Empirical research on irrational behaviors of individual investors in vietnam stock market

1 NATIONAL ECONOMICS UNIVERSITY ADVANCED EDUCATIONAL PROGRAM ***************************** BACHELOR THESIS EMPIRICAL RESEARCH ON IRRATIONAL BEHAVIORS OF INDIVIDUAL INVESTORS IN VIETNAM STOCK MARKET St[.]

Our dissertation would not be possible without the enthusiastic help of several individualswho in one way or another guided and supported us from preparation to completion of thestudy

First of all, we would like to send our warm thanks to professors and all of staff members

of Advanced Educational Program who always follow our research step by step to give ussupports as needed Especially, we would like to express our utmost gratitude to ourbeloved instructor – Master in Finance Nguyen Duc Hien for his valuable andinspirational instruction despite his extremely busy working schedule

We also would like to send our special thanks to people who work for trading floors orsecurities companies for their enthusiasm and supports as we implemented our survey intheir work:

 Mr Quach Manh Hao – deputy director of Thang Long securities company

 Mr Hung – Vice head of department of Foreign Trade securities company

 Mr Tu – Director of Viet Dragon securities company

 Mr Trung – analyst and broker of An Binh securities company

 And other brokers at stock exchanges in Hanoi

Last but not least, we would like to give our thanks from bottom of our hearts to individual investors, who do not know who we are, but still spend their little time

on answering our surveys, for us to be able to complete the interesting research.

TABLE OF CONTENTS

ABSTRACT5

1 Rationale 6

2 Background of Vietnam stock market 7

3 Research objectives 9

4 Research questions 9

5 Significance of Research 9

6 Research scope 10

CHAPTER 2: LITERATURE REVIEW 11 1 Standard Finance 11

1.1 Four Pillars of Standard Finance’s Model 11

1.2 Standard Finance Approach 16

1.3 Input Elements of Standard Finance 16

1.4 Limitation of Standard Finance 16

2 Behavioral Finance 17

2.1 Introduction of Prospect Theory 17

2.2 Behavioral finance 22

CHAPTER 3: METHODOLOGY 28 1 Data source 28

2 Questionnaire design 28

3 Sampling 32

4 Analyzing process 33

CHAPTER 4: DATA ANALYSIS AND FINDINGS 37 PART I: PROSPECT THEORY TESTING FOR INDIVIDUAL INVESTORS IN VIETNAM STOCK MARKET 37

1 Overview of individual investors in Vietnam stock market 37

2 Prospect theory testing in Vietnam stock market 41

PART II: BEHAVIORAL BIASES OF INDIVIDUAL INVESTORS IN VIETNAM STOCK MARKET 43

1 Behavioral Biases’ Frequency and One-sample T Test 43

2 The influence of personal factors on individual investors’ behaviors 50

3 Explanatory Factor Analysis (EFA) 56

CHAPTER 5: RECOMMENDATIONS 64 CHAPTER 6: CONCLUSION 68 APPENDIX: QUESTIONNAIRE 70 REFERENCES 74

ABSTRACT

If standard finance assumes that investors are rational, behavioral finance defines thosepeople as normal ones If the former provides investors with techniques to maximizeinvestment profits, then, the later discovers characteristics inside investors to help themavoid cognitive errors, which may cause financial losses Therefore, standard finance andbehavioral finance supplement each other However, while standard finance hasdeveloped for a long period of time, behavioral finance is still a new concept for manyinvestors all over the world

In Vietnam, behavioral finance has just been introduced in recent years The most popularbias, which people can easily realize in Vietnam, is herding behavior For example, in

2006 - the booming year of Vietnam stock market, it was likely that everyone jumped instock investment However, the root of behavioral finance as well as various biases incurrent Vietnam stock market has not been studied thoroughly

Therefore, this research focuses on proving existence of cognitive errors and findingbehavioral biases of individual investors in current Vietnam stock market Surveys aredistributed to individual investors to get the primary source After analyzing answers of

231 individual investors in the market by running SPSS to calculate frequencies and applyexplanatory factor analysis, the authors provide an overview of Vietnamese individualinvestors’ behavior In general, they are subject to prospect theory, and among otherbiases, the most common ones in Vietnam stock market are overconfidence, overoptimism, herding behavior, and seasonality

The story above is just one of the most typical investing stories about economic bubbles

in history Not only did they happen in tulip bulb market, economic bubbles also occurred

in real estate market (Real estate in Florida bubble), and especially in stock markets(South Sea bubble, Great Depression in America, dotcom bubble, etc.) So, besides thespeculation, it is questioned if there are any other factors creating the bubbles in themarkets

