Behavioral Biases and Investment Decisions: An Empirical Review.

Behavioral finance challenges the traditional assumption of rationality in investment decision-making, revealing how cognitive and emotional biases shape financial behavior. This study explores the influence of behavioral biases on investor decisions, particularly in volatile markets like the Nairobi Securities Exchange (NSE). Drawing on theoretical frameworks such as Decision Theory, Herd Behavior Theory, Prospect Theory, and Overconfidence Theory, the review examines how psychological biases diverge from classical finance principles. For instance, Prospect Theory highlights loss aversion, where investors disproportionately fear losses, leading to suboptimal decisions like premature selling of profitable assets or holding onto underperforming ones. Similarly, herd behavior amplifies market volatility as investors emulate majority actions, while overconfidence leads to excessive trading and risk-taking, undermining rational market engagement.Empirical evidence corroborates these theoretical perspectives. Studies in developed and emerging markets, including the U.S., Lithuania, and Taiwan, demonstrate the prevalence of biases like overconfidence and loss aversion. Notably, Barber and Odean (2001) reveal that overconfident investors incur lower returns due to higher trade costs. In the context of the NSE, fluctuations in trading volumes and indices underscore the impact of biases, with the NSE 20 share index showing an 11% rise in 2019 and an 8% decline in 2018. This instability discourages consistent investor participation, emphasizing the need for bias mitigation strategies.Critically, while behavioral finance offers robust insights into irrational investment behavior, its applicability to emerging markets like Kenya requires further exploration. Existing research predominantly focuses on developed markets, with limited contextualization for regions with unique economic dynamics. This study underscores the importance of addressing behavioral biases to enhance rational investment decision-making and foster stable financial market participation, particularly in developing economies