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The role of cognitive heuristic-driven biases in investment management activities and market efficiency: a research synthesis

Maqsood Ahmad (Faculty of Business, School of Accounting and Finance, The Hong Kong Polytechnic University, Hunghom, Hong Kong)

International Journal of Emerging Markets

ISSN: 1746-8809

Article publication date: 28 June 2022

Issue publication date: 23 January 2024

2044

Abstract

Purpose

This article aims to systematically review the literature published in recognized journals focused on cognitive heuristic-driven biases and their effect on investment management activities and market efficiency. It also includes some of the research work on the origins and foundations of behavioral finance, and how this has grown substantially to become an established and particular subject of study in its own right. The study also aims to provide future direction to the researchers working in this field.

Design/methodology/approach

For doing research synthesis, a systematic literature review (SLR) approach was applied considering research studies published within the time period, i.e. 1970–2021. This study attempted to accomplish a critical review of 176 studies out of 256 studies identified, which were published in reputable journals to synthesize the existing literature in the behavioral finance domain-related explicitly to cognitive heuristic-driven biases and their effect on investment management activities and market efficiency as well as on the origins and foundations of behavioral finance.

Findings

This review reveals that investors often use cognitive heuristics to reduce the risk of losses in uncertain situations, but that leads to errors in judgment; as a result, investors make irrational decisions, which may cause the market to overreact or underreact – in both situations, the market becomes inefficient. Overall, the literature demonstrates that there is currently no consensus on the usefulness of cognitive heuristics in the context of investment management activities and market efficiency. Therefore, a lack of consensus about this topic suggests that further studies may bring relevant contributions to the literature. Based on the gaps analysis, three major categories of gaps, namely theoretical and methodological gaps, and contextual gaps, are found, where research is needed.

Practical implications

The skillful understanding and knowledge of the cognitive heuristic-driven biases will help the investors, financial institutions and policymakers to overcome the adverse effect of these behavioral biases in the stock market. This article provides a detailed explanation of cognitive heuristic-driven biases and their influence on investment management activities and market efficiency, which could be very useful for finance practitioners, such as an investor who plays at the stock exchange, a portfolio manager, a financial strategist/advisor in an investment firm, a financial planner, an investment banker, a trader/broker at the stock exchange or a financial analyst. But most importantly, the term also includes all those persons who manage corporate entities and are responsible for making their financial management strategies.

Originality/value

Currently, no recent study exists, which reviews and evaluates the empirical research on cognitive heuristic-driven biases displayed by investors. The current study is original in discussing the role of cognitive heuristic-driven biases in investment management activities and market efficiency as well as the history and foundations of behavioral finance by means of research synthesis. This paper is useful to researchers, academicians, policymakers and those working in the area of behavioral finance in understanding the role that cognitive heuristic plays in investment management activities and market efficiency.

Keywords

Acknowledgements

The author thanks the anonymous reviewers for the valuable feedback and comments during the review process. The author is also incredibly grateful to Professor Dr. Paltrinieri, Andrea Senior Editor, for the constructive feedback and expertise in helping to finalize this paper. Dr. Paltrinieri's excellent and patient editorial assistance was invaluable across the review process.

Citation

Ahmad, M. (2024), "The role of cognitive heuristic-driven biases in investment management activities and market efficiency: a research synthesis", International Journal of Emerging Markets, Vol. 19 No. 2, pp. 273-321. https://doi.org/10.1108/IJOEM-07-2020-0749

Publisher

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Emerald Publishing Limited

Copyright © 2022, Emerald Publishing Limited

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