If the answer to the question above is “No”, then, it leads to the discussion about thebubbles in stock market, the place having the biggest number of bubbles in the history.Since the emergence of stock markets, investors and financial analysts have developed

various numerical techniques to evaluate and forecast value of the stocks Thosetechniques belong to standard finance, which is based on an assumption that investors arerational and market is efficient Therefore, if investors are totally rational, and market isreally efficient, only speculation cannot create bubbles in the market Then, why bubbles

in stock markets still happened

After the Nobel Prize in Economics of Daniel Kahneman for his study of Prospect Theory

in 2002, behavioral finance became popular among financial practitioners and academics.Behavioral finance is a science that involves sentimental factors in finance Whilestandard finance assumes investors are rational, behavioral finance simply considersinvestors as normal people Many biases of investors were discovered and namedafterward: over confidence, over reaction, mental accounting, herding behavior, and so

on People then could comprehend that the over expectation to the potent of market andthe herding behaviors of investors are the main causes of bubble in the market and pushmarket up far away from their true value In other cases, irrational behaviors of investorscan make stock price up and down abnormally

Together with bias discoveries, suggestions to solve those biases have been alsodeveloped by the economists to help investors enhance their investment returns

Although behavioral finance has grown approximately 40 years and developedworldwide, it is still a fresh field in Vietnam Therefore, the topic about behavioralfinance drives this research to supply deeper look into behavior of Vietnamese individualinvestors In this research, the main focus lays on detecting irrational behaviors ofindividual investors in current Vietnam stock market

2 Background of Vietnam stock market

Vietnam stock market officially came into operation since July 20, 2000 with anestablishment of Ho Chi Minh Stock Exchange (HOSE) Then, in March 8, 2005, Hanoi

Stock Exchange (HNX) was inaugurated From only two companies listed in HOSE in

2000, the number of listed companies in Vietnam stock market at the moment is 682, with

313 companies in HOSE, 396 companies in HNX, and 27 companies in both of two stockexchanges The simple registration procedure and small initial investment requirement arethe mains reason for the rapid growth of Vietnam stock market

After 12 years of operation, Vietnam stock market has overcome many periods Inparticular, the period from 2000 to 2005 was start-up stage with modest capitalization,accounting for only around 1% of total GDP However, after booming period in 2006 and

2007, stock market capitalization came up to 43% of GDP Then, due to the difficulties inboth domestic and global economy, together with the collapse of stock market bubble,stock market capitalization dropped to 18% in 2008 In 2009, a recovery frommacroeconomics helped to raise stock market capitalization to 37.7% of total GDP Thatnumber in 2010 was 40% Nevertheless, 2011 was a difficult year for Vietnam economy

in general and for Vietnam stock market in particular Due to high inflation, thegovernment simultaneously tightened monetary policy and reduced public spending.Therefore, Vietnam stock market was strongly affected with the market capitalizationdecreased to around 20% of total GDP at the end of the year At the moment, after thefirst quarter of 2012 with positive signals from inflation-reduction efforts of thegovernment, Vietnam stock market is having slight recovery in term of both capitalizationand liquidity

In the past 12 years, people have witnessed Vietnam stock market’s abnormal up anddown of stock price For example, in the 2006 bubble, price of every stock went up Incontrast, in 2011, this went down, no matter how the business performances of companieswere Theoretically, stock price depends only on available information in the market.Hence, in the economic conditions and operating information of companies in 2006 or

2011, those abnormal movements of Vietnamese stock market may be the consequences

of psychological factors of investors in market

3 Research objectives

Investors in Vietnam stock market are currently having much more experiences than 12years ago Back to 2006, at the peak of the bubble, investors in the market were various interms of occupation, age, education, etc Referring to that period, it may lead to a quickconclusion that a characteristic of Vietnam stock market was herding behavior ofinvestors However, after the collapse of the bubble, the active participants in Vietnamstock market were adjusted That means, over the time, the characteristics of investors inthe market have changed

In this research, the main objective is to have a look into cognitive errors of individualinvestors in Vietnam stock market After detecting common biases among Vietnameseindividual investors and relationship of those biases with personal factors of eachinvestor, this study provides recommendations for investors so that they can adjust theirirrational behaviors and enhance investment results

4 Research questions

In this research, the following questions are going to be answered:

1 Is prospect theory applicable for individual investors in Vietnam stock market?

2 Do behavioral biases exist in Vietnam stock market? If yes, what are those biases?How is the relationship between those biases and personal factors of individual investors?

in Hanoi only Moreover, this work concentrates on finding out cognitive errors ofindividual investors in Vietnam stock market, so the methodology to collect information

is primary source

CHAPTER 2: LITERATURE REVIEW

In a paper named “Behavioral Finance versus Standard Finance, Mier Statman, whoseresearch focuses on behavioral finance, wrote:

“Behavioral finance is built on the framework of standard finance but supplies a replacement for standard finance as a descriptive theory.”

