forces (i.e.
cognitive heuristics and affective biases) and sociology forces (cultural and mass influences).
3.1.1 Psychology forces

Psychological forces impact individual investor decision and behavior through the influence of both
cognitive heuristics and affective biases. Cognitive heuristics generally refers to the influences of
various cognitive short-cut strategies in decision-making due to limited cognitive capacity
(Warneryd, 2001). From the survey-based research reviewed, the following are the common
cognitive heuristics affecting institutional investors’ decision making.
Table 2: Cognitive heuristics and investment implications

Heuristics Descriptions Investment Implications
Anchoring Anchoring occurs when individual make Various reference points are used as a benchmark.
estimates by referring to an initial value. In This practice could induce deviations in security and
investment application, investor’s forecasts of market prices in the short-run (Fromlet, 2001).
future value may be affected by reference to Investor often anchors on initial purchase price as a
some benchmark (Warneryd, 2001). reference point for loss or gain and financial crisis as
bad experience (Baker and Ricciardi, 2014).
Availability Availability heuristics is tendency of individual The information related to well-known companies is
to form estimates or judgments based on the ease more available and could dominate impression
of instances or occasions can be brought to mind (Warneryd, 2001). Recent information by analysts or
(Warneryd, 2001). brokers influences decision (Montier, 2002).
6
Confirmation Confirmation bias refers to a situation where Investor search for confirming evidence and ignore
investors desire to find information that is in disconfirming evidence (Shefrin, 2000). More often,
confirmation with their existing beliefs (Montier, investor overweight on information in their favor
2002). (Montier, 2002).
Disposition effect Disposition effect is defined as tendency of Riding looser too long to avoid recognizing bad deals
selling winners too early and riding losers too and cutting losses can do harms to investment values
long (Shefrin and Statman, 1985). (Fromlet, 2001).
Gambler’s fallacy Gambler’s fallacy is a phenomenon whereby Investor overly pessimistic after bull markets and
investors inappropriately predict a sure reversal overly optimistic after bear markets (De Bondt,
(negative recency) (Shefrin, 2000). 1991).
Hot hand fallacy Investor believes that certain events will be If an investor has won in the past, he/she likely
repeated (positive recency) (Kudryavtsev, chooses to bet and win in the future (Kudryavtsev,
Cohem and Hon-Snir, 2013). Cohem and Hon-Snir, 2013). This also induces trend-
chasing attitude (Baker and Ricciardi, 2014).
Loss aversion Loss aversion is defined as a situation where This could explain the situation where investor hold
people generally opt to take a chance rather than loosing stocks and not to sell anything at a loss
the guaranteed losses in an investment options (Shefrin, 2000). Risk averse investor will not take
(Shefrin, 2000). more risk (Baker and Ricciardi, 2014).
Mental accounting Mental accounting refers to individual tendency Investor risk taking would be varies depending on
to treat their different investment instruments or which mental account they are dealing (Shefrin and
portfolio differently (Shefrin and Statman, 1985) Statman, 1985). Portfolio formation as pyramid of
assets with different goals and risks (Statman, 1999)
Over optimism People tends to exaggerate their own abilities Over optimism can induce excessive trading behavior
that can be induced by illusion of control and (Shefrin, 2000; Bodnaruk & Siminov, 2014).
self-attribution bias (Montier, 2002)
Overconfidence Overconfidence is described as people thinking Overconfidence can promote optimism and induce
they know more than they really do (Shiller, excessive trading behaviors (Shefrin, 2000; Montier,
2000) because they consider themself to be 2002; Bodnaruk & Siminov, 2014). Overconfidence
experts in their decision making (Fromlet, 2001). induces control of illusion bias where individual
believe they can control a particular situation
(Fromlet, 2001).
Representativeness Representativeness is defined as the tendency to Causes overreaction (underreaction) and optimism
give certain developments, reports, or statements (pessimism) to bad (good) news (De Bondt and Thaler,
more importance without serious thought 1985; Shefrin, 2000). Overemphasis on negative facts
(Fromlet, 2001). People in situation of (Fromlet, 2001). Past losers are undervalued and past
uncertainty generally tend to look for familiar winners are overvalued (Shefrin, 2000). Influence of
patterns and believe that the pattern would be company (Cooper, Dimitrov and Rau, 2001). Buying
similar (Warneryd, 2001). stock after prices rise (Baker and Ricciardi, 2014).
Affective biases refer to biases induced by affective states namely emotion, sentiment and mood of
an individual in the course of decision-making. Their descriptions and some examples of possible
investment implications are as summarized below. Noted that, in the current practice, behavioral
finance scholars used the emotion, sentiment and mood interchangeably or collectively as affective
biases because of difficulties in distinguishing them. The current referred theory of bounded
rationality does not discuss them. Nonetheless, we argue here that they can be distinguished as
explained in Table 3.
Table 3: Affects and investment implications

