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Determination of factors that affect the investment decision of a retail investor
Purpose - Research Objective
The purpose of this research study was to study the impact of some of the major drivers of stock prices on the investment decisions of retail equity investors. Risk appetite was considered a mediating variable and gender was considered a moderating variable for the purpose of the study.
A questionnaire was developed which provided respondents with hypothetical situations, based on which they were asked to evaluate a particular investment. Furthermore, based on a set of such contrasting hypothetical scenarios, the respondent was to make an investment decision. A separate set of questions were administered to estimate the risk appetite of the respondents. All this data, except that of risk appetite, is measured on a Likert scale, and the data is analysed through simple liner regression analysis. The data was found to be reliable.
All the parameters chosen were proven to have the expected relationship with the output variable of investment decision. Risk appetite was proven to have an impact on each of the input-output relationship, except that of the financial factors and the investment decision.
The research addresses only retail investors. The results have a selection bias due to the data set containing respondents mainly being MBAs and youth population. We expect limited objectivity from respondents while answering questions on Herd Behavior. Since the questionnaire was developed on our own (verified by experts though), the reliability test is not above the required level for all constructs.
The research will help us (students) understand the various factors that investors perceive to be important while investing. This study can be useful for Brokerage Firms & Portfolio Managers in understanding the perceptions/thought process of their clients; hence they can reach out to them in a better manner. The study may also be to useful to us in the future if at all we eventually land up in a work profile that pertains to investments in stock markets.
Originality / Value
While there have been many studies detailing the impact of any one of the input factors on the investment decision, this is a first-of-a-kind study which has been done to study the impact of all five factors, with the unique kind of moderating and mediating variables.
Macroeconomic Factors, Firm Factors, Financial Factors, Herd Behavior, Investment Decision, Risk Appetite, Gender, Peer Opinion, Expert Opinion.
As part of our term project in Business Research Methods course, we have taken up the study of the factors which affect how investors choose stocks. To this end, we have done extensive literature survey and identified five of the major factors which affect stock prices and consequently investment decisions. These five factors have been proven to impact security prices over the years, as is evinced by the many theoretical references.
For each of the factors considered, we have developed a hypothesis based on the theoretical basis from our exhaustive literature survey. We have considered the risk appetite of the investor as a mediating variable, helping us understand how this factor impacts the investment decision - independently and also in combination with the various factors. The moderating variable is gender, which helps us analyze how much of the investment decision is effected by gender bias.
Having developed various hypotheses, we administered a questionnaire giving investors various situations covering all the factors we have considered, and how those would impact their investment decision. Regression analysis has been done to test the hypotheses and results thereof have been discussed later in this paper.
Research Background and Hypotheses
With the help of various articles derived from sources such EBSCO and EMERALD, we have narrowed down to five variables which will be tested for their impact on investment decisions. These are as follows:
1. Macroeconomic Factors
3. Firm Oriented
5. Expert Opinion
Below we explain what parameters we shall use to measure each of the five variables, we would here present the theoretical basis behind choosing them, supported by literature survey.
i. Macroeconomic Factors
It is a well-known fact in finance and economics that economic indicators have major implications for the asset markets. For example, the federal funds rate movement in US leads to an inverse movement in equity prices (Ekanayake et al, 2008). Each time the rate goes down, the interest rates on fresh bond issues also goes down. This means that investors look for more return elsewhere, which in-turn benefits the equity markets, and with increasing demand the stock prices go up (Ekanayake et al, 2008). Similarly, especially in India, aggregate macroeconomic indicator such as IIP tend to have a positive correlation with the stock prices (Pradhan, 2007), which makes it a major factor to be considered at the time of investment decision.
Moreover, it is not only the domestic macroeconomic indicators which have an effect on the stock prices. For e.g. even the Vietnamese stock prices are affected by US macroeconomic data (Hussainey et al, 2009). Similarly, even inflation figures affect stock prices negatively, with rising inflation leading to a depression in stock prices, and vice-versa (Fama, 1981). Of course many of these relationships can then be derived from each other as the macroeconomic factors such as interest rate, IIP and inflation are related amongst each other as well.