The first part in this chapter is a review of standard finance, including its basic models,approach, inputs, and limitations Then, behavioral finance and its application areintroduced in the second part and developed later in other chapters of the research

1 Standard Finance

Standard Finance has four pillars:

 Modigliani – Miller Theorems (Capital Structure Irrelevance Principle), MertonMiller & Franco Modigliani

 Modern Portfolio Theory (Mean–Variance Portfolio Theory), Harry Markowitz

 Capital Asset Pricing Model, John Lintner & William Sharpe

 Black – Scholes Model (Options Pricing Model), Fischer Black, Myron Scholes &Robert Merton

1.1 Four Pillars of Standard Finance’s Model

a Modigliani – Miller Theorems (Capital Structure Irrelevance Principle), Franco Modigliani & Merton Miller

The theorem was introduced by Franco Modigliani and Merton Miller in 1958 It statesthat under the special condition, which includes no tax, no bankruptcy cost, asymmetricinformation in an efficient market, the way the company finances its assets does not affectits value

The theorem, which is made up of two propositions, was initially proven under theassumption without taxes

Proposition I:  

Where: 

 VU is the value of an unlevered firm 

 VL is the value of a levered firm 

Proposition II: 

 ke is the required rate of return on equity, or cost of equity

 k0 is the company unlevered cost of capital

 kd is the required rate of return on borrowings, or cost of debt

  is the debt-to-equity ratio

Two propositions can also be extended to a situation with taxes.Proposition I:

Where:

 VL is the value of a levered firm

 VU is the value of an unlevered firm

 TCD is the tax rate (TC) x the value of debt (D)

Proposition II:

Where:

 rE is the required rate of return on equity

 r0 is the company cost of equity capital with no leverage

 rD is the required rate of return on borrowings, or cost of debt

 D / E is the debt-to-equity ratio

 Tc is the tax rate

In general, the Modigliani–Miller theorem has impacted the capital markets by promotingthe use of leverage, because when being levered in condition of having tax, firms candeduct payments of interest

b Modern Portfolio Theory (Mean-Variance Portfolio Theory), Harry Markowitz

Modern Portfolio Theory was introduced in a 1952 article and a 1959 book named

“Portfolio Selection” by Harry Markowitz

This theory provides portfolio managers with a useful tool to decide the weights ofdifferent assets in order to set up an optimal portfolio MPT based on the concept of

“diversification”, which is a collection of various investment assets that generally lowerthe risks created by individual assets

In MPT, an asset's return is normally distributed function, risk is the standard deviation ofreturn, and a portfolio is a weighted collection of assets, so the return of a portfolio is theweighted combination of the assets' returns By combining imperfectly positivelycorrelated assets, MPT reduces the total variance of the portfolio return

In the model:

Portfolio return is the proportion-weighted combination of the different assets' returns

Where:

 Rp is the return on the portfolio

 Ri is the return on asset i and wi is the weighting of component asset i

Portfolio volatility is a function of the correlations ρij of the component assets, for all assetpairs (i, j) We have the following formulations:

Portfolio-return variance:

Where ρij is the correlation coefficient between the returns on assets i and j

Alternatively the expression can be written as:

,Where ρij = 1 for i=j

Portfolio-return volatility (standard deviation):

c Capital Asset Pricing Model (CAPM), John Lintner & William Sharpe

Based on MPT of Harry Markowitz, Capital Asset Pricing Model was developed byWilliam Sharpe in 1964

The CAPM is a model for pricing an individual security or a portfolio For each security,security market line (SML) and its relation to expected return and systematic risk (beta)are used to show how the market prices individual security in relation to its risk class

Where:

 is the expected return on the capital asset

 is the risk-free rate of interest

 (the beta) is the sensitivity of the expected excess asset returns to the expectedexcess market returns, or also

 is the expected return of the market

d Black-Scholes Model (Options Pricing Model), Fischer Black, Myron Scholes & Robert Merton

The Black-Scholes Model was first devised in 1973 by Fischer Black and Myron Scholes,and then developed by Robert Merton

The Black-Scholes Equation:

Where:

 S is the price of the stock

 V(S,t) is the price of a derivative as a function of time and stock price

 r is the annualized risk-free interest rate, continuously compounded

 σ is the volatility of the stock's returns

 t is a time in years

The equation shows that investor can hedge the option by buying and selling the rightunderlying assets in order to eliminate the risk This hedge implies that there is only oneright price for the option, as returned by the Black–Scholes formula, which values a calloption, given below:

The price of a corresponding put option based on put-call parity is:

For both

  is the cumulative distribution function of the standard normal distribution

 C(S,t) the price of a European call option and P(S,t) the price of a European put option

 T − t is the time to maturity

 S is the spot price of the underlying asset

 K is the strike price

 r is the risk free rate 

 σ is the volatility of returns of the underlying asset

1.2 Standard Finance Approach

Standard Finance only concerns with two objectives including risk and return The goals

of all the 4 models can be clearly recognized with how to minimize, or even eliminaterisks, and maximize return Therefore, its approach relies on two oversimplifiedassumptions: Investors are rational and markets are efficient In other words, investorsalways make their decision rationally in a market that asset price is always equal intrinsicvalue

1.3 Input Elements of Standard Finance

Standard Finance includes models with statistical measures of risk and return to set up anoptimal portfolio for investors Besides those numbers, no other considerations, such asthe characteristics of investors, are shown in the models

1.4 Limitation of Standard Finance

The framework of Standard Finance makes assumptions about both investors and marketsthat create limitations for application in reality

The first limitation of Standard Finance is the assumption of investors that all investorsaim to maximize economic utility Moreover, Standard Finance also assumes all investorsare rational and risk-averse In fact, investors are often biased and affected by many otherconditions surrounding

The second limitation is raised from the assumption of efficient market, where marketprice is always equal intrinsic value However, in reality, the market price often does notreflect the true value of assets due to irrational investors Furthermore, investors alsocannot access the same information at the same time Additionally, the assumption that allinvestors are price takers in market is not always true, because investors with largeamount of sales and purchases can affect the market in some ways

In closing, although we can estimate the covariance of some assets, it is very difficult tomeasure expected returns Actually, setting up a portfolio based only on statisticalmeasure of risk and returns yields simplistic results, but we cannot go to exact optimalsolution for each investor

2 Behavioral Finance

2.1 Introduction of Prospect Theory

Prospect theory regarded as the foundation of behavioral finance was firstly developed byDaniel Kahneman and Amos Tversky in 1979, Tversky and Kahneman in 1992 Later on,some further ideologies based on prospect theory were developed by Chew and MacCrimmon (1979), Chew (1983), Bell (1982), Loomes and Sugden (1982), Quiggin (1982),Segan (1987, 1989), Yarri (1987) and so on

The paper on prospect theory that was introduced the first time by Daniel Kahneman andAmos Tversky in 1979 presented a critique of expected utility theory as a descriptivemodel of decision making under risk Unlike expected utility theory, prospect theoryapproached the issue in different way, it helps to comprehend the human behaviors inreality under risk or uncertainty It simultaneously developed an alternative model for themodel of expected utility

2.1.1 Critique on expected utility theory

a Expected utility theory

Expected utility theory is an important foundation of behavioral finance It analyzed theway we make decision under risk or uncertainty Make decision under risk or uncertaintyrelated to make choices between prospects

A prospect (x 1 , p 1 ; x 2 , p 2 ; …; x n, p n ) is a contract that yields outcome x i with probability p i ,

where p 1 + p 2 + …+p n = 1 We simplify notation by omitting the null outcomes and use (x, p) to denote the prospect (x, p; 0, 1- p) that yield x with probability p and 0 with

probability 1- p The (riskless) prospect that yields x with certainty is denoted by (x)

Making choices between prospects depend on each of their utility To measure the utility,

we use U function u(xi) is the expected utility of outcome xi And the application of

expected utility theory to choices between prospects is based on the following threetenets:

(i) Expectation: U (x 1 ,p 1 ;…;x n ,p n ) = p 1 u(x 1 ) + … +p n u(x n )

(ii) Asset integration: (x 1 , p 1 ; x 2 , p 2 ; …; x n, p n )is acceptable at asset position w if U(w

+ x 1, p 1 ;…; w + x n, p n )>u(w)

(iii) Risk aversion: u is concave (u '' <0) When having to make choices between

certain prospect and risky prospect with the same expected utility, people tend

to choose the first options

As the result, the expected theory prospect developed a U function to measure utility to make decision between prospects by comparing the value of U and then choose the U having maximum value

b Invalidation cases of expected utility theory

In expected utility theory, the utilities of outcomes are weighted by their probabilities Infact, the paper on prospect theory by Kahneman and Tversky indicate a series of choiceproblem in which people’s preferences systematically violate the principle of expectedutility theory

