FINANCIAL LITERACY BIASES IN PROSPECT THEORY: EMPIRICAL EVIDENCE ON HOW INDONESIAN MONEY MARKET INVESTORS MAKING FINANCIAL DECISIONS

• Main Author: Ayu Anggraeni, Nia
• Format: Final Project
• Language: Indonesia
• Online Access: https://digilib.itb.ac.id/gdl/view/72428
• Institution: Institut Teknologi Bandung

Decision makers have tendency to take action irrationally in decision making process in facing uncertainty. That irrational behavior is due to the systematic error of judgment that is led by biased cognitive process. Daniel Kahneman and Amos Tversky (1979) build a new theory named Prospect Theory that opposes Expected Utility Theory. This Theory says that in a gain domain or profit attainment, an individual tends to avoid risk. In the contrary, when individuals are given a high probability of uncertainty in loss domain they tend to take risk. In short, individuals have an irrational tendency to be less willing to gamble with profits than with losses as mentioned by Tvede (1999). Kahneman and Tversky named that bias as Reflection Effect. Prospect Theory learns how individuals behave when faced with two alternatives with a known probability. When experience certain events, people tend to ignore other possibilities that may occur. This bias is called Certainty Effect. There are many similar studies have been done in other countries but a research to test applicability of Prospect Theory in Indonesia is still rare. This experimental study objective is to analyze what type of Prospect Theory biases are significantly affecting subject in Indonesia. This study considers Reflection Effects, Certainty Effects, Isolation Effects, and Endowment Effects as bias predictor. This study also taking into account Financial Literacy aspect in the analysis. Subjects in this observational study are 205 potential investors in Indonesia. To gather the data, this study adapts the questionnaire used by Kahneman and Tversky (1979) and changes the currency to Rupiah to improve the subjects’ comprehension. To analyze subject demographics, this study requires qualitative questions through online questionnaire. The results in which are in form of pairs of answers are analyzed one by one to identify if there were majority preference in subjects’ decision. This study concludes that Financial Literacy does not significantly affect the biases in Prospect Theory. From the Odds Ratio analysis, this study able to conclude that biases’ magnitude in making financial decision is greater for subject with low financial literacy.