Affect state Descriptions Investment Implications
Emotion Emotion state (greed, hope, worry fear, panic) is Emotion can induce optimism (pessimism),
induced by a particular (favorable or unfavorable) overconfidence (low confidence), overreaction
event (Shefrin, 2000). (underreaction), and risk tolerance (Shefrin, 2000;
Warneryd, 2001; Baker and Ricciardi, 2014).
Sentiment Sentiment state (optimistic or pessimistic) is Sentiment can induce optimism (pessimism),
induced by a particular (favorable or unfavorable) overconfidence (low confidence), overreaction
event. (underreaction), and risk tolerance. Sentiment
proxies influence investors (Baker and Wurgler,
2006).
Mood Mood state (good or bad mood, happy, sad, stress) Mood can induce optimism (pessimism),
is induced by a particular (good or bad) event. overconfidence (low confidence), overreaction
(underreaction), and risk tolerance. Mood state is
induced by weather (Hirsleifer and Shumway,
2003) due to seasonal affective disorder.
7
3.1.2 Sociology forces
Sociologists believe that investment in financial markets is a social phenomenon where individual’s
thinking and actions are not isolated from others. In this perspective, social influence is expected to
occur in decision-making given the complex and uncertain situations (Warneryd, 2001). The
justifications for this social influence as highlighted in Festinger (1954) are that individuals have an
innate tendency to compare themselves with others and that they generally evaluate their attitude
and capacity against others as a comparison. Table 4 shows some important social forces that may
affect investment decision making.
Table 4: Social forces and investment implications