Increase in GDP also has a positive impact on stock prices (Daferighe et al, 2009). All the above theoretical explanations point towards the fact that macroeconomic variables do play a major role in movement of stock prices, which is but natural as stock prices in an efficient markets should capture the business growth potential of the company and macroeconomic factors are one of the biggest drivers of business growth. Thus, these factors should ideally form an important basis of any investment decision in equity markets.
H1: Macroeconomic Factors have an impact on equity investment decision.
Having more than 7 years of prior investing experience amongst us, we knew that herd mentality does play a role in the investment decisions of a conventional, retail equity investor. On researching the available literature, we were vindicated when latest studies have proven that the top ten discussed stocks on a message board on a particular day not only provide abnormal returns on that particular day, but often also on the next day (Sabherwal, et al, 2008). It just goes to prove the importance of herd mentality in the investment decision of a retail investor. Similarly, increase or decrease in trading volumes also effects the stock price movements. Increasing volumes are considered a good sign due to higher investor interest and this can increase the stock price. Conversely, in times of strife, increased volumes can also be due to selling pressure, which will decrease prices.
Another well known market fact is that sale of large blocks of stocks (in excess of USD 10 million) often tends to impact the price of the underlying stock negatively (Guthman, et al). This is also the reason why often large mutual funds or institutional share holders liquidate their holdings in batches, so as to prevent their sale from depressing the prices and thus causing them a loss.
H2: Herd behavior has an impact on equity investment decision.
iii. Firm related
It is very natural that firm-related factors affect the stock price of the firm. An example of this is a stock-split announced by the firm. While technically a stock split is just a numerical change, it is generally observed to give a boost to the stock's price due to reduction in spreads and an increase in liquidity after the split (Pavabutr, 2008). Similarly, a company might announce a dividend which generally leads to an increase in the stock price, a sign of inefficient markets, which Indian markets are (Nippel, 2009). Similarly, a share buy-back also leads to a price increase, as the risk per outstanding share increases and since smaller share holders have to bear this risk, they demand slightly higher premium, which leads to price increase (Nippel, 2009).
Another factor here is insider knowledge and insider actions. As per most accounting standards, listed entities are required to publish any transactions in their own securities by officials of the company. Such information generally involves purchase or sale of company securities by senior company officials. The moment this information is made public, it most definitely has an impact on the stock price. If a senior official of the organization sells some of his personal stock in the company, then retail investors would perceive that he/she has knowledge of some impending bad news, due to which he has decided to sell off his stake when the prices are still good. This would push down the stock prices. A purchase action would lead to an opposite effect. Such information also affects a firm's stock price, which is a consequence of the aggregate investment decisions.
H3: Firm factors / news have an impact on equity investment decision.
Financial information about the company such as earnings, return figures, dividend announcements (the quantum, and not the announcement itself) impact the stock prices (Ariff, et al, 1997). More than the raw numbers, the impact is due to the deviation of the earnings compared to the expected numbers.
H4: Financials of the firm have an impact on equity investment decision.
v. Peer/Expert opinion
This is one of the most important factors affecting the decisions of a retail investor to invest in a stock. Many times it is seen that people invest on basis of advice/tips from their peer group. Most of the retail trading in India is done via local physical brokers where recommendations are shared profusely. A recent phenomenon is sharing of tips through electronic medium like social networking sites (Sabherwal, et al, 2008). Birth of social investing websites, where stock tips and recommendations from fellow users is the biggest draw, has become watershed the investment universe (Koppikar 2009). Increasingly, investors no longer consult their neighbours or their friends, but log on to social investing websites and connect with like-minded investors, who influence their investment decisions. The advantage of these websites is their targeted and focused information and communication, which are proving very effective in pulling new customers towards these websites.
H5: Financials of the firm have an impact on equity investment decision.
Mediating Variable: Risk Appetite of the Investor
One of the most holistic ways of measuring the effectiveness of an investment is the Sharpe Ratio, which is essentially the excess return generated by the security over the market expected return, per unit of risk undertaken. The risk is measured through the standard deviation of the securities returns over the years.
