Behavioural Biases and Investment Decisions with Mediating Role of Risk Perception and Moderating Role of Financial Literacy

Overview

This peer-reviewed open-access article tests a behavioural finance model to explain how behavioural biases shape retail investors’ investment decisions in an emerging market context (the Pakistan Stock Exchange/PSX). The study shows that biases affect decisions directly and also indirectly through risk perception, while financial literacy weakens (buffers) the harmful impact of those biases on decision quality.

What the study covers

The authors collected primary data from 280 active PSX retail investors using an online structured questionnaire (Google Forms) and analysed the model using PLS-SEM (SmartPLS). The framework positions behavioural biases as the driver, risk perception as a mediating mechanism, and financial literacy as a moderating capability that helps investors control biased decision patterns.

Key findings and insights

Behavioural biases significantly influence investment decisions (β = 0.329; p < 0.001), confirming that investors deviate from fully rational choices when cognitive/emotional shortcuts dominate.
Behavioural biases also significantly increase risk perception (β = 0.540; p < 0.001), meaning biased thinking reshapes how investors interpret risk, not just what they choose.
Risk perception significantly affects investment decisions (β = 0.304; p < 0.001) and partially mediates the bias → decision relationship (indirect effect β = 0.164; VAF ≈ 33%).
The model explains a substantial share of decision variance (R² ≈ 0.542 for investment decisions), indicating meaningful predictive power for behavioural finance applications.
Financial literacy significantly moderates the bias → decision link (β = −0.302; p < 0.001), meaning higher literacy reduces the impact of biases on investment decisions (buffering effect).

Why this matters for organisations

For regulators, exchanges, and financial institutions, the message is practical: improving “decision quality” is not only about giving more information, it also requires reducing behavioural vulnerabilities. The findings support targeted investor education that combines financial knowledge with bias awareness and risk interpretation skills, especially in emerging markets where retail investors rely heavily on informal signals and social narratives. This also helps guide brokerages, banks, and educators in designing programmes that improve disciplined decision routines rather than just teaching concepts.