Social forces Descriptions Investment Implications
Herding Investors are inclined to believe the majority Attention to winners stocks with the pre-established
opinion and run on the same as directions believes that good performance repeat itself
(Fromlet, 2001). (Fromlet, 2001).
Social influence Influence emanating from other people’s opinion Warneryd (2001) highlighted the following social
or behavior. Social influence induced investors to influence in investment decisions;
follow a market leader, to react accordingly with i. Small group influence through direct contact
other investors or to imitate others behaviors with others.
(Warneryd, 2001). ii. Direct observation and interpretation of others’
behaviors.
iii. Believing on reports reflected in media.
iv. Bandwagon effects which mean people like to
confirm to opinion and behavior of the
majority.
Cultural norms Culture is defined as a system of shared values, Cultural explain information content (Nguyen and
beliefs and attitudes that influence perception, Truong, 2013) and investment behavior (Beracha,
preferences and behaviors of a group of society Fedenia and Skiba, 2014). Cultural influence home
(Anderson, Fedenia, Hirschey and Skiba, 2011). bias and international diversification (Anderson,
Culture includes cultural traits, festival, and Fedenia, Hirschey and Skiba, 2011). Fastival
superstitious beliefs. influence - Investor exploiting the Ramadhan
anomaly in trading strategy (Bialkowiski, Bohl,
Kaufmann and Wisniewski, 2013). Investor
exploiting the Chinese New Year anomaly (Ahmad
and Hussain, 2001). Superstition like beliefs on
horoscopes, numbers, and objects also influence
investment strategies of certain group of ethnic like
Chinese which explains the price clustering
phenomenon (Brown, Chua and Mitchell, 2002).
3.2 Heterogeneity of Behaviors
Behavioral finance paradigm acknowledges that individual thinking, behavior, and actions in risky
and uncertain investment decision-making are dynamic and complex. Empirical evidences from
interdisciplinary inquiries provide insights that different individual or group of individual has
different degree of behavioral biases. These differences are due to differences in individual,
cultural, and institutional forces as discussed below.
3.2.1 Individual traits
Individual traits refers to demographic and personality type. Behavioral aspects of demographic and
personality type are possible influence on decision making and financial risk taking behavior have
been well documented in finance and economics literature since Siegal and Hoban (1982).
Demographic forces as important determinants for individual investment decisions and risk
taking behaviors have been well established in behavioral finance literature. These factors include
the followings. The first factor is gender differences. In psychology research, men have been
acknowledged as more risk tolerant compared to women in many risks taking decisions (Byrnes,
Miller and Schafer, 1999) partly because they are more exposed to overconfidence bias (Montier,
8
2002). This hypothesis has also been supported in behavioral finance research (De Venter and
Michayluk, 2008; Halko, Kaustia and Alanko, 2012). The second factor is age differences. Positive
relationship between investor ages and level of risk tolerance has been empirically supported in
finance research. Riley and Chow (1992) documented that investor level of risk aversion decreases
with their ages. However, evidence from Halko et al., (2012) showed that age effect on risk
aversion is reduced when controlling for financial knowledge. The third factor is experience
. Empirical evidences showed that more experienced and expert investors are more prone to
overreaction and overconfidence biases (Chen, Kim and Nofsinger, 2004; Griffin and Tversky,
1992) and more risk takers (Corter and Chen, 2006). An education difference is the fourth factor.
Previous research suggests that education is important in predicting preferences and behavior. In
finance research, finance education that is expected to increase financial literacy has been
associated with choices for investment (Schooley and Worden, 1999; Bernheim and Garrett, 2003)
risk taking behavior (Wang, 2009; Sjoberg and Engelberg, 2009) and encourages wealth-creating
investment (McCannon, 2014). In Nikiforow (2010), they show that training on behavioral finance
does increase awareness and reduce the fund managers’ behavioral biases.
Personality types are psychological characteristics of individual. Many have examined the
connection between personality type and risk tolerance level. There are many personality tests
available but the popularly used psychology-based personality type tests are the Myers-Briggs Type
Indicator1 , Big Five personality taxanomy2 , Zuckerman’s Sensation Seeking Scale (Zuckerman,
1994), Domain-Specific Risk Taking Scale3 (Weber, Blais and Betz, 2002; Blais and Weber, 2006)
and Risk Tollerance Questionnaire (Corter and Chen, 2006). Using the Myers-Briggs Type
Indicator test in behavioral finance research provides insights that higher score for extraversion,
intuition, thinking and perceiving are positively related to higher level of risk tolerance (Filbeck,
Hatfield and Horvath, 2005). Use of Big Five personality taxanomy in finance research also
explains investment behavior and variation in risk taking among investors in accordance with their
personality types. In Mayfield, Perdue and Wooten (2008), they provide evidence that extraverted
individual intend to engage in short-term investing and neuroticism individuals shows that they are
more risk averse and do not engage in short-term investing. Meanwhile, individual with openness to
experience are inclined to engage in long-term investing. The Zuckerman’s Sensation Seeking Scale
has been used by Belcher (2010) in examining the student personality characteristics and portfolio
preferences but found no discernible pattern between psychological characteristics and portfolio
preferences.
3.2.2 Cultural traits
Culture impact on finance is a new emerging sub-field of behavioral finance research. Based on
sociology perspective, culture is partly important in understanding individual behavior. Cultural
factor has a great determinant role in investment decision-making because investors personally and
collectively adhere to conserve personal relationship within the organization or society they belong
to (Ellison and Fudenberg, 1993). Growing evidences from behavioral finance research and other
sociology research indicated that investors’ behaviors are related to the cultural origin of the
individual. This perspective suggests that individual investment behavior could be predicted based
on their cultural characteristics. The importance of this perspective has long been neglected in
finance but there are growing recent works looking into this issue.
Hofstede’s cultural dimension (Hofstede, 1980) of individualism, uncertainty avoidance and
long-term orientation has been recently capitalized in behavioral finance research to explain the
1
See Filbeck et al. 2005 for detail descriptions.
2
See Mayfield et al. 2008 for detail descriptions.
3
See Blais and Weber (2006) for detail of questions.
9
behavior of stock markets. Nguyen and Truong, (2013), for example, provides worldwide evidences
that information content of stock markets is higher in more individualistic countries and in low
uncertainty avoidance countries. Beracha, Fedenia and Skiba (2014) provide evidence those
institutional investors from different cultural background trades differently. In addition, they
provide evidence that institutional investors trade with higher frequency in their home countries and
in countries with similar cultural background. This finding can be corroborated to earlier findings
by Anderson, Fedenia, Hirschey and Skiba (2011), which provide evidence that home bias and
international diversification by institutional investors are influenced by cultural bias. Bialkowiski,
Bohl, Kaufmann and Wisniewski (2013) confirmed that fund managers exploit the Ramadhan
anomaly in their trading strategy.
3.2.3 Institutional traits
We discuss two important institutional traits namely governance and ethical concerns. Current
corporate governance policy and practice, which are based on the rational model of decision
making, may be insufficient to mitigate future corporate failure (Marnet, 2005). Lack of corporate
governance in curving the behavioral biases and information asymmetry has been pointed out as
one of the reasons for failure in addressing behavioral induced risks in financial markets. Mernet
(2005) argued that to gamble imprudently seems inherent in human nature. Stocks returns in
emerging markets tend to be more positively skewed which can be attributed to managers having
more discretion to release good information immediately and bad information slowly (Claessens
and Yurtoglu, 2013). This is probably due to the fact that the current practice of corporate
governance does not take into account the need to curve behavioral biases. Some scholars have
voiced the needs for corporate governance to include a new mission for corporate governance to
control behavioral biases in firms (Baccar, Mohamed and Bouri, 2013) and in financial markets in
general (Suto and Toshino, 2005).
Ethical concerns have also been reported to have important roles in mitigating behavioral
biases in fund management. In this perspective, Marco, Munoz and Vargas (2011) provide evidence
of differences in risk taking behavior between ethical and conventional mutual fund managers. This
stream of research is new which has yet to be explored in behavioral finance research.
3.3 Irrationality investment decisions
Behavioral biases cause irrationality in various aspects of investment decisions. In the following
Table 5, we synthesize the irrational investment decisions in four dimensions namely information
use, investment analysis use, investment and trading strategies, and portfolio management
strategies.
Table 5: Investment biases and psychological mechanisms

