Project of: Research Article

Subject: Advance Research Methodology

Submitted To: Dr. Khuram Shezad

Submitted By: Shadnan

Registration No: MMS 143072

Program: MS Management Sciences (Finance)

Electronic copy available at: http://ssrn.com/abstract=2727890

Impact of Financial Literacy, Financial Knowledge, Moderating Role of Risk Perception on
Investment decision

Muhammad Ali Jinnah University Islamabad, Campus

Registration no: MMS143072

Email: shadnankhan013@gmail.com

Mob: 03339655458

ABSTRACT

The purpose of this paper is to assess the financial literacy and financial knowledge of the
individual and professional investors who invest in the local market. In additions, it examines
the relationship between financial literacy, financial knowledge and the influence of risk
perception that effect investment decision. The survey was conducted on different investors of
Rawalpindi and Islamabad. Data was collected from 257 personnel using adopted
questionnaires consisting of measuring each variable on five point likert scale. For data
analysis statistical tools such as correlation and regression were tested using SPSS. Result
indicates that there is significant positive relationship between financial literacy, financial
knowledge, risk perception and investment decision. However, the demographic factors such
as gender and age are negatively associated with to investment decision. The current study is
considered the first of its kind conducted in Pakistan. To the best of my knowledge, no such
studies have been conducting regarding measuring financial literacy, financial knowledge and
risk perception or the relationship between financial literacy, financial knowledge level and
risk perception that influence investment decisions.

Key Words: Financial Literacy, Financial Knowledge, Risk Perception, Investment

Decisions.

Electronic copy available at: http://ssrn.com/abstract=2727890

Introduction

Financial markets are the place where different investors come to make investment decision
regards of their funds. It is difficult for peoples to make decision of long-term saving (Clark-
Murphy & Soutar, 2004). investors learns new information from previous information.The
investment decision is determined by the behaviors of the investors (Masini & Menichetti, 2002)
means that investment decision will depend upon the nature and behavior of investors to the
market situations. The decision about the investment in the market will depend upon the
environment of the market (Pagell, Wiengarten & Fynes, 2003).Shapira and Venezia (2001)
Describe that there are two types of investors, individual investors and professional investors.
The proponents of expected utility theory insist that the behaviors of individual investors are less
relevant as compared to professional’s investors (Ross, 1998). When different investors are
grouped by similarity of their investment decision process, a small single grouped appears to be
highly knowledgeable about its investments. However most of the investors appear having little
knowledge of different strategies and financial of the investment. The investor’s personal traits
and behavior are involved in making financial decision, which directly effect the investment
decision of individuals and professional investors.

Fama (1970); Brown and Goetzman (1995); Carhart (1997); Rhodes (2000) all concluded that
past performance of the investment does not necessarily to predict return in the future. The recent
events surrounding the global crisis that began in 2008 which shows that , when peoples and
institutions make bad financial errors, poor financial decision making can have substantial costs
not only for individuals but it also effect society as well (Annamaria, Lusardi, & Olivia Mitchell,
2011). The deficiencies in financial literacy are most important causes in financial decision
making. Most of the individuals’ investors make investment involuntary that may have no
experience or interest in financial investment and they are faced with decisions which type of
fund to join, and then selecting investment choices to direct their superannuation savings.
Gallery, Natalie, Newton, and Cameron (2011) suggest that fund members are making complex
investment decision during their working lives that have far reaching financial implications on
retirement benefits. Past research and industry data shows that vast majority of individuals are in
the default superannuation fund chosen by their employer.

Electronic copy available at: http://ssrn.com/abstract=2727890

Financial literacy and financial knowledge effect the investment decision. American lack
financial literacy and don’t have the ability to make a sound financial decision, especially with
regard to retirement planning (Peterson, 2007). The financial knowledge is a critical factor in
financial decision making ( Kozup, pagano, & creyer, 2011). At the same time risk are the most
important factor with regard to investment decision making. In the modern world risk is
perceived and acted upon two fundamental ways. Risks are the feeling refer to our instinctive
and intuitive reaction to danger. Paul and Ellen (2006) suggest that risk analysis bring logic,
reason, and scientific deliberation to bear on risk assessment and decision making.

