Quantitative model for impact of behavioral biases on asset allocation decisions: a case study of investors in UAE

Abstract

Individuals are expected to be rational and follow the approach prescribed under different traditional finance theories while constructing portfolios. In reality, studies from different parts of the world show that individuals do not act rationally due to cognitive limitations and influence of emotions and feelings. Additionally, in quite a few countries, religion plays an important role in decision-making. As a result, individuals make suboptimal decisions, like holding poorly diversified portfolios, excessive or minimal trading, and taking excessive or too little risk with their portfolios. The analysis of impact of behavioral biases and religiosity has not been done in the context of individual investors living in UAE, which this paper addresses. A survey questionnaire was administered to Arab nationals living in UAE. Data of 129 individuals were analyzed. The findings showed that these investors were influenced by emotional and cognitive biases, had good knowledge of religiosity, & placed them as important. This behavior is consistent with investor behavior observed in the rest of the world. Subsequent to these empirical findings, the paper has developed a quantitative model to predict the impact of behavioral biases and religiosity on asset allocation decisions. The research approach used for developing the quantitative model can be replicated by researchers from across the world tailored to their own regions.