2.1 INTRODUCTION

To illustrate the literature review, a brief discussion will be discussed on behavioral finance, conceptual definition of dependent variable (risk perception), independent variables (information asymmetry, demographic factors, overconfidence and expert knowledge) and the relationship between dependent variable and independent variable.

2.2 BEHAVIORAL FINANCE THEORY

Behavioural finance is a part of finance that there is involvement in psychological decision processes. Investor behaviour and stock market are closely related in behavioural finance. Ricciardi and Simon (2000) studied the behavioural finance explaining the emotional process which influences investor in decision making process.

Behavioural finance is a field of finance that proposes psychology-based theories to explain stock market anomalies. It is assumed that the information structure and the characteristics of market participants systematically influence one’s investment decisions as well as market outcomes. Behavioural finance attempts to fill the void that market hypothesis cannot captured plausibly in models based on perfect investor rationality. Behavioural finance has two building blocks: cognitive (how people think) psychology (too confident with their experience) and the limits to arbitrage (predicting in what circumstances arbitrage forces will be effective and ineffective or when markets will be inefficient).

Psychological factors (Ricciardi and Simon, 2000) included in the behavioural finance theory where psychological factors influence the financial decision making process of individuals. Knowledge is a part of psychological factor that influence investors to make decision. Types of information determine the investor to seek and understand where the stock market is going. Thus, he or she will decide to make decision to purchase stock.

Emmanuel, Harris, and Komakech (2010) mentioned on cognitive psychology in terms of investors’ beliefs and preference during decision making. Investment portfolio in stock market will be judged by investors and decide whether portfolio market is beneficial to them. Experience and memory to search information are the components that determine the investors to make decision. Additionally, personal knowledge provides opportunity when making comparison and will be evaluated.

For instance, behavioural finance described psychological biases influence investor behaviour and stock prices (Nik, 2009). Investors refer to past performance to evaluate the present performance in stock market. They do not involve all asset categories. The perspective will change when making decision as investors have make comparison the period of time. In addition, investors behave aggressively when purchasing stock as they do believe that high profit gain. On the other hand, investors who do not have confident are only to purchase the small amount of stock.

Ritter (2003) stated that the cognitive psychology include overconfidence where investors are confident on their abilities. In entrepreneurship context, entrepreneurs are overconfident because they believed participate in market industry do face risk and as a return, they earn high profit. In finance, an example illustrate in the study which is too little diversification, investors only invest in one item rather than two or more items. Because of that, they invest too much in stock company.

Besides that, Ricciardi (2004) stated that psychology influence a person perceive risk of activity. Personality traits and demographic play an important role which differences among survey respondents.

2.3 CONCEPTUAL DEFINITION OF RISK PERCEPTION

Risk is the matter of perception that is related to problems in business and economics (Brachinger and Weber, 1997). People assumed risk is a negative preference and bad outcome. However, Brachinger and Weber (1997) stated that risk increase when gamble appears many times and risk decreases when there are positive translations. For instance, risk is used to evaluate and predict choices under uncertainty.

In finance, risk is the main determinants of investment decision (Ozer, Ergeneli and Karan, 2004). Investors act irrationally and concerned all information when making decision process. Limited information expose to individual investors in risk perception. Understanding the risk perception is vital of how risk perception is measured. Therefore, psychological factors are relevant in risk perception among investors.

Ricciardi (2007) focused on the risk perception in behavioural finance. In the literature review, behavioural approach is used in the risk to evaluate through laboratory experiment and questionnaire instrument. Risk is classify as subjective and contained the beliefs, attitudes and feelings towards risk.

Ricciardi (2007) mentioned the risk tolerance where investors feel better with the natural risk given type of investment. Investors do not change their mind and consider what they perceived. Risk increases when investors invest more assets in investment (Kendirl and Tuna, 1999).

Willingness to take risk is depending on how investor tolerates the risk. Some investors are conservative that they afraid to lose money. Risk perception is that what is the maximum risk exposure that they want to take and comfortable with. They can make portfolio mix by doing ratio between stocks and fixed income. This could be the best method that can decrease the risk exposure (Chambers and Rogers, 2004).

Several studies found that risk perception is influence by psychological factors. For example, McConnel, Gibson and Haslem (1985) examine the knowledge towards risk taking behaviour. The shareholders are the respondent and are answered through mailed questionnaire. It was to access to see whether the investors’ knowledge is positively correlated with specific risk-return preferences. Three risk-return preferences were utilized for calculating risk preference.

Also, in 2000, Houghton, Simon, Aquino and Goldberg introduce the three independent variables (laws of numbers, illusion of control, and overconfidence) to investigate the risk perception decision making. A surveyed was conducted with business college students. The findings showed that the laws of numbers and illusion of control decreased in risk perception and overconfidence was not correlated in risk perception.

Yip (2000) investigated the financial risk tolerance as a psychological trait. Students were participated on-line trading simulation and risk tolerance was measured through pre competition, post competition and takes up eight weeks after the competition. Financial experience and knowledge do not affect the stability of risk tolerance. In trading strategies, males are more risk than women. Therefore, financial risk tolerance is considered as a trait.

Besides that, different level of risk was examined by Grable and Lytton (1999) to investigate the demographic, socioeconomic and attitude on individual behaviours. A survey is located in Southeastern United States and divided into two category respondents (above average versus below average risk tolerance investors). Statistical method discriminant analysis was utilized in grouping investors into risk tolerance.

Walia and Kiran (2009) studied an analysis of investors’ risk perception towards mutual funds services. The investors’ purchase decision for mutual funds is influenced by chain of factors. Investor should opt for investment avenue are determined by the risk and expected return. Structured questionnaire were designed with 5 point Likert scale used to measure the risk perception towards various financial avenues. Respondents were investors who had experience of mutual fund investment. Ranking and raking methodology was also followed to prioritize the investor’s preferences.

Veld and Merkoulova (2008) studied the risk perceptions of individual investors. The purpose of this paper is to test which risk measures influence the individual investors’ decision making. Experimental questionnaire were tested based on 2226 members of a consumer panel. Questionnaire contains experimental questions in the form of pairwise comparisons and also tested whether the answer to the experimental questions are related to demographic of the respondents. The result showed a comparison of stock and bond investments is interesting for our purposes, since these two categories not only have a different amount of risk associated with them, but also differ in their risk profile; respondents with a preference for the semi-variance as a risk measure are more likely to hold individual stocks. Overall, results of these regressions show that the different types of risk attitudes among individual investors, found in the previous parts of the paper, directly translate into their investment behaviour.

Sung and Hanna (1996) investigated that financial risk has on effect of financial and demographic variables. Employed respondents were participated in the 1992 Survey of Consumer Finances. To measure this, logistic regression analysis showed that female headed household were risk tolerant compare to male head or a married couple. In this research, gender, marital status, ethnic group and education found different in understanding of the nature of risk.

Hence, in this study, risk pe