Investment Irrational investment behavior (Effects) Irrational behavior (Causes)
management
dimension
Information use Rely on various information other than firm and Biased information search (Garling et al.
economic fundamentals including; Company visits 2009; Cronqvist and Siegel, 2014) to avoid
(Clatworthy and Jones, 2008); Newspaper reports information overload and uncertainty of
(Al-Abdulqader, Hanna and Power, 2007); Political decisions. Herding bias induce use of non-
news (Lai, Low and Lai, 2001); Analysts reports fundamental information (Lutje, 2009). Also
(Clatworthy and Jones, 2008); Other opinions (Wong partly induced by personality and social traits.
and Cheung, 1999; Hellman, 2005); Rumors (Lai,
Low and Lai, 2001); Non-accounting information
(Clatworthy and Jones, 2008; Lutje, 2009); Words of
mouth (Shiller and Pound, 1989).
Investment analysis use Popular use of technical analysis (Wong and Induced by momentum trading (Menkhoff
Cheung, 1999; Lai, Low and Lai, 2001; Al- and Nikiforow, 2009) to exploit anomalies
Abdulqader et al. 2007; Menkhoff, 2010; Kourtidis et and trend or performance chasing (Baker and
al. 2011) Ricciardi, 2014).
10
Investment and trading Excessive trading/ excessive portfolio turnover Overconfidence; Sensation-seeking (Garling
strategies (Bodnaruk and Siminov, 2014). et al. 2009; Cronqvist and Siegel, 2014); Self-
attribution bias (Baker and Ricciardi, 2014).
Disposition effect (tendency of selling stocks that Loss aversion; Mental accounting; Framing;
have appreciated in price too early and holding on Asymmetric risk attitude; Multiple reference
losing stocks too long) (Baker and Ricciardi, 2014). points (Garling et al. 2009; Cronqvist and
Siegel, 2014).
Overreaction to news Overconfidence; Optimism; Money illusion
(Cronqvist and Siegel, 2014; Garling et al.
2009).
Performance chasing (Baker and Ricciardi, 2014) Excessive extrapolation; Hot hand fallacy;
Representativeness (Garling et al. 2009;
Cronqvist and Siegel, 2014; Baker and
Ricciardi, 2014).
Attention to winner and spotlight stocks (Arnswald, Induced by herding, attention and momentum
2001). trading biases.
Momentum trading (Scott, Stumpp and Xu, 1999; Overconfidence bias (Scott, Stumpp and Xu,
Menkoff and Nikiforow, 2009; Richardson, Tuna and 1999) and herding bias (Menkhoff and
Wysocki, 2010). Nikiforow, 2009).
Self-monitoring (Kourtidid, Sevic and Chatzoglou, Self-attribution bias and overconfidence
2011). (Baker and Ricciardi, 2014).
Portfolio management Insufficient diversification/ Naive risk diversification Ambiguity aversion; Familiarity, Mental
strategies (Garling et al. 2009; Cronqvist and Siegel, 2014). accounting; Diversification heuristics; Co-
variation neglect (Garling et al. 2009;
Cronqvist and Siegel, 2014).
Short-termism (Suto and Toshino, 2005; Lutje, 2009; Herding (Lutje, 2009) and momentum trading
Menkhoff, 2010). for short term gains (Suto and Toshino, 2005)
Home bias (Menkhoff and Nikiforow, 2009). Investor preference for familiarity on local
market (Menkhoff and Nikiforow, 2009).
Few insights can be drawn from the above evidences. First, the use of information other than
firm and economic fundamental factors challenge the modern asset pricing postulates that only
fundamental information matters in asset pricing modeling. Second, the popularity of technical
analysis use in equity investment analysis can be related to the influence of behavioral biases in
investor decision-making. Third, behavioral biases believe to be the root cause of various non-
rational trading strategies. Finally, in portfolio management strategies, behavioral biases can be
reconciled to explain various non-rational portfolio management strategies. Collectively, all these
will influence the level of portfolio diversification, risk and returns differently than what was
thought in modern portfolio theory. These evidences seem to be consistent with behavioral finance
views.
3.4 The missing links in behavioral finance research
In this section, we draw discussion on theory and practical flaws of behavioral finance perspectives
on behavioral biases. The theory is the fundamental problem that needs attention. Current
theoretical perspectives used in explaining the behavioral biases in behavioral finance research are
the theory of bounded rationality (Simon, 1955), theory of planned behavior (Ajzen, 1991), and
risk-as-feelings theory (Lowenstein, Hsee, Weber, and Welch, 2001). These theories attempt to
interpret the behavior from the theoretical lenses of psychology and sociology. Still, there is no
clear understanding (Baker and Ricciardi, 2014) and no clear taxanomy (Fuller, 1998) on behavioral
biases. In this regards, there is a need to understand the neural basis of irrational behaviors’ origin,
causes and effects because all decision and behavior are started from the human mind itself.
In practice, the perspectives and believe on the nature of behavioral biases are also unclear.
Particular questions such as whether behavioral biases are good or bad for investors, fund
management company, and the financial markets in general are inconclusive. Some claims that
heuristics and biases can guide successful decisions and actions and others beliefs they could cause
