Behavioural biases and investment decisions with mediating role of risk perception and moderating role of financial literacy

Abstract Behavioural biases influence investment decisions by altering how investors perceive risks and assess financial data. In developing markets like the Pakistan Stock Exchange (PSX), where behavioural biases affect investment decisions both directly and indirectly through risk perception, the moderating function of financial literacy has been overlooked. In order to assess how behavioural biases influence the decisions made by retail investors, this study presents a comprehensive behavioural finance model that incorporates risk perception as a mediating variable and financial literacy as a moderating variable. A structured questionnaire was developed using Google Forms and distributed online to gather primary data. A purposive sample technique was used, and 280 valid responses were obtained from active PSX retail investors. Partial least squares structural equation modelling (PLS-SEM) was used to analyse the data using SmartPLS. The findings show that behavioural biases significantly impact investment decisions directly and indirectly through perceptions of risk. Furthermore, financial literacy significantly moderates this relationship by reducing the negative impact of behavioural biases on investment decisions. These findings contribute to the field of behavioural finance by highlighting the importance of financial knowledge in lowering biased investment behaviour. The study provides valuable insights for regulators, lawmakers, and financial educators in the creation of focused investor education programmes aimed at enhancing decision-making quality and lowering behavioural vulnerabilities in emerging financial markets.