According the expected utility theory, investors should have chosen the outcome A ofeach problem because they gave out the higher utility Nevertheless, in reality, most ofpeople choose the outcome B in the first problem and the outcome A in the second onebecause of certainty effect

 The reflection effect

The certain effect discussed preference between positive prospects while the reflectioneffect discussed preference between negative prospects

> B (-3,000; 0.25)

[58]

We could see the preference between negative prospects in table 2.2 is the mirror image

of the preference between positive prospects in table 2.1 Therefore, the pattern waslabeled as reflection effect

 Probabilistic insurance

Assume that you are required to take part in an insurance contract In the contract, youhave to pay 50% of premium at the beginning compared to a normal insurance contract Ifthere is any damage, 50% probability you will pay the rest of premium and insurancecompany will incur all the damage and losses Other 50% probability, you will be paidback 50% amount of premium and incur all of the losses

Most of people surveyed answered that they do not be attracted by the insurance contractwhereas according to expected utility theory, the kind of insurance contract should havebeen attracted more than the normal ones

 The isolation effect

When making choices between different prospects, we often do not care about the similarpattern yet pay attention to different patterns between them For example, individualinvestors were as

- Problem 1: You are certain to receive $1,000 Make decisions between:

The editing phase is to organize and reformulate the options so as to simplify subsequentevaluation and choice In the phase, outcomes of the decision are ranked according to abasic “rule of thumb” (heuristic) There are some rules applied for the editing phase suchas: Coding, combination, segregation, and cancellation

In the following evaluation phase, people decide which outcomes they see as basicallyidentical, set a reference point and then consider lesser outcomes as losses and greaterones as gains People behave as if they would compute a value (utility) based on the

- x 1 , x 2  are the potential outcomes

- p 1 , p 2… are their respective probabilities 

- v is a so-called value function that assigns a value to an outcome The value

function (sketched in the Figure 2.1) that passes through the reference point is shaped and asymmetrical Losses hurt more than gains feel good (that is lossaversion) This differs greatly from expected utility theory, in which a rationalagent is indifferent to the reference point

s The function w is a probability weighting function It expresses that people tend to

overreact to small probability events, but under-react to medium and largeprobabilities

Figure 2.2.1

2.2 Behavioral finance

2.2.1 Primary Themes of Behavioral Finance

With the root as Prospect Theory, Behavioral Finance studies influences of three mainaspects of cognitive errors on investors:

First, Heuristics is the situation when investors make decisions based on their own values,ideas, or “rule of thumb” That means the investors are irrational in their choices

Second, Framing is the way that problem, event or data is stated and the impact of thatway on investors’ decisions

Third, Market Inefficiency is the circumstance when market outcomes are not appropriatewith the expected outcome rationally This aspect shows the factors that createunexpected outcome in the market

2.2.2 Types of Investor Biases

Based on the three main themes, behavioral finance develops many specific biases ofinvestors The biases mentioned in this paper are the most prevailing ones

a Heuristics includes following biases:

 Overconfidence Bias: Overconfident investors are people who strongly believe in

their ability of prediction and the precision of information in the market In otherwords, those people tend to think that they are more intelligent and get betterinformation than they actually do Overconfident investors can have the followinginvestment mistakes:

- Overestimating their ability to assess a company as a potential investment Thus,they may not realize negative information that affects significantly investmentresult

- Trading excessively because they believe that their decision is right, and they arebetter than other people to discover the promising investment

- Underestimating downside risks because they do not recognize that they lacknecessary information to go to comprehensive conclusion

- Holding under-diversified portfolios Due to a belief of their prediction ability,they allow more risks than they can tolerate.

 Over Optimism Bias is the way investors over optimistically looking at the

economy, the market, and the investments they make Over optimism can cause thebelow mistakes for investors:

- Overloading them with their company stock because they think that stocks of theircompany are better than stocks of others

- Underestimating factors that can affect their overall returns, for example, inflation,tax, interest rate, etc

- Tending to think that they are above average investors because of their optimism

- Investing near geographic region because they may be unduly optimistic about thepotential of their local geographic area

 Representativeness Bias is presented when investors tend to relate a new situation

with a situation that they are familiar with, or they consider a small size of datarepresents all the population This bias can make investors get significant errors by:

- Using data in a short period of time in the history for their current research andquickly go to conclusion

- Seeing success of stock analysts in some cases and generalizing ability of thoseanalysts