disasters. In addition, whether behavioral biases are permanent and temporary and whether this is
expected to have short-term or long-term influences on financial prices and markets behavior are
11
openly debated. In this regards, some scholars argued behavioral biases could cause prices to
deviates from fundamental value for long periods (Shefrin, 2000). Others believe the effects are
only temporary and need not be incorporated in theorizing and modeling works in finance.
4. Theorizing and Conceptualizing Institutional Investor Behavioral Biases
4.1 Theoretical framework
Major drawback in current behavioral finance works is the absence of unified theory in explaining
irrational behaviors’ origin, causes and effects. The existing bounded rationality theory and
prospect theory are insufficient to describe the complex and dynamic nature of human behavior. As
such, establishing a unified theoretical base is important. In this regards, Tuyon and Ahmad (2014),
proposed the theoretical triangulation of the following theories to holistically understand and to
acknowledge interdisciplinary perspectives from cognitive neuroscience, psychology and sociology
in theorizing and modeling investor irrational behaviors. Some scholars have highlighted
triangulation of interdisciplinary perspectives as a possible solution to understand human thinking,
behavior and actions (Bednarik, 2013). We argue the same is needed in behavioral finance.
The first is bounded rationality theory. Bounded rationality theory of Simon (1955) suggests
that investors’ decision making is not fully rational but is bounded rational. It asserts that because of
human cognitive and emotional element, decisions are normally goal oriented and adaptive (Jones,
1999). This is because, as a normal human being, both the logic thinking and the illogic thinking
influence investor’s behaviors. Kahneman (2003) conceptualizes the dual system of human mind
into intuition (System 1) and reasoning (System 2). The operational processes of System 1 are
categorized as fast, automatic, effortless, associative and emotional. While the operational processes
of System 2 are slower, serial, effortful, deliberately controlled and rule-governed (Kahneman,
2003). However, we argued that this theory only described the rational and irrational behavior from
the cognitive psychology perspectives. It does not explain the origin, causes, and effects of
behaviors.
The second theory is prospect theory. The use of expected utility theory as a descriptive
model of decision making under risk in modern finance perspective has been criticised first by
Kahneman and Tversky (1979). The model assumption of economic agent’s full rationality
behavior in real practice does not hold because most of the time people preferences systematically
violates the assumption of expected utility theory (Kahneman and Tversky 1979). Accordingly,
Kahneman and Tversky suggested prospect theory as an alternative model of decision making under
risk and uncertainty (Kahneman and Tversky, 1979; Tversky and Kahneman, 1986). Prospect
theory distinguishes two phases in individual choice process namely framing and valuation. In the
framing stage the individual constructs a representation of the acts, contingency and outcomes
relevant to the decision. While, in the evaluation stage, individual assesses each of the prospects
available and chooses decision accordingly (Tversky and Kahneman, 1992). According to this
theory, the choice value function has the following characteristics; (i) defined on deviation from the
reference point, generally concave for gains and convex for losses, steeper for losses than for gains,
and (ii) having a nonlinear transformation of the probability scale (Kahneman and Tversky, 1979;
Tversky and Kahneman, 1992). The limitation is that propsect theory also provide after-the-fact
explaination to irrational behaviors (Warneryd, 2001).
The third is theory of mind. Cognitive scientists draw two separate cognitive systems of
human mind (Evans, 2003). This dual system of human mind is known as cognitive and affective
systems (Abu-Akel and Shamay-Tsoory, 2011; Poletti, Enrici and Adenzato, 2012; Alos-Ferrer and
Strack, 2014). According to this theory, human thinking is processed by two systems namely
cognitive system that comprises of knowledge, beliefs and intentions and affective system that
12
accounts for emotions, feelings and mood (Abu-Akel and Tsoory, 2011; Poletti et al., 2012). This
perspective has become a popular base for behavioral research in understanding both the rational
and irrational elements in human decision-making and behaviors. This is inline with Berlin (2011)
opinion that understanding the individual irrationality requires an understanding of this basic human
mind that underlies both rational and irrational behaviors. This is also in line with Mukherjee’s
suggestion for dual system model of preferences under risk (Mukherjee, 2010). In addition, Alos-
Ferrer and Strack (2014) argued that this dual process ideas and concepts justify the incorporation
of bounded rationality in individual thinking into economic theory.
The fourth model is the ABC model. Activating-Beliefs-Consequences or in short “ABC

