Investor’s Behavior Biases and Stock Risk Return Relationship
Author: Komal Javaid

The previous literature suggests that like all emerging markets Pakistani market is inefficient. The Capital asset pricing model does not explain the stock risk -return behavior and there is need to add more attributes in addition to market return to explain risk return relationship of stocks. This study attempt to analyze whether by including the investors behavior overconfidence and risk aversion effect in to the CAPM model, the explanatory power of the model is increased in case of Karachi stock exchange. Sometime investors overestimate the reliability and accuracy of their private information and give it too much weight to it that exhibit the overconfidence effect. The overconfident investors avoid the regret and sense of guilt that’s why they hold the losses and turnover is used as proxy for overconfidence. Another behavioral bias used in this study is disposition behavior in which investor’s retain losing stocks and sell winning stocks too early in order to avoid loss. This behavior so far relates to loss aversion behavior. To find the effects of disposition behavior, sortino ratio and Sharpe ratio method are used. Sortino ratio is used to capture the downside risk of investors which is sometime neglected while assessing the level of risk. From the results of observing overconfidence behavior it is shown that there is positive association between returns and turnover and disposition behavior shows that intercept turns out to be insignificant and mispricing is also captured which is not done by CAPM. Thus this behavior bias also has positive effect on expected return. The results lead to main implication, first; resetting on evidences of loss aversion, disposition and overconfidence we find a method for improving investor’s decision making. Second this study identifies specific behaviors biases in that explain the stock return. Third the behavioral biases must be considered while making investment decisions. Supervisors:- Dr. Attiya Javaid

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Keywords : Disposition Bias, Return Relationship, Stock Risk
Supervisor: Attiya Yasmin Javid

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