The beauty of this measure is that it captures not only the excess return but also the risk undertaken to achieve the same. This effectively measures the risk-adjusted return of a security, hence, making it possible to compare the returns of various securities, across industries or time horizons.
The fact that such a ratio exists and that it is considered one of the foremost measures of measuring investment return highlights the importance of the risk in the any measurement of investment returns.
Hypotheses: Each Construct will have an impact on equity investment decision. (Therefore, five in all)
H11: Risk Appetite has an impact on the investment decision.
Moderating Variable: Gender
Gender has been considered as a moderating variable in our model. Naturally, there are significant implications of the higher risk aversion towards investments in women (Barkset et al 1996; Bruce & Johsnson, 1994; Jianakopolis & Bernasek, 1998). Theory suggests that women tend to be more holistic and meticulous in their investment decisions, considering all the various factors and understanding them completely before making a final decision (Worley, 1998). Studies (Kover, 1999) have found that less than have the women, as compared to the men, were willing to take a substantial amount of risk for the prospect of a substantial amount of return. This also points towards the fact that women would more prefer low-risk investments as compared to men.
H1: -> Macroeconomic factors have an impact on the investment decision.
H2: -> Firm related factors/news have an impact on the investment decision.
H3: -> Financials of the firm have an impact on the investment decision.
H4: -> Peer/Expert Opinion have an impact on the investment decision.
H5: -> Herd Behavior has an impact on the investment decision.
H6: -> Macroeconomic factors have an impact on the risk appetite.
H7: -> Firm related factors/news have an impact on the risk appetite.
H8: -> Financials of the firm have an impact on the risk appetite.
H9: -> Peer/Expert Opinion have an impact on the risk appetite.
H10: -> Herd Behavior have an impact on the risk appetite.
H11: -> Risk Appetite has an impact on the investment decision.
Research Design & Methods
We have started the research by first collecting primary data through a situation based online questionnaire.
The objective is to take an investor through various hypothetical situations and find out which factors he uses most often to take investment decisions. The whole questionnaire is divided into four sections with each part administering questions on different companies.
The questions employed give contrasting news to respondent about the overall future prospect of the company. There will be exactly one question for every factor to be tested in every section. In the end of the respective parts he is asked to put down his preference for investment in stock considering all the questions of that particular section.
The questionnaire is structured and uses the Likert scale for question. There is an addendum section in the end to profile investors on their riskiness. This has been taken from an existing research.
We were able to collect sample of 143 responses from amongst students, executives, businessmen, housewives etc.
Operationalization of Variables
Investment in stocks is defined as an activity where purchase decisions are made for long term as opposed to trading where focus is on short term profit making with quick entries and exits. By retail stock investors, we mean, individuals (as against institutions) in India who participate in the prominent equity markets of India like BSE/NSE, through equity or derivatives. An important distinction here is investors who invest themselves as compared to through portfolio managers or financial planners.
Now, India being an emerging financial market is yet to experience volumes in retail investing like those in the more developed economies of the west. Also, investors in India use less sophisticated tools and are financially lesser educated than their western counterparts. Typical to an emerging market, Indian markets are characterised by companies with high growth rates and volatility. The research questionnaire has been designed keeping these things in mind.
Through our research we are trying to study factors which affect how investors choose stocks. By reviewing existing literature, of previous similar researches as well as of theories governing the impact of the major variables affecting stock prices, and hence investment decisions, we have come up with five factors which we believe are most important in an investor's decision whether to invest in a stock or not.
Macroeconomic factors capture the overall well-being of the economy through one particular number or a set of statistics. These numbers not only capture the past performance of the economy but also provide indications of expected future performance of the economy.
Common measures of measuring economic activity are GDP growth rate, IIP, Inflation Rate (CPI or WPI). All these are periodically released by the government bodies and underlying hypothesis is that change in these numbers will affect economic environment and in turn impact investments in capital markets.
Peer opinion is investing advice from another person who either himself invests or holds knowledge about stock markets. Peers include friends, family, neighbours, colleagues, social investing sites and investing communities.