model” is the cognitive psychology’s theory of causation that provides underlying theory to
understand the cause and effect of behavioral anomalies expressed by investors and its impact on
stock market. This ABC model is founded by a clinical psychologist, Dr. Albert Ellis in 1950s
(Ellis 1976). According to this model, the root cause of human irrational behavior (both by affective
and cognitive) can be understood logically by this theory of causation. According to this model, the
C-behavioral consequences (in this case behavioral anomalies, can be positive or negative) arise
from B-core beliefs or belief system (affect and cognitive which contains both rational and
irrational elements) that are triggered by various A-activating events (Ellis, 1976;1991; Li and Lee,
2011). Similar approach has been used by Brahmana, Hooy and Ahmad (2012) in explaining the
psychological factor (i.e. mood) on irrational financial decision-making in stock market.
To summarize, bounded rationality as an alternative to full rationality first establishes the

theoretical framework for dual decision making that is comprised of reasoning (rational-based) and
intuition (irrational-based). The prospect theory as an alternative to expected utility theory provides
theoretical explanations for heterogeneity of behavior. Theory of human mind provides the neural
origin of irrational behavior that is embedded in affective side of human mind. Finally, the ABC
model facilitates the interpretation of causal and effects of irrational behaviors. Collectively, these
theories can be used as a unified theory in understanding investor bounded rational behaviors. The
next section discusses on how these theories and the evidence reviewed previously, can be
connected to form the conceptual framework in explaining the origin, causes, and effects of
behavioral biases in institutional investor settings.
4.2 Conceptual framework
Based on the syntheses of theories and evidences, the following conceptual framework (Figure 2) is
derived to examine the origin, causes and effects of fund managers’ behavioral biases.
13
Origin Causes Effects
Behavioral biases Irrational behaviors Irrational Investment Investment

decisions performance
Information
Heuristics use
Cognitive
(rules of thumb)
heuristics
Investment Risk
Psychology
analysis use
factors
Return
Sentiment Investment
strategies Risk-Adjusted
Affective Emotion
biases Return
Mood
Portfolio
management
strategies
Individual Institutional Cultural

