Effect of Cognitive Biases on Profits of Investors at the Gikomba Market in Nairobi, Kenya

Abstract

Cognitive biases, such as representative bias, loss aversion bias, overconfidence bias, and herd instinct, can significantly influence investment decisions, often leading to suboptimal outcomes. Anchored on behavioral finance theory and supported by the efficient market hypothesis and the marginal productivity theory of profit, this research aimed to explore how these biases impact investor profitability in a bustling market environment. This study investigated the effect of cognitive biases on the profits of investors at the Gikomba market in Nairobi, Kenya. The target population for this study comprised 11,280 traders across various categories in the Gikomba market, including secondhand clothes, hardware and furniture, textiles, beverages, cereals, grocery, and poultry. A descriptive research design was employed, and a sample size of 384 respondents was determined using the Fischer formula. Data was obtained via a structured questionnaire issued to the selected traders, focusing on their investment behaviors and cognitive biases. Data analysis involved descriptive as well as inferential statistics. Descriptive statistics summarized the prevalence of different cognitive biases, while inferential statistics, particularly multiple regression analysis, were used to assess the impact of these biases on investor profits. The model summary revealed a strong positive correlation between the independent variables and investor profits, with an R square value of 0.933, indicating that 93.3% of the variance in investor profits was explained by the model. The regression analysis results showed that overconfidence bias had the most substantial positive effect on investor profits (B = 0.669, p < 0.001), followed by herd instinct (B = 0.367, p < 0.001), loss aversion bias (B = 0.258, p < 0.001), and representative bias (B = 0.203, p < 0.001). The demographic factors of investor’s education level, age, and gender were found not to have a significant effect. The study concludes that cognitive biases play a critical role in shaping investment decisions and outcomes at the Gikomba market. Overconfidence, herd instinct, loss aversion, and representative biases significantly influence investor profitability, often leading to higher returns but also increasing exposure to risks. The minimal impact of demographic factors highlights the predominance of cognitive biases over personal characteristics in determining investment success. Based on these findings, several recommendations are proposed. Policymakers should prioritize investor education programs that address cognitive biases, incorporating behavioral finance principles into financial literacy initiatives. Regulatory bodies should implement guidelines that promote transparency and informed decision-making, ensuring that investors have access to comprehensive market data and analytical tools. Financial advisors should integrate behavioral finance insights into their practices to offer more effective guidance to their clients. For future research, it is suggested to employ longitudinal study designs to observe changes in cognitive biases and their impact on investor profits over time. Expanding the scope to include multiple markets would also enhance the generalizability of the findings.