Nowadays investor decisions are often reported biased due to human nature. Financial literacy
and financial knowledge are considered important terminologies for controlling investor nature
while making important investment decisions. More studies are found on the relationship of the
particular variables in western cultures but limited literature is available in Asian culture
including Pakistan. While the role of risk perception as an important moderator on the
underlying mechanism is ignored. Risk perception will alter the nature of the particular
relationship.

This study will raise the significance of financial literacy and financial knowledge among both
individual and professional investors. Pakistani culture is a man dominant culture and society. In
Pakistan both individual and professional investors are not so much independent as compared to
developed countries. This study will focus on why and why not investors want to make
investment.
Literature Review
Theoretical Framework and Hypothesis

Financial literacy and investment decisions:

In previous literatures an extraordinary amount of studies has been conducted on financial
literacy (Anz 2008; Lusardi & Mitchell, 2006; 2007; van Rooij et al., 2007). In prior studies it
has been discovered that there is a direct or accurate relationship between financial literacy and
investment decisions and it is affected or is related with education, age, gender and experience
(Agnew & Szykman 2005; Baileyet al., 2003; Lusardi & Mitchell 2007). On many occasions and
researches financial literacy has been defined but the most common definition is “the ability to
forecast the effective decisions made about the execution of financial resources or money
(Schagen & Lines, 1996). Financial literacy involves two types of finances i.e. financial and
human and when it is provided to humans it affects the ability of person to forecast about the use
of money (Huston, 2010), thus it means that the financial literacy will affect the ability of a
person to use the money or finances.Investment decision has a relationship direct with the
financial literacy (Baileyet al., 2003). This is dependent upon experience and the literacy about
the investment which has to be made (Lusardi & Mitchell 2007). Volpe et al. (2002) discussed
that investors who are online are more successful than normal investors in securities market as
they have more knowledge as the normal investors are covered by more misinformation and
manipulation. Financial literacy will help to make the investment safer if there is uncertainty
involved in it (Fuss &Vermeulen, 2004). This means that financial literacy has great importance
and can save a lot of investment in markets where there is high level of uncertainty involved.
Driver et al (2002) discussed that financial literacy helps to analyze market where there is high
level of uncertainty involved in the markets and helps industries with high level of investments,
i.e. the markets with high level of uncertainty have high risk and there might be many problems
involved in it which can be avoided by financial literacy. On the base of previous literature the
following hypothesis is generated.

H1: There is significant positive relationship between financial literacy and investment decision.
Financial knowledge and investment decision:
Financial knowledge affects the relationships between investment decisions and provides a base
for safety and also it has been stated that the investments in stock markets when high investments
decisions are made are all done due to the basic financial knowledge (Van Rooij et al. 2007). It
has been discussed previously that person with more experience will have more knowledge then
person will less experience, these might age or investment experience (Chen& Volpe, 1998).
Thus while making high investment decisions it is necessary to have financial knowledge.
Financial knowledge means to know about finances or money and its values or having
information about finances and money while financial literacy means to have knowledge about
finances and having skills and abilities to utilize and use that money or finances (Diacon &
Ennew, 2001; Warneryd, 2001; Jordan & Kaas, 2002). Many investors feel confused and have
problems in stock markets as they don’t have the basic knowledge about the stock market which
makes it difficult for them to invest (Rooij et al. 2007).Christelis et al. (2010) and McArdle et al.
(2009) found why with more wealth it is easy to invest more in the market and has great chances
of attaining profitability but all of this possible if there is a valued financial knowledge available
about the markets. Ameriks et al. (2003), Lusardi and Mitchell (2007) also provided links and
supports about the relationship existing between financial knowledge, literacy and investment
decisions. On the base of previous literature the following hypothesis is generated.