 Confirmation Bias refers to tendency of investors to select the ideas suitable with

their belief, and deny the ones which do not fit Behavior of investors who own thisbias is trying to collect information that proves their belief, and undervaluing oreven ignoring claims that contradict their opinion Confirmation bias may causeinvestors to do the following incorrect things:

- Over concentrating on company stock

- Holding under diversified portfolios

 Regret Aversion Bias is the hesitation of investors to choose among different

options because they fear that they will not choose to best ones Example ofmistakes originated from regret aversion bias are:

- Holding winning stocks for too long because investors fear that the stock price willcontinue to increase after they sell them

- Being too conservative in investment choices

- Being too pessimistic about downward trend of market and trying to avoid thatmarket, even though in depressed market, opportunities still exist

- Being affected by herding behavior

- Preferring stocks of “good companies”

b Framing is expressed through Mental Accounting Bias:

 Mental Accounting Bias describes investors who group their assets into

non-interchangeable mental accounts to classify and assess economic outcomes Theconcept of framing means that people change the perspective on money andinvestments according to surrounding circumstances they face Mental accountingmakes investors to separate their investments into separate accounts Thesecategories may include money for college fund or money for retirement Due tothis bias, investors may have some investment mistakes:

- Irrationally distinguishing between returns derived from income and those derivedfrom capital appreciation

- Allocating assets differently when employer stock involved

- Hesitating to sell stocks that once generated significant gains but then have fallen

in price over time

c Market Inefficiency is presented by Herding Behavior and Seasonality:

 Herding Behavior is the way investors follow others without any planned direction.

For example, this bias can make investors to buy stock just because price of thatstock is increasing

 Seasonality Bias is a change in behavior of investors due to effect of time or event.

For instance, investors may behave differently on Monday or Friday (first and lastday of the week), or in January, or in special events (Tet holiday)

2.2.3 Other Factors and Behavioral Finance

Besides biases mentioned above, genders and personality types are also important factorsthat affect the decision of investors

a Gender:

Gender is one of the most essential factors determining decision-making style of anindividual investor A lot of studies researched the influence of sex, especially on risktolerance and overconfidence of female and male investors

First, the results have shown that men are less conservatively in investing than women Astudy by the federal government’s Thrift Savings Plan, Hinz et al (1997) found thatwomen tend to hold fixed-income assets (65 percent women versus 52 percent to men)rather than equities (28 per cent women versus 45 per cent to men) In general, women areunwilling to take more risks to get higher expected returns

Second, women are less overconfident than men In the report named “Boys Will BeBoys: Gender, Overconfidence, and Common Stock Investment” (2001), Barber andOdean showed that in trading behavior, men are more overconfident than women

Finally, the present studies provide more data to show that men and women are different

in their susceptibility to behavioral biases

pessimistic overconfident

Gender-Based Scale

realistic unrealisticlow risk tolerance high risk tolerance

< -| -I -| ->Women Men

b Education

According to Christiansen et al (2006), investors with a higher education invest a largerproportion of asset in stocks and bonds This finding supports conclusion in other severalstudies of Mankiw and Zeldes (1991), Haliassos and Bertaut (1995) and Guiso et al.(2003) that the higher level of education investors have, the more they involve in financialmarket

However, in studies by Bowman’s (1982) and Schooley and Worden (1999) showed theopposite conclusion, that means there is still a negative relationship between wealth andrisk tolerance

e Personality Types

Based on Myers-Briggs Type Indicator (MBTI), Michael M Pompian and John Longoconnected the personality types of people to the decision characteristics of people Thereare sixteen personality types which are created from eight letters represent aspects ofhuman personality: E (Extraverted) – I (Introverted); S (Sensing) – N (Intuitive); T

(Thinking) – F (Feeling); J (Judging) – P (Perceiving) Those sixteen personality typeswill reflect the characteristics of people as the following Personality Type-Based Scale:

pessimistic overconfidentrealistic unrealisticlow risk tolerance high risk tolerance

< -| -I -| ->INFJ ENFJ

ENTP ESTJ ISTP ESFP

Personality Type-Based Scale

from individual investors in stock exchanges in Hanoi are collected The examination onthe stock exchanges of following securities companies is processed:

- An Binh securities company

- Agriculture securities company

- Dong A securities company

- Saigon Hanoi securities company

- SSI securities company

- Thang Long securities company

- Viet Capital securities company

- Viet Dragon securities company

- Vietcombank securities company

On those stock exchanges, our objects include:

- Investors who presented on the stock exchanges

- Brokers of stock exchanges who also invest in stocks

- Investors who did not presented on the stock exchanges We approached thoseinvestors via brokers and investors who presented on the stock exchanges

