Developing an instrument for measuring the effects of heuristics on investment decisions

Based on a thorough review and synthesis of the literature in behavioral finance, the purpose of this paper is to develop three measures of heuristics that tend to influence investment decisions of individual investors.

Using perceptual data collected from a sample of 167 individual investors in the USA, the reliability and validity of heuristics measures are assessed by confirmatory factor analysis with structural equation modeling. Then, the second-order model is executed in order to indicate the paths among the study’s constructs. Finally, a multiple-group analysis is conducted to analyze the moderating effects of demographic factors on the relationship between the perceived level of heuristics and their constituent dimensions.

Of the three groups of heuristics, salience is found to be the most important followed by mental accounting, while representativeness features as relatively less important. Regarding the moderating effects, only investment experience is noted to have a significant moderating impact.

The data utilized for testing and validating this instrument was acquired from a relatively small sample of individual investors in the USA, which makes the generalization of findings somewhat limited.

Both researchers and practitioners in behavioral finance can use these measurement scales to better understand the impact of heuristics on individual investment decisions and also to develop models that relate the critical factors of heuristics to the performance of individual investment decisions.

To date, there has been no systematic attempt in the extant behavioral finance literature to develop a valid and reliable instrument on heuristics which would aid to improve the quality of decision making in investment analysis.