H2: There is a significant positive relationship between financial knowledge and investment
decision.

Risk perception and investment decision:

Recent studies have shown that intuitive risk measures such as subjective risk perception can
better proxy for investors' intuition about financial risks than can variance and standard deviation
(see e.g. Weber et al. (2004) and Klos et al. (2005)).Rettinger and Hastie (2001),Weber et al.
(2002), and Baucells and Rata (2006) illustrate that differences in risk taking over various
content domains, such as the financial domain (e.g. investment decision) and the health domain
(e.g. seat-belt usage), can mainly be explained by differences in risk perceptions. More precisely,
these studies show that risk perceptions vary substantially between different content domains. On
the base of previous literature the following hypothesis is generated.

H3: There is a significant positive relationship between risk perception and investment decision.

Moderating role of Risk perception:

Risk perception can be defined “the perceived damage from the future” but according to Douglas
‘the probability of an event combined with the magnitude of the losses and gains that it will
entail. Individual perception of risk has clear relationship with investment decisions
Chance/gambling, financial investing, business decisions, and personal decisions determines
which decisions are taken by respondents showing the degree of risk taking (MacCrimmon &
Wehrung, 1986, 1990). Personal decisions about financial investment is determined by the
familiarity and controllability but is affected by the amount risk perceived (Slovic et al., 1986)
(Diacon & Ennew, 2001; Warneryd, 2001; Jordan & Kaas, 2002). People have different
responses and perceptions about the risk and return which depends upon the prior and previous
information, responses and knowledge shown and discussed with them(Diacon & Hasseldine,
2007), thus meaning that risk is an important factor that determines investment decision and
depends upon the kind of knowledge that a person possesses about the investment. On the base
of previous literature the following hypothesis is generated.

H4: Risk perception moderates the relationship between financial literacy and investment
decision in such a way that the relationship is strong.
H5: Risk perception moderates the relationship between financial knowledge and investment
decision in such a way that the relationship is strong.
Research Model:

Risk Perception
(MOD)

Financial Literacy

(IV)

Investment decision
(DV)

Financial Knowledge

(IV)

METHODOLODGY

Procedure and Sample

The present research is a cross sectional study with descriptive nature, as research has already
been conducted in this area. Moreover it is a casual type of investigating. The participants of this
study were individuals and institutional investors. Data will be gathered through a questionnaire
by using technique called convenience sampling, from Islamabad stock exchange. Initially, 350
questionnaires were distributed and 275 were received back. Out of these 19 questionnaires were
incomplete and were omitted. Therefore 257 questionnaires were used for the study, representing
response rate of 73.4%. The participants were asked not to mention their names or organization’s
names anywhere in the questionnaire to guarantee confidentiality.
Sample Characteristics

The sample consists of 68.5% males and 31.5% females. The sample consist of participants
belongs to different age groups. 35.4% were between the age of 25 and less, 47.1% between 26
and 33 years, 16.7% were between 34 and 41 years.

In the term of qualification, 19.1% of the respondents were bachelor, 23% of the respondents
were master, and 58% had MS/M.Phil. The sample consists of participants of different
experiences in their field. 79.8% had experience between 5 and less, 16.7% between 6 and 13
years, 3.5% between 14 and 21.
In this study quantitative technique was used, in which descriptive and
Instruments inferential statistical techniques used in data analysis. Through Mean, Median,
Standard deviation and variance described the data. While the hypothesis was tested
through correlation and regression techniques. SPSS version 23 was used for data
Investment decision: analysis decision was measured using questionnaire with 5 dimensions
Investment
(1=Strongly Disagree to 5= Strongly Agree) by Ahmed M ( 2013)

Some of the items are: money is important goal of my life, it is the more satisfying to save than
to invest money, stock market are unpredictable that’s why I would never in stocks, I would
invest a larger sum of money in stock.