traits traits traits
Biological Sociology
factors factors
Figure 2: The conceptual framework: Irrational behavior’s origin, causes and effects
The basic empirical model for the above conceptual framework can be represented as follow;
Model: (Irrational behavior) causes (Irrational investment decision) effects (Investment performance)
The above conceptual framework is theoretically and empirically supported. Garling, Kirchler,
Lewis and Raaij (2009) and Pitters and Oberiechner (2012) also conceptualize that cognitive biases,
affective influence and social influence collectively affect investor behavior and induce stock
market behavior. We provide the same conceptualization but based on different theoretical
underpinnings. As discussed in theoretical framework section, bounded rational theory, prospect
theory, theory of mind, and the ABC model collectively explain our conceptual framework.
The origin of behavioral biases can be deduced from theory of mind, which describes the
human decision originated from two systems of thinking namely cognitive and affective systems.
These systems induce both cognitive heuristics and affective biases (sentiment, emotion and mood)
in human decisions. This theory complements bounded rational theory and prospect theory
collectively in explaining the dynamic of human behavior. The causes of irrational behavior in
inducing irrational investment strategies can be inferred from the ABC model, which postulates that
behaviors are triggered by specific triggering external events.
In addition, we extend the conceptual framework by taking into account the heterogeneity of
behavioral biases as induced by individual, institutional, and cultural traits. We also examine the
theoretical link between behavioral biases (psychological mechanisms) and investment irrational
behavior, which has been relatively neglected.
5. Discussion, conclusion and practical implications
5.1 New insights
14
We provide two new insights. First, this paper proposes alternative theoretical perspectives i.e.
theoretical triangulation (of bounded rationality theory, prospect theory, theory of mind, and ABC
model) drawn from knowledge in psychology, sociology and biology. We believe, this perspective
provides a rich understanding on the origin, causes and effect of irrational behavior of normal
human being. Second, we draw a conceptual framework based on syntheses of the above suggested
theories and empirical evidences in understanding the origin of institutional investors’ irrational
behaviors, their influence on irrational investment management strategies, and their direct impact
on fund performance. These theoretical and conceptual perspectives can be corroborated with
behavioral finance postulation that stock prices and market behaviors are not solely based on
fundamentals, but also other non-fundamental factors which directly influence investor decision
making. In this paper, we argue that psychology, sociology, and biological forces induce these non-
fundamental factors.
5.2 The next course of actions
Finally, the possible practical implications are highlighted for scholars, practitioners and regulators.
To scholars, the theoretical and conceptual frameworks drawn in this paper could be utilized and
empirically examined for future research in understanding the institutional investor behavioral
biases’ origin, causes and effects on investment strategies and performance. Human behaviors are
indeed complex as claimed by many, but understanding them in depth is possible with the
availability and collaborative efforts of interdisciplinary perspectives. Neglecting to understand
them because of complexity is not a rational decision. Current inquiries have been focussing on
explaining behavioral heuristics and biases on ad-hoc basis and after-the-fact explanations
(Warneryd, 2001). To understand investor behavior, the best approach is to focus on individual
decision making through detailed interviews, observations, and controlled experiments as suggested
in Warneryd (2001). We observe that research in this perspectives is still lacking in finance. We
also observe that in future research there is a need to take into account the individual, cultural and
institutional differences to recognize the heterogeneity of human behaviors.
To institutional investors, in particular the fund managers, knowledge on behavioral biases’

origin, causes and effects could be utilized to devise investment analysis and fund management
strategies to capitalize on the positive effects and to avoid negative effects of behavioral biases.
Shefrin (2000), Fromlet (2001), and Montier (2002) have warned of the serious repercussion if
behavioral biases are ignored in investment analysis. List of strategies and checklist to overcome
behavioral errors are discussed in Kahneman and Riepe (1998), Fromlet (2001), and Baker and
Ricciardi (2014).
Insights for behavioral asset pricing modeling - Priced risk of investing in any financial
instrument comprises both the fundamental and behavioral risks. As such, there is a need to
consider various behavioral biases in asset pricing modeling. Scholars in behavioral finance have
suggested some new asset pricing theories by combining both fundamental and behavioral risks to
determine asset returns. Main reference to this area is behavioral capital asset pricing theory by
Sherfrin and Statman (1994), investor psychology in asset pricing by Hirshleifer (2001), affect in a
behavioral asset pricing model by Statman and Anginer (2008) among others.
Insights for behavioral portfolio management - A recent comprehensive review of