Herding is defined as imitative behaviour which impacts investment decision. An example would be an investor making a purchase/sell purely on the basis of trading volumes. This is different from peer opinion in the context that it does not involve proactive advice / tip from peers but the individual is merely follows what the herd is doing. A good way to measure herding is through checking volumes of the stock invested. Often retail investors invest only in hot stocks which they get to hear every now and then.
Firm related factors
This is basically any news or announcement regarding the company which may significantly impact the investing. After reviewing existing literature, we settled on following measures for this head:
Basically by financials we mean that how attractiveness of stock changes for a retail investor with an announcement about the financial health of a company. This would constitute profitability figures like EPS, Net Profit, and Operating Profit etc.
This basically is advice administered by an expert on stocks to the investor. Examples of experts would include: specialists on TV news, established investors, local brokers, brokerage or investment house and portfolio management services.
GDP, IIP, Inflation
Dividends, Bonus, Splits
Directly from questions
Directly from questions
Building upon the literature survey, we identified the exact variables that would represent each factor. These have been listed / summarized above. Post this, we had to look at applicable ways to measure each of them.
The literature survey that we had undertaken, while extensive, did not address methods of measuring these factors via quantitative questionnaires. It had focused more mathematical approaches, which required data not easily available to us.
Towards this end, we developed a questionnaire by ourselves which would cover the various factors we had considered by means of situational questions. Each question had a situation which ended with an investment suggestion, to which the respondent had to either agree or disagree on a Likert Scale of 1-5.
To verify the validity of the questions, we got these verified through subject matter experts from the academia (Prof. Santosh Sangem) and from the investor community (Mr. Indrajit Yadav / Mr. Gaurav Chowdhary). All the questions were shown to the-above mentioned individuals and their feedback for the same was obtained.
Once our question set was approved, we arranged the questions into 4 sets of 5 questions each, with each question in a set corresponding to one of the five factors. At the end of each set, there were questions measuring the output - investment decision.
Additionally, we had 4 more questions in the survey which were to measure the risk appetite of the investor. These were taken from an existing questionnaire and the authenticity of these questions did not have to be validated.
Reliability test is conducted for all variables and results like Means, Standard Deviation and Cronbach's alpha are listed in Table 1.
Results of regression analysis like Significance level and Beta values for hypothesis H1 to H5 are shown in Table 2. This proves that Economic factors, Financials of firm, Peer/Expert opinion and Herding have significant impact on investment decision of an investor. This also establishes that results can be mediated. But Firm related factors can't be proved to have a significant impact on investor decision.
Table 3 shows results of regression analysis for hypothesis H6 to H11. This proves that Economic factors, Firm related factors, Financials of firm, Peer/Expert opinion and Herding have significant impact on Risk Appetite of an investor which in turn has significant impact on Investment Decision. This shows that antecedent variables are significantly correlated with intermediate variable.
Table 4 shows the combined impact of antecedents (Economic factors, Firm related factors, Financials of firm, Peer/Expert opinion and Herding) and intermediate variable (Risk Appetite) on Investment decision using regression. This shows that Economic factors, Firm related factors, Peer/Expert opinion and herding are significantly related to Investment Decision. But Financials of firm non-significantly impacts Investment decision.
Table 5 shows mediation significance for each factor (Economic factors, Firm related factors, Financials of firm, Peer/Expert opinion and Herding) with intermediate factor as Risk Appetite on Investment Decision. It shows that mediation effect of Risk Appetite is significant for Economic factors, Peer/Expert opinion and Herding.
Results of regression analysis like Significance level and Beta values for hypothesis H1 to H5 are shown in Table 6. This proves that Firm related factors, Peer/Expert opinion and Herding have significant impact on investment decision of an investor. This also establishes that results can be mediated. But Economic factors & Financials of firm can't be proved to have a significant impact on investor decision.
Table 7 shows results of regression analysis for hypothesis H6 to H11. This proves that Firm related factors, Peer/Expert opinion and Herding have significant impact on Risk Appetite of an investor which in turn has significant impact on Investment Decision. But Economic factors & Financials of firm can't be proved to have a significant impact on mediating variables. This shows that antecedent variables are significantly correlated with intermediate variable.