Risk perception: Risk perception was measured by a scale with the 5 dimensions from
(1=Strongly Disagree to 5= Strongly Agree) by Hean Tat Keh,Maw Der Foo,Boon Chong Lim
2002).

Some of the items are: I want to earn more money than my current income level in the long run, I
am looking for businesses or employment with higher income, I believe that the key issue of
running different types of businesses are similar, I can accurately forecast the total the demand
for my business.

Financial literacy: Financial literacy will be measured by a scale with the 5 dimensions from
(5=Strongly Agree to 1= Strongly Disagree) by Parker and Decotiis (1983).

Some of the items are: I am some what knowledgeable of stock market activities on the KSE, I
usually follow the stock market through financials news on TV at least twice a week, I usually
visite the KSE website at least every three months.
Financial knowledge: Financial knowlede will be measured by a scale with the 5 dimensions
from (5=Strongly Agree to 1= Strongly Disagree) by Parker and Decotiis (1983).

Some of the items are: The balance sheet shows the financial position of the company at a
specific point of time, Interest will influence the future value of saving, Insurance is a useless
option for investor, Investment in Government securities in full of risk.

FINDINGS

Correlation Analysis

The very purpose of correlation is to indicate the relation between two variables or to examine
whether the two variables move in similar or opposite directions.

Table 1 Correlation & Reliabilities

Variables 1 2 3 4

1 Financial literacy 1
2 Financial knowledge .417* 1
3 Risk perception .725* .456* 1
4 Investment decision *.606* .316* .630* 1
*. Correlation is significant at the 0.01 level (2-tailed) * *
* * *

In Table 1, results of descriptive statistics and correlation among the variables are presented.
Correlation analysis shows positive and significant correlation between Financial literacy,
financial knowledge and Investment decision. Financial literacy and Financial knowledge is
positively and significantly correlated with Investment decision at .606**and .316**

Regression Analysis

For drawing conclusions regarding the dependence of one variable on another, regression
analysis is used. Regression shows the extent to which a variable depends on another,
independent variable on which it is being regressed. After controlling demographic variables
Gender, Age, Experience and Qualification, a regression analysis was executed between IV and
DV.
 Table 2 Results for Regression Analysis of investment decision

Investment
decision
Predictors Β R² ΔR²
Step 1
Control variables .305
Step 2
Financial literacy .385*** .445 .140

Financial knowledge .182*** .356 .051

n=257, Control variables were, Gender, Age, Experience and Qualification, ***p<.000 and
***p<.000

Hypothesis 1 assumes that Financial Literacy is positively related with the Investment Decision.
Table 2 indicates that Financial literacy is significantly associated with investment decision with
β=.385*** and p<.000.
Hypothesis 2 assumes that financial literacy is also positively related with the investment
decision with β= .182 and p<.000, so on the base of this support hypotheses 1 and 2 both are
accepted.
Table 3 Moderation analysis results for Risk perception
Investment
decision
Predictors Β R² ΔR²
Step 1
Control variables .305
Step 2
Financial literacy 2.365
Financial knowledge -1.547
Risk perception 1.627 .535 .230
Step 3
FLRP -.593***

FKRP .360*** .593 .058

n=257, Control variables were Gender, Age, Experience and Qualification, ***p<.001
From Table 3, it can be observed that interaction term of “financial literacy and risk perception”
effect on the relationship of “financial literacy and investment decision” with β=-5.93***,
p>.063.
So as the interaction term of “financial knowledge and risk perception” effect on the relationship
of “financial knowledge and risk perception” with β=.360***, p>.001, so on the basis of the
support hypotheses 3 and 4 are also accepted.

