Abstract:
Herd behavior, where investors mimic the trades of others rather than relying on their
own information or analysis, is a widespread phenomenon that can lead to suboptimal
investment decisions and market inefficiencies. Hence, understanding how to reduce
this behavior is crucial for improving individual investment outcomes and sustainable
market performance. Though the literature suggests that self-reflection and financial
literacy have potential to mitigate herd bias, it is unclear as to how these two
perspectives interact to minimize this irrational behavior. By drawing on insights from
the adaptive market hypothesis, transformative learning theory, concept of bounded
rationality and dual process theory, this study attempts to enhance the understanding of
this phenomenon by introducing a conditional mediation model that promotes self directed learning. It predicts that investors can reduce their herd bias through self reflection on their past stock trading experiences, which they can practice by engaging
intuitive logical thinking and strengthen further through their financial literacy. Since
herding is generally predicted to be more prevalent in frontier stock markets, the study
was conducted in a frontier market - the Colombo Stock Exchange. The data was
obtained through a self-administered questionnaire from 253 active individual investors,
and analyzed by applying the PROCESS procedure. The findings reveal the significance
of self-reflection as a mediating variable across its antecedents, which provides strong
evidence for its central role in reducing herd bias. Notably, the findings indicate that
self-reflection has a stronger effect on reducing herd bias of investors with lower level
of financial literacy. It implies that investors with low financial literacy are more
susceptible to herd bias, and self-reflection facilitates them to recognize and minimize
their herd bias. Accordingly, the study concludes that promoting self-reflection can
empower individual investors to become more financially literate and thereby mitigate
their herd bias.