Table 8 shows the combined impact of antecedents (Economic factors, Firm related factors, Financials of firm, Peer/Expert opinion and Herding) and intermediate variable (Risk Appetite) on Investment decision using regression. This shows that Financials of firm, Firm related factors, Peer/Expert opinion are significantly related to Investment Decision. But Economic factors and herding non-significantly impact Investment decision.
Table 9 shows mediation significance for each factor (Economic factors, Firm related factors, Financials of firm, Peer/Expert opinion and Herding) with intermediate factor as Risk Appetite on Investment Decision for the female respondents. It shows that mediation effect of Risk Appetite is significant for Peer/Expert opinion.
Results of regression analysis like Significance level and Beta values for hypothesis H1 to H5 are shown in Table 10. This proves that Economic factors, Financials of firm, Peer/Expert opinion and Herding have significant impact on investment decision of an investor. This also establishes that results can be mediated. But Firm related factors can't be proved to have a significant impact on investor decision.
Table 11 shows results of regression analysis for hypothesis H6 to H11. This proves that Economic factors, Firm related factors, Financials of firm, Peer/Expert opinion and Herding have significant impact on Risk Appetite of an investor which in turn has significant impact on Investment Decision. This shows that antecedent variables are significantly correlated with intermediate variable.
Table 12 shows the combined impact of antecedents (Economic factors, Firm related factors, Financials of firm, Peer/Expert opinion and Herding) and intermediate variable (Risk Appetite) on Investment decision using regression. This shows that Economic factors, Financials of firm, Firm related factors, Peer/Expert opinion are significantly related to Investment Decision. But herding non-significantly impacts Investment decision.
Table 13 shows mediation significance for each factor (Economic factors, Firm related factors, Financials of firm, Peer/Expert opinion and Herding) with intermediate factor as Risk Appetite on Investment Decision for the male respondents. It shows that mediation effect of Risk Appetite is significant for Economic factors, Financials of firm and Peer/Expert opinion.
Pictorial Representation of standardized β values for various sub-models
The nomenclature for beta values in the text boxes (in the images below) for different constructs: All data/ Female Respondents only/ Male Respondents only.
For Economic Factors
For Firm Related Factors
For Financial Factors
For Peer/Expert Opinion
For Herd Behavior
Discussions & Implications
We have identified implications on three levels - academic, analytical and practical. At an academic level, the research will help us understand the various factors that investors perceive to be important while investing. At an analytical level, the responses to individual questions for different factors can be analysed separately and used in other researches.
From a practical standpoint, this study can be useful for brokerage firms and portfolio and portfolio managers in understanding the perceptions / thought process of their clients, and they can better understand the factors important for their clients. Also, if any of us eventually works in this kind of a work profile, then this kind of a research and study exercise will stand us in a good stead.
One of the major limitations of the research is that it addresses only retail investors. Also, the results have a selection bias due to the data set containing respondents mainly being MBAs and youth population. Another limitation is that we expect limited objectivity from respondents while answering questions on Herd Behavior. Finally, since the questionnaire was developed on our own (verified by experts though), the reliability test is not above the required level for all constructs.
There exists a lot of future scope in this field. For starters, future research can be conducted for traders, high-net worth individuals (HNIs) and Institutional Investors (IIs). Also, research and hypothesis testing can be conducted to evaluate the effectiveness if news articles related to investment decisions and their impact on the same.
Another field where future research can be done is to rate which of the factors investors rate above other factors, at the time of making an investment decision.
We tested 11 hypotheses split across three levels - impact of the various factors on the investment decision, impact of the various factors on the risk appetite and impact of risk appetite on investment decision.
Of the five factors, only the “Firm related factors/news” doesn't seem to be as closely related to the investment decision as has been predicted in theory. All of the five chosen factors do have an affect on the risk appetite of the investor, justifying the decision to choose risk appetite as the mediating variable.
The risk appetite mediating variable directly impacts the investment decision also. As far as the moderating variable of gender is concerned, male respondents were found to have lesser reliance on the firm-related new and factors in factoring their investment decisions, whereas women were found to take investment decisions without much consideration towards macroeconomic factors or financial news of the firm.