Discussion and conclusion

According to the study conducted above there was found a significant relationship between
financial literacy, financial knowledge and investment decision. In prior studies it has been
discovered that there is a direct or accurate relationship between financial literacy and
investment decisions and it is affected or is related with education, age, gender and experience
(Agnew & Szykman, 2005; Baileyet al., 2003; Lusardi & Mitchell 2007; van Rooij et al. 2007).
Financial literacy will affect the ability of a person to use the money or finances. The significant
relationship between financial literacy and investment decision is indicated by the fact that when
individuals and institutions have financial literacy such as basic information about stock
exchange, stock buying and selling, and information of many other different types of financials
instruments then both of the investors will make good investment decision. On the other hand
when investors do not have basic information about financial instrument then they are not in a
position to take good investment decision.A significant difference in the level of financial
literacy was found as well between the respondents according to their gender. Specifically,
women have a lower level of financial literacy than men. Financial literacy affected significantly
the investment decisions of theindividual investors. Specifically, financial literacy had a
significant positive effect.
Our results also indicate that financial knowledge affects investment decision.Studies have
confirmed the positive relation between financial knowledge and investment decision. According
to prior studies conducted Financial knowledge means to know about finances or money and its
values or having information about finances and money while financial literacy means to have
knowledge about finances and having skills and abilities to utilize and use that money or
finances (Diacon & Ennew, 2001; Warneryd, 2001; Jordan &Kaas, 2002).Investors with low
education cannot make better decisions and vice versa. Those who are not able to correctly
calculate interest rates out of a stream of payments end up borrowing more and accumulating
lower amounts of wealth.Lack of knowledge will effect financial decisions. As investment
decision is risky and technical so financial knowledge is must for investors to make investment
decision. Our study shows that financial mistakes are most prevalent among the young and
elderly, who are also those displaying the lowest amount of financial knowledge. In Pakistani
context people just try to earn money without proper financial knowledge, in Islamabad stock
exchange a lot of investors who don’t know exactly how much financial knowledge is important
for investment decisions. That’s why there were a lot of hurdles in collecting accurate date from
right people.
On the other hand the moderating effect of risk perception on the relationship of financial
literacy & knowledge and investment decision is also found significant. Thus it will partially
moderate the relationship between financial literacy & knowledge and investment decision. Risk
perception is a factor that may affect all the investment decision even in the presence of financial
literacy and knowledge. Such factor can affect investors with low income or those who newly
joined this field strongly. Because investors with low income will have fear of losing their
money and investors who don’t have proper knowledge will don’t know how, where & on which
product to invest.entail. Individual perception of risk has clear relationship with investment
decisions Chance/gambling, financial investing, business decisions, and personal decisions
determines which decisions are taken by respondents showing the degree of risk taking
(MacCrimmon & Wehrung, 1986, 1990). Risk is main factor in finance, so investors have
different types of risk behaviors. Risk also effects the investment decision. The perception of
different investors about risk are different, some of them are risk taker and risk averse. Those
both risk taker and risk adverse perception will affect their investment decision.
Many past studies show that there is positive relationship between financial literacy, financial
knowledge and investment decision. The risk perception also effects the investment decision, but
in our result show that moderation of risk perception between financial literacy, and financial
knowledge significant and positive. It means that the moderating role of risk perception strong
the relationship between financial literacy, financial knowledge and investment decision.
Implication for managers:

The data and information are very useful for managers who are basically involved in investment
processes. The information gives help to fund manager, how to make investment decision, how
to take risk of investment, and how to generate portfolio of investment for achieving returns. The
data help and give ideas to fund managers how to invest in particular way. The statements we
make about how to invest are implication for future investment. There are different variables
which are directly link with investment, so fund managers also take the decision in the light of
that variable. The data are useful both individual and professional investors, as well as different
types of fund managers and different types of managers who delivers the financial services to
different clients/customers.

Limitations

The time horizon for this study was too limited and proper research of variables was not
possible. And the data was collected cross sectional from few cities and the trend is now shifting
towards longitudinal studies for properly solving the problems. The other limitations cannot be
ignored in Pakistani context as Aycan et al (2000) stated that Pakistan is totally different country
and need separate studies. The concept of research studies in Pakistan is very low and the
respondents are not giving accurate responses.