behavioural biases in fund management industry is provided in Cuthbertson, Nitzsche, and
O'Sullivan (2016). This article highlighted the presence of behavioral biases among individual fund
managers, fund governance, and organizational structure. Despite the threats, behavioural biases
can be capitalized as a strategy to device investment analysis and to develop a sustainable fund
portfolio. The behavioural portfolio theory by Shefrin and Statman (2000) highlighted the needs to
15
manage the behavioural risks influences to investment portfolio returns through portfolio selection
and diversification. In investment analysis application, Bollinger (2008) suggested to combine
fundamental, technical, quantitative, and behavioral analysis perspectives. In investment portfolio
management, lessons can be learned from some good examples of fund managers in the United
States that have incorporated the behavioral finance theory into their investment analysis and
management strategies. For instance, MarketPsych LLC (https://marketpsych.com) is an investment
analysis company that is focusing on behavioural risks analysis based on psychoanalysis and
neuroscience perspectives. In equity portfolio management, Fuller & Thaler Asset Management,
Inc. (http://fullerthaler.com) are using bottom-up approach to exploits insights from behavioural
finance to manage their funds.
To the financial markets regulators, this paper has highlighted the needs to regulate these
behavioral risks as stressed in Daniel, Hirshleifer and Teoh (2002). This regulation help to mitigate
the effects of irrational behavior and imperfect markets. In this regards, they suggested two
important issues for public policy, namely to come up with policies which help investors avoid
errors, and to promote the efficiency of the markets. Governing the financial markets against
behavioural risks is needed (Suto and Toshino, 2005) and particularly crucial in Asian financial
markets due to psychological and sociological inclination of market participants in Asia which have
been reported to be more prone and vulnerable to behavioural biases (Kim and Nofsinger, 2008).
This issue remains relevant and is still being neglected in fund management industry management
and governance framework globally (Cuthbertson, Nitzsche, and O'Sullivan, 2016).
Collectively, the applications of behavioral finance theory and strategies to govern the
behavioral biases on the part of investors, institutions, and in the market place are crucial. Urgent
attention and policy commitment is needed to be in place to protect the welfare of the investors and
the efficiency of the financial markets. These can bea valuable complementary strategies towards
building a sustainable investment management practice that will benefit the investing society, the
industry, and the nation.
Acknowledgement
This research is funded by Universiti Sains Malaysia (USM) through USM-RUI Grant no.
1001/PMGT/816276. We greatly acknowledge the financial assistance provided by the university.
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Management Research Review

Institutional investor behavioral biases: syntheses of theory and evidence

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2.1 Behavioral finance theoretical perspectives

Approximation of human behavior is the cornerstone in understanding the reality of financial

Efficient market hypothesis Adaptive market hypothesis

Equilibrium/Static/Linear Asset prices Disequilibrium/

Rational hypothesis Investors Bounded rational

2.2 Interdisciplinary insights on investor and market behaviors

2.3 Institutional investors and their investment behavior.

In practical investment perspective, the practices of fund management based on modern

2.4 Evidence on institutional investors’ behavioral biases

Table 1: Summary of studies on institutional investor behavioral biases

Self-marketing Japan Suto and Toshino (2005)

3.1 Common behavioral biases among institutional investors

3.1.1 Psychology forces

Table 2: Cognitive heuristics and investment implications

Table 3: Affects and investment implications

Table 4: Social forces and investment implications

3.2 Heterogeneity of Behaviors

3.2.2 Cultural traits

3.2.3 Institutional traits

3.3 Irrationality investment decisions

Table 5: Investment biases and psychological mechanisms

3.4 The missing links in behavioral finance research

4. Theorizing and Conceptualizing Institutional Investor Behavioral Biases

4.1 Theoretical framework

The fourth model is the ABC model. Activating-Beliefs-Consequences or in short “ABC

To summarize, bounded rationality as an alternative to full rationality first establishes the

4.2 Conceptual framework

Behavioral biases Irrational behaviors Irrational Investment Investment

Individual Institutional Cultural

5. Discussion, conclusion and practical implications

5.1 New insights

5.2 The next course of actions

To institutional investors, in particular the fund managers, knowledge on behavioral biases’

Insights for behavioral portfolio management - A recent comprehensive review of

Economic Review, 93(5), 1449-1475.

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