The Influence of Behavioural Biases on Household Financial Decision-Making: Evidence from the Mediating Role of Financial Literacy

Abstract

This study aims to analyze the role of behavioural biases in financial decision-making of households by considering the role of financial literacy as a mediator. While household financial decision-making is critical in financial wellbeing, people often make poor financial decisions because of their cognitive and emotional biases. Based on Prospect Theory, behavioural finance theory and the Theory of Planned Behaviour, this paper suggests that behavioural biases have a direct and indirect effect on money-related decisions made by the household via financial literacy. In particular, this research analyzes how the overconfidence bias, loss aversion, herding behaviour, mental accounting, and anchoring bias affect household financial decision-making and evaluates the mediation effect of financial literacy. The research design adopted was quantitative with a cross sectional survey of household financial decision makers. A total of 386 valid respondents were targeted for data collection and analysed using Partial Least Squares Structural Equation Modelling (PLS-SEM) with the Smart PLS 4 software. The results show that all of the five behavioural biases negatively affect household financial decision making and that all are significant. The findings also suggest that behavioural biases have a profound impact in lowering financial literacy and financial literacy plays a positive role in financial decision-making within households. Mediation testing reveals that using mediation analysis the path from behavioural biases to financial decision-making by the household is partially mediated by financial literacy, indicating that knowledge can play a role in reducing harmful effects of behavioural biases on financial behaviour. The findings of the structural model show good explanatory and predictive power, which supports the conceptual framework proposed. This study is useful to the literature of behavioural finance in two ways: firstly, it combines behavioural biases into a single compass and secondly it establishes financial literacy as a key mechanism between psychological biases and household financial decision making.