Future Recommendation:
Future researchers should also expand their research work for economic outcomes or personal
outcomes as a dependent variable which might be shown as a positive relationship with financial
literacy and financial knowledge, furthermore human capital could be used as a mediator and
future orientation could be used as a moderator.
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 Appendix:

Questionnaire

Dear Respondent,
I am a student of MS Management Sciences at Mohammad Ali Jinnah University Islamabad. I am
conducting a research on impact of financial literacy and financial knowledge moderating role of risk
perception on investment decisions. You can help us by completing the attached questionnaire, which I
think you will find quite interesting. I appreciate your participation in my study and I assure that your
response your responses will be held confidential and will only be used for education purposes

Section 1: Demographics

Gender 1 2
Male Female

Age 1 2 3 4 5
25 and less 26-33 34-41 42-49 50 and Above

Qualification 1 2 3 4 5
Matric Bachelor Master MS/M.Phil PhD

Experience 1 2 3 4 5
5 and Less 6-13 14-21 22-29 30 and Above

Section 2: Financial Literacy

The following statements relate to your opinion about Financial Literacy of investor in Capital Market
of Pakistan.
1 2 3 4 5
Financial Literacy Strongly Disagree Neutral Agree Strongly
Disagree Agree
FL1 I am somewhat knowledgeable of stock market activities on the
KSE
FL2 I usually follow the stock market through financial news on TV at
least twice a week
FL3 I usually follow the stock market through financial news papers
every week
FL4 I easily access the latest reports, prospectus and financial
statements of any company on the KSE annually
FL5 I usually attend seminars, conferences & workshops hosted by the
KSE at least 3 times a year
FL6 I usually visit the KSE website (at least every 3 months)

FL7 When seeking financial advice, I deal with licensed brokers,

 intermediaries or financial services companies

Section 3: Financial Knowledge

The following statements relate to your opinion about Financial Knowledge of investor in Capital
Market of Pakistan.
1 2 3 4 5
Financial Knowledge Strongly Disagree Neutral Agree Strongly
Disagree Agree
FK1 The Balance Sheets shows the financial position of the company at
a specific point in time.
FK2 Interest will influence the future value of savings.

FK3 Insurance is a useless option for investors.

FK4 The Income Statement and Balance Sheet is one and the same
thing.

FK5 Investment in Government securities in full of risk.

FK6 My academic profile includes significant knowledge of the finance.

Section 4: Risk Perception:

The following statements relate to your opinion about Risk Perception of investor in Capital Market of
Pakistan.

1 2 3 4 5
Risk Perception Strongly Disagree Neutral Agree Strongly
Disagree Agree
RP1 I want to earn more than my current income level in the long run

RP2 I am looking for businesses or employment with higher income.

RP3 I believe that past entrepreneurial experience helps in assessing
riskiness
of a new business.
RP4 I believe that the key issues of running different types of businesses
are similar.
RP5 I can accurately forecast the total demand for my business.
RP6 I can accurately forecast when larger competitors will enter the
market
RP7 I can make my business a success, even though others may fail.
 Section 5: Investment Decision
The following statements concern your Investment Decision in the capital market. For each item of the
statements below, please indicate the extent of your agreement & disagreement by ticking the appropriate
number.

1 2 3 4 5
Investment Decisions Strongly Disagree Neutral Agree Strongly
Disagree Agree
ID1 Money is most important goal of my life.
ID2 It is the more satisfying to save than to invest money.

ID3 Stock market are unpredictable that’s why I would never in stocks.

ID4 I would invest a larger sum of money in stock.

ID5 The uncertainty of whether the market will rise or fall keeps me
from buying stocks.
ID6 I prefer to save money because I am never sure when things will
collapse and I will need money.
ID7 I budget my money very well.