For the detailed questions of behavioral finance, two types of questions are utilized:Likert scale and nominal questions In Likert scale questions, we provide seven levels ofagreement with a notion (Level 1: Totally Disagree; Level 2: Strongly disagree; Level 3:

Disagree; Level 4: Neither agree nor disagree; Level 5: Agree; Level 6: Strongly agree;Level 7: Totally agree), or seven levels of importance of information sources (Level 1:Totally unimportant; Level 2: Very unimportant; Level 3: Unimportant; Level 4: Neutral;Level 5: Important, Level 6: Very important; Level 7: Totally important) for investors tochoose the one that fits their opinion In nominal questions, we provide Yes/No questions

or multiple choice questions for them to choose Each type of question will be processeddifferently in analyzing process afterward

b Bias diagnostic questions:

The questions used to diagnose biases of investors are presented in our survey as follows:

 Prospect theory: Multiple-choice question

There are two cases In each case, investors have to choose one decision:

Case 1:

a, Decision 1: 100% of probability having VND 600,000

b, Decision 2: 60% of probability having 1,000,000 VND and 40% of probability having nothing.

Case 2:

a, Decision 1: 100% of probability losing VND 600,000

b, Decision 2: 60% of probability losing 1,000,000 VND and 40% of probability losing nothing.

 Overconfidence bias: Likert questions

C1: You are confident in your ability of forecasting stocks in the market.

C2: You believe that your ability to choose stocks for investment is better than other investors in the stock exchange.

 Over optimism bias: Likert questions

O1: You have the same opinion with financial analysts that 2012 is a promising year for Vietnam stock market.

O2: If VN Index decreases by 5% tomorrow, you believe that it will soon recover in the next few days.

 Representativeness: Likert questions

R1: Fund management X gained positive result in difficult time of Vietnam stock market (2008 – 2009) You believe in the profitability of this fund in the future.

R2: You believe that stocks of governmental enterprises are all undervalued in the Initial Public Offering (IPO)

R3: You believe that investing in stocks of petroleum industry will definitely bring to you profit.

 Confirmation: Multiple-choice question

Imagine that you forecast price of stock A will decrease, but some information in the market claims that stock A’s price will increase in the next period How does the outside information affect your investment opinion and action?

a, You still believe in your forecast and evaluation, so you do not change your opinion about stock A’s price in the coming period, and sell the stock.

b, You will find more information and examine your forecast before making the decision.

c, The outside information affects a lot to your opinion You feel unpleasant with that information Therefore, you will find out more information to prove that your initial forecast is right

 Regret Aversion Bias: Multiple-choice question

You invested in 1000 shares of a stock with the price of VND 20,000/share, and

forecasted that the price of this stock would increase in coming period As your forecast, price of the stock increased for a long time and went up to VND 30,000/share At this price, you were confused to sell the shares or not Finally, you decided to keep the stock with a hope that the stock price would continue to increase However, the stock price suddenly dropped to VND 24,000/share What are you going to do next?

a, Sell immediately You want to gain profit.

b, Keep the stock You want to wait for the stock price to increase again.

 Mental Accounting Bias: Multiple-choice question

Imagine you have two cases need to be decided:

Case 1: If you win a lottery with an award of VND 500 million and decide to invest that amount of money in common shares and bonds, how will you allocate your portfolio?

 Herding Behavior: Likert questions

H1: Trading activities of big investors in Vietnam stock market affect your stock

investment decision making

H2: Proposal of financial analysts is important to your investment decision

H3: Rumor is important to your investment decision

H4: Actions of other investors in the stock market are important to your investment

decision

 Seasonality: Yes/No question

Did you change the frequency of your transactions in stock market before and/or after Tet holiday in the past?

a Yes

b No

3 Sampling

There are two sampling periods:

In the first period, we collected a small number of samples to test the effectiveness ofquestionnaire The number of questionnaire surveys must be big enough to create reliableresult, so 30 questionnaire surveys were distributed and evaluated

In the second period, we distributed questionnaire surveys in broad scale After datacollection process, there are totally 243 questionnaire answers collected in nine stockexchanges However, after filtering, there are 231 answers are used for our research Thecriteria for usable answers are: 1 Investor answered more than 70% of the questionnaire;

2 The answer of investor does not have clear signal of randomly choices (e.g: more than

10 consecutive questions in questionnaire have the same choice)

4 Analyzing process

In order to transfer our raw data into meaningful conclusions, we use SPSS software toanalyze statistics The analyzing procedure in SPSS is summarized as follows:

Data entry

a Data entry:

231 questionnaire answers were put into the software to be processed later We did thisstep separately and then compared to each other to make sure the exactness of input dataset

b Descriptive Statistics:

In this step, we use frequency application to have an overview of investors’characteristics, e.g, gender, education, experience and purpose of stock investment Wealso use frequency to examine biases of investors through number of investors’ choices ineach question

c One-sample T Test

A one sample T test allows us to test whether a sample median differs significantly from ahypothesized value The procedure for one-sample T Test is as follows:

 Set up the hypothesis:

A.  Null hypothesis: assumes that there are no significant differences between the

population mean and the hypothesized value

B.  Alternative hypothesis: assumes that there is a significant difference between the

population mean and the hypothesized value

 Run one-sample T Test on SPSS

One-sample T Test

Exploratory  Factor Analysis

Independent-samples T Test

Descriptive Statistics

 Hypothesis testing: In hypothesis, statistical decisions are made to decide whether

or not the population mean and the hypothesized value are different.  In the testing result,

we look at the significance value If the significance value is small enough (for example,sig is smaller than 0.05), we can reject the null hypothesis that there are no significantdifferences between the population mean and the hypothesized value

- For Liker-scale question, our test value is 4 If the sig < 0.05, we reject thehypothesis that the mean of population is equal to 4, and we use the sample meanfor population mean

- For multiple choice questions, we group the answers into 2 options and code them

as 1 and 2 in SPSS Our test value is 1.5 If the sig < 0.05, we reject the hypothesisthat mean of population is equal to 1.5, and we use the value of sample mean forpopulation mean When sample mean < 1.5, investors tend to choose option 1, andwhen sample mean > 1.5, investors tend to choose option 2

In our research, using one-sample T Test is an initial step for us to check whetherinvestors have biases or not by finding overall mean of their answers This step providesbasis for further analysis afterwards

d Independent-samples T Test

The independent samples (or two-sample) t-test is used to compare the means oftwo independent samples In our research, we use this test to examine the relationbetween investors’ characteristics and their level of biases The procedure forindependent-samples T Test is as follows:

 Set up the hypothesis:

A.  Null hypothesis: assumes that there are no significant differences between the means

of two independent samples

B.  Alternative hypothesis: assumes that there is a significant difference between the means of two independent samples

 Run independent-samples T Test on SPSS

 Hypothesis testing: In hypothesis, statistical decisions are made to decide whether

or not the means of two independent samples are different.  In the testing result, we firstlook at the sig of Levene’s Test for equality of variances If sig in Levene’s Test < 0.05,

we use Equal variances not assumed in T test If sig in Levene’s Test >=0.05, we useEqual variances assumed in T test If the significance value in T test is small enough (forexample, sig is smaller than 0.05), we can reject the null hypothesis that there are nosignificant differences between means of two independent samples

e Explanatory Factor Analysis (EFA)

EFA is an analysis to help uncover the underlying structure of a relatively large set ofvariables: There are two sub-steps:

Reliability Analysis: is a method to test the reliability of Likert scale questions used in our

research By computing Cronbach alpha, we can conclude whether the scale is reliable tohave further analysis or not If the alpha of a scale is 0.6 or higher, the scale is chosen to

be processed in later steps

Factor Analysis: is used to reduce from a large number of variables into a small number

of factors that explain most of the variance that is observed with a large number ofvariables The most effective way to detect number and characteristics of factors islooking at Rotated Component Matrix table Our purpose of this step is to find out themain factors affect behavior of individual investors and name them

Factor Analysis Reliability Analysis

CHAPTER 4: DATA ANALYSIS AND FINDINGS

With the data provided and processed, in this chapter, we are going to answer twoquestions of our report in two main parts:

Part I: Prospect theory testing for individual investors in Vietnam stock market Part II: Behavioral biases of individual investors in Vietnam stock market

PART I: PROSPECT THEORY TESTING FOR INDIVIDUAL

INVESTORS IN VIETNAM STOCK MARKET.

1.Overview of individual investors in Vietnam stock market

Before examining the existence of cognitive errors, we have a look at the characteristics

of active individual investors in Vietnam stock market at the moment

a.Gender:

Among 231 investors, 55.8% is male and the other 44.2% is female That means inVietnam stock market, the number of male is bigger than the number of female with thedifference of 10% In literature review section, we mentioned the role of gender that isone of the most essential factors determining decision-making style of an individualinvestor Therefore, the difference in ratio of gender in Vietnam stock market may affectthe characteristics of the whole Vietnam market in general

b.Age:

In our data, the youngest individual investor in Vietnam stock market is 20 years old, and the oldest one is 65 years old We group people basing on their age as the chart below: