ISBN 978-8108-3816-4 Proceedings of 2009 International Conference on Economics, Business Management and Marketing Singapore, 9-11 October, 2009

Investors Confidence Index (IC Index) as an Investment Determinant in Dhaka Stock Exchange
Anup Chowdhury 1 and Suborna Barua 2
1

Senior Lecturer, BRAC Business School, BRAC University

2

Lecturer, United International University

Abstract. Investors psychology, sentiment, attitude towards risk, degree of risk tolerance or aversion and other risk characteristics largely influence the investment decision which is empirically observed by Deck et al. (2008). Lashgari (2000), Dennis and Mayhew (2002), Suk and Tully (2003), and Wurgler (2006) have used general and risk characteristics of investors to developed models on confidence index on stock markets. This study, in line with those efforts, tries to measure the individual investors level of confidence on the Dhaka Stock Exchange (DSE) of Bangladesh as a determinant of investment. The Investor Confidence Index indicates a large portion of these individual investors have low confidence on the stock market of Bangladesh with none found to be positive in favor of a better immediate future. Keywords: risk characteristics, investor sentiment, investor confidence index, stock market.

1. Introduction
Do investors in general act rationally? The question is being hotly debated by practitioners and academics alike. The answer may well lead to an understanding of individual investor behavior, and explain why markets frequently or occasionally seem to overreact or underreact on both the upside and downside. Underlying the growing interest in behavioral finance is the notion that investors are not always rational, but sometimes act irrationally or emotionally when faced with difficult decisions. Researchers site numerous examples of individuals displaying irrational behavior, being inconsistent and making errors in judgment and incompetent decisions when faced with uncertainty. While behavioral theories deal with the psychology of investors in the effort to explain the irrationality, a much interesting area of study is the assessment of determinants of the level of investment by individual investors. Theorists believe that the whole market moves largely based on the psychology of the investors. Past background, personal information, education and surroundings and many other factors also influence the behavior of an investor. Therefore, if this behavior can be explained wholly or mostly in part, the market behavior and the irrationality of the investors can be explained more precisely. While theoreticians are trying to explain the market using different determinants such as macro factors, firm specific factors, fundamentals or technical factors and many others, market as a whole can also largely be explained by the psychology of investors. Risk perception from that perspective plays a highly significant role, since it explains the overall risk characteristics of a market and of individual investors. Regulatory bodies and market practitioners can be benefited through such assessment of investors perceptions about risk. The future possible movement also can be estimated from this type of assessment study. This study tries to explore the specific determinants of investments in Bangladeshi capital markets. In the recent years, Bangladeshi capital markets have been witnessing a good pace of growth. Two exchanges, Dhaka Stock Exchange (DSE) and Chittagong Stock Exchange (CSE), have been more organized and active during the last two years. The daily turnover in DSE is around USD 10 billion in 2008 against USD 3.5

billion and is expected to grow USD 20 billion by 2011. As trading volume and amount are increasing rapidly, riskiness and volatility have also gone up in the stock markets. Therefore, with the increasing size and volatility of the markets, the need to study the psychology of individual investors in terms of risk perception, investment, stock market environment, has become very important in order to predict the future direction or future possible movement of the market. This study is first of its kind on the capital market of Bangladesh and will focus on DSE the larger of the two bourses. The assessment of investors psychology has been made with an objective to estimate the factors and determinants of the amount of investment (resource allocation decision) by the investors.; for this, the study would incorporate ten variables or factors and would try to find which factors are contributing more in determining the amount of investment by the investors both before and after incorporating risk characteristics as an explanatory variable.

2. Literature Review
Both the individual and institutional forms of the characteristics of the investors influence the efficient operation of the stock market. Even the behavior of the investors in formulating and implementing new policies in a stock market must be understood by the policy makers and regulatory agencies. Several explicit and implicit variables lead the investment decision and evolution of a market. Definitely, these variables can be largely divided into two groups macroeconomic and market specific. Macro factors work as well-built determinants for investment. the impact of the macroeconomic variables, such as the inflation rate, the interest rate, the composite index of the Stock Exchange of Bucharest and the exchange rate, upon the evolution of the mutual funds market in Romania was identified and quantified by Dima, Bogdan, Barna, Flavia and Nachescu (2006) who advocated that overall financial markets growth accounted as the leading influencing factor. In addition to this many other issues also persuade the stream of investment in the market. For example, it is well recognized that based on the past performance of their investment domestic equity fund investors essentially decide the investment amount (Gruber, 1996). This proposition has also been confirmed by Sirri and Tufono (1998). Sirri and Tufano (1998) also found that domestic equity fund investors accentuate on recent past performance and thus determines investment extent based on the highest recent returns that was also found by Chevalier and Ellison (1997). Sirri and Tufano (1998) and Barber et al. (2005) also found that Fees or the Expense Ratio (e.g. loads fees) also does matter in investment stream. Besides these, many other factors such as fund size, fund age, and fund risk are associated to fund investment injected by the investors. Zhao (2005) measured the consequence of investment objectives and changes in exchange rates on the flows into international equity funds. Investment is also determines the long-term credit and short term credit availability (Piana, 2001). The financial cost of acquiring funds -- either in the form of loans or equities also works as a leading influencing factor in investment rate. Additionally, investors in the stock market also look for three types of information while investing: (1) historical stock prices, (2) publicly available information including financial data and business data, and (3) insider information (Shidachi, 2001). Tease (1993) found that controlling other important macroeconomic determinants of investment, share prices do not seem to explain much of the variation in investment in any of the G7 countries. In investors decision making especially in the stock or equity markets, risk has always been a leading factor. And risk is the outcome of uncertainty. As an integral of perception of risk investors have to bear in the present time, essentially their investment behavior would be a one to one communicator with the future expectation on the stock market. Research studies therefore have developed quantitative models for asset allocation which incorporates features of psychological and economic paradigms. Therefore, researchers have sought empirical evidence of a sentiment factor that reflects fluctuations in the opinions of traders regarding the future prospects for the stock market since it could be source of non-diversifiable risk (Brown, et al., 2002). Uncertainty means that the effect of overconfidence (Daniel, Hirshleifer, and Subrahmanyman, 1998), this verifies that expectation and confidence on stock market does matter a great deal for the investors. In a financial market context with asymmetric information, Benos (1998), Odean (1998) and Daniel, Hirshleifer and Subrahmanyam (1998) show theoretically that overconfidence leads to poor

performance. Even in case of pricing assets in the market, studies have also recognized that investor sentiment may be an important component of the market pricing process (Baker and Wurgler, 2006). As a result, estimating and measuring investors sentiment and confidence over stock market may lead to important policies for institutions and regulators. Dennis and Mayhew (2002) used the Put-Call Ratio of options investment and Randall, Suk and Tully (2003) used the Net Cash Flow into Mutual Funds ration to capture the investors sentiment level. Baker and Wurgler (2006) identified potential measures of measuring sentiment are surveys, mood proxies, retail investor trades, mutual fund flows, trading volume, dividend premia, closed-end fund discounts, option implied volatility, first-day returns on initial public offerings, volume of initial public offerings, new equity issues, and insider trading. Lashgari (2000) used the Barrons Confidence Index which is widely acclaimed. Whaley (2000) uses the VIX-Investor Fear Gauge. There are quite a few investor confidence index developed and used continuously such as Alfa Bank Investor Confidence Index of Alfa Bank, Russia and State Street Investor Confidence Index of State Street, a fund manager in United States. Bandopadhyaya and Jones (2005) used the risk appetite measure developed by Persaud (1996) for currency markets to develop and quantify an Equity Market Sentiment Index (EMSI) for a group of firms in an equity market index. Zhang (2008) derived a model of individual sentiment in which individual biases or systematic tendencies to overvalue private pseudo-information" signals may lead to the formation of erroneous beliefs. Shiller created questionnaires about investor attitudes and had been distributed every six months in 1989 and 1996 to institutional investors in both the US and Japan. As Shiller stated regarding capturing the psychology of investors, Certain investor attitudes and opinions are commonly remarked by observers of speculative markets as having changed in important ways through time and the changes as having important consequences for the markets. One such attitude is bubble expectations, that is, investor thinking that leads towards speculating on a perceived temporary uptrend before the bubble bursts. At the outset, this paper has been constructed based on a questionnaire designed for assessing investors psychology regarding their individual risk tolerance level in context of DSE. Considering the global efforts, this paper tries to find out the determinants of investment amount, general and risk characteristics and the confidence on stock market at the micro or individual investors level.

3. Methodology
3.1. Data and its sources Direct interviewing with individual investors has been accomplished to gather primary data, which delivers all required information for this paper. Survey on 300 samples of individual investors has been conducted to obtain required information for this study in November, 2008. At the filtering stage, data of 27 investors were removed due to inadequacy of useful information. The questionnaire comprises 14 questions. The first part of the questionnaire extracts information about investment determinants, and second part from question 1 to 14 gather information regarding the degree of risk perception of investors. Only DSE investors have been covered for direct interviewing. Ten brokerage houses were selected for the survey. 3.2. Investor Confidence Index 1 In this paper, an Investor Confidence Index (ICI) has been developed using survey responses. The formula for calculating the confidence index has been developed in the following way:

Investors' Confidence Index =

D + D
1

D + D
3

++

D
N

100

Estimation of Investment Determinants, risk attitude and general characteristics of investors are available on request from the authors.

where,

D1 to Dm = Score of Determinants of Investors confidence (1st to mth factor) m = No. of Determinants N = No. of Observations

Therefore, this stands that,

Investors' Confidence Index =

D
N m

100

The questionnaire has been used to obtain every investor opinion and confidence on 10 different variables regarding betterment of the overall investment situation. Answers include dichotomous options such as good, indifferent, and bad indicating the possible status of the 10 variables in the following 3 months. The variables that constitute the overall confidence score of the investors are: Status of Profitability, Debt Financing Availability, Level of Investment Cost, Overall Market Situation, Overall Riskiness, Regulatory change, Effectiveness of Regulatory Authorities, Possibility of a Crash, Government Initiatives for Stock Market, and Level of Rumor in the market. The opinion has been asked for forward 3 months which basically captures their expectation and perception regarding the possible situation of the stock market in the immediate future or that we can call as short term future. The overall confidence of all investors has been obtained and the following category shows the different definition of confidence with respect to average or median score:
Overall Investor's Confidence Low Level of Confidence Moderate Level of Confidence High Level of confidence Score Range < 50 50 to < 75 75

The analysis is divided into three separate aspects. In the first part of next sections, identifies the individual investors confidence score. The second part discusses the determinants of investment amount alone and also involving confidence level on stock markets on the part of the individual investors, followed by the findings summary of the whole study.

4. Estimating Confidence Index

To estimate the confidence level of individual investors on the stock market, ten different variables are utilized here. First, confidence regarding these ten different aspects of the stock market has been analyzed and then the overall confidence level has been discussed. Some 81 percent investors believe that overall status of the market regarding the whole environment for investment in the stock market, has not changed from the recent past (6 month trail back), with around 41 percent believe that there has been meaningful change and the overall environment of investment in the market has become much better. Around 90 percent of the investors believe that the current markets profitability situation is helpful to earn at a moderate and high rate of profit. This is complied with the earlier finding that around 50 percent investors are earning fairly over 25 percent on their investment. This return is much higher compared to other investment alternatives available (e.g. bank deposits) The perception regarding availability of external or debt financing to finance their investment in the market is not much good. Some 38 percent investors say that availability is not adequate and around 60 percent believes the availability is average and there should be more flexible financing schemes. Almost 60 percent investors commented that the margin ratio should be at least 0.8 and above where 23 percent thinks this should be over 1.

Regarding the cost of investment against the comments on profitability, this is evident that around 82 percent investors are quite happy with the current cost they have to bear for investing in the market. This certainly works as a factor why they are earning on an average of 50 percent return on their investment even after bearing the cost of investment. An interesting finding comes from the table of rumor where 71 percent investors are worried about the high level of rumors in the market. This can be referred to another table which shows the preference on source of information while an investor is investing. This is very interesting finding that higher portion (58 percent) of investors responded with option 3 here meaning they use both market information and also research works in investment decision making while another around 35 percent responded they use only market information but no research. The finding to a greater extent justifies the general observation that investors in DSE do not use research information to take decision. Regarding perception of the regulators 48 percent investors believe that regulators skill is bad with more 48 percent comments it as average. Therefore almost 95 percent of the investors rate the regulators of the stock market as average skilled or low. But still regarding the changes in the recent regulations, they are moderately positive towards the regulatory bodies. Around 71 percent investors believe that there is at least a chance of crash in the stock market with 30 percent commented this chance has high. At the same time essentially, 40 percent investors commented that the government measures towards stock market is moderately good and 48 percent termed it as not helpful. This constitutes that almost 81 percent investors are not really very happy with the government measures. In measuring the overall confidence level considering every aspect explained earlier, the extremely poor confidence is noticed here. All investors are either moderate confident or do not have any confidence on the stock market at all. This is quite an alarming matter for the stock market stakeholders especially institutions and regulatory bodies to notice. Almost 66 percent investors commented that they have low confidence over the overall sustainability of the current growth of the stock market. This is due to the fact that in almost all aspects discussed earlier, investors reported to be pessimistic and not much confident, very important indication for stakeholders in this market (Table-2).
Table: 2 - Overall Investor's Confidence Low Confidence Moderate High Total % 66.3 33.7 0.0 100

Constituting the overall Investor Confidence Index (ICI), the following result is found as shown in Appendix A2. Appendix A1 shows that investor confidence is not really good and the scenario is true irrespective of investor category in terms of investment size. All investors micro, very small, small, medium, large and very large investors have low degree of confidence for the immediate future of the stock market. This indicates a poor overall market is expected by the individual investors in the next short term of future (forward 3 months). As shown by Appendix A2, the overall Investor Confidence Index constructed has a mean value of 45, which is less than 50 indicates low confidence, 50 to 75 indicates moderate confidence and high for above 75. Therefore, this ICI score clearly indicates and advocates the earlier all finding regarding the confidence level that individual investors have low confidence on the stock market. This is repeatedly notable that this confidence level is a crucial factor for the survival of the stock markets current growth. Note that the highest value for the ICI is 67.5 means even the highest confidence level at the individual level is moderate and evidently no single investor has reported high degree of confidence on the stock market as a whole. One reason behind this may be the sample includes individual investors, most of which are moderate and small in nature. Therefore, in case of any shock due to large scale manipulation, institutional intervention, regulatory intervention or any external shock (e.g. economic downturn), individual investors are generally the worst affected party and hence many of them loose their capital.

5. The Investment Determinants Model with confidence Score

We use the first OLS estimation equation involving the individual investors confidence calculate in the above way as an independent variable (Appendix-B2). This is to find out what potential impact the level of confidence might have on the short term future of the stock market on the investment amount of the investors. As has been explained, gender, trading method, career as an investor in the stock market, profitability, monthly income, and profession of the investors have significant impact on the investment size. Interestingly, as evident from the regression result, the Individual Investor Confidence Score have no significant impact on the size of investment although the sign is negative as expected and what it should be. This is really interesting by what this result means. Investors determine their investment size irrelevant of their expectation of short term future, but why? The answer may be in two ways. One is the short period of forward 3 months for which the confidence index has been developed is not long enough to change the level of investment on the part of the investors. The other is as the market is severely inefficient investors really do not care much about what prospect they can perceive regarding the near future, and thus may or may not determine their investment size based on long term expectation. For a further test, we employ the 2SLS model of estimation to validate the findings stated earlier. The second test of 2SLS model also once again validates that still the individual confidence score of investors do not have any significant impact on their investment size. Therefore, we further can see proof of the existence of the two possible ways of explanation stated in the earlier paragraph.

6. Findings and Conclusion

Major findings of the study are pointed below at a glance:

Individual investors are mostly within micro, very small or small bracket with investment less than 2.5 million by investment size where mostly are below age 40 and mostly with income level less than or equal to taka 40,000 monthly. Therefore, recent tide of market expansion has brought in many small scale investors with aggressiveness and most of the investors have been engaged with stock market investment for only last 3 years. Investors earned on an average 56 percent return on their investment in 2007 and mostly they trade by themselves directly. Investors are mostly influenced by their profit, savings, age, investment horizon and gender in deciding how much to invest in the stock market. Among them profitability has the highest positive effect and short term investment horizon has the highest negative influence. Age also has positive impact on investment amount as OLS and 2SLS regression shows. Age and short term investment horizon, both are found responsible in all of the four regression estimation using OLS and 2SLS. Responds of several questions showed that regardless of investors class based on investment size; investors tend to take protective mode in deciding on transactions in the stock market. This statement is fairly evident from answers of all questions presented here. Investors confidence level on the brokerage house is at the moderate level (65 percent), a substantial portion of investors decide regarding investment based on market information where around 70 percent investors believe that there degree of rumor in the market is high. The overall Investor Confidence Index constructed has a value of 45 a value less than 50 indicate low confidence. Therefore, this ICI score clearly indicates and advocates the earlier all finding regarding the confidence level that individual investors have low confidence on the stock market. This is repeatedly notable that this confidence level is a crucial factor for the survival of the stock markets current growth. There is no significant impact of the short term expectation or perception of the future on the investment suggested by both the OLS and 2SLS model estimation. Therefore, we assume that market inefficiency and high aggressiveness to earn profit may be one way of this condition or the

other way the long term expectation rather than short term may or may not have significant impact on the investment size which has not been considered in this study.

Finally, the 77 percent of surveyed investors opined that brokerage houses in the DSE are moderately efficient. 44 percent and 50 percent investors invest based on market information only and both market information and research respectively. Investors though risk aggressive, are investing highly in the market. But at the same time the current market is highly volatile. Despite this high volatility investors invest aggressive only because return is evidently very high compared to other investment opportunities. This scenario certainly conforms to the general understanding of risk-return literatures in finance. The reason why investors are generating high profit despite the high level of rumor is attributed largely to the inefficiency of the market. This large scale inefficiency certainly paves the way for the manipulators to make unfair gains at the cost of small investors. In fine, this study has been first of its kind in Bangladesh and therefore has a lot of scope for improvement in the questionnaire design, methodology and analysis approach. In spite of that this study may become useful to the investors, brokerage house and regulators if the sample size can be extended. Regulators may have may be benefited by these studies of behavioral finance in policy formulation. Therefore, the need and importance for a more rigorous and detailed study on Bangladesh capital market has become a mandatory one. There is a wide opportunity for academicians in Bangladesh to contribute to these research studies in behavioral finance.
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Appendix A
A 1: Investor Confidence Score by Investment Size Moderate High Investor Low Category confidence Confidence Confidence Total 47.83 52.17 0 100 Micro 6.08 13.04 0 8.42 64.96 35.04 0 100 Very Small 49.17 52.17 0 50.18 70.37 29.63 0 100 Small 20.99 17.39 0 19.78 78.05 21.95 0 100 Medium 17.68 9.78 0 15.02 100 0 0 100 Large 1.66 0 0 1.1 53.33 46.67 0 100 Very Large 4.42 7.61 0 5.49 66.3 33.7 0 100 Total 100 100 0 100 A 2: Investor confidence Index Descriptive Statistics Mean 45.0824176 Standard Error 0.48586733 Median 45 Mode 37.5 Standard Deviation 8.02784575 Sample Variance 64.4463074 Kurtosis -0.82198044 Skewness 0.29479984 Range 37.5 Minimum 30 Maximum 67.5 Sum 12307.5 Count 273 Largest (1) 67.5 Smallest (1) 30 Confidence Level (95.0 percent) 0.9565387

Appendix B
B1: First Estimation of OLS 0.000000 R-squared Adj R-squared Logavginv Age Gender Fmlymem Bsnstype Strtyr Coef. 0.020870 0.695658 0.000131 -0.096163 0.009195 Std. Err. 0.007909 0.365630 0.026306 0.236728 0.013583 T 2.640000 1.900000 0.000000 -0.410000 0.680000 logavginv = log value of Average investment amount in 2007 age = Investors age gender = Male/Female fmlymem = No. of family dependants bsnstype = Trading methods used in share buy and sale (Direct or Indirect or Both) strtyr = No. of years an investor dealing with share market logavgmthin = log value of Average monthly income

Prob > F

0.6531 0.6364 P>|t| 0.009000 0.058000 0.996000 0.685000 0.499000

Logavgmthin Logavgprft Dpvtbus Invdur Stdur Logavgesav _cons

0.235861 0.440511 0.111964 0.088484 -0.281008 -0.027551 4.472242

0.076199 0.051045 0.133054 0.117112 0.143005 0.013463 0.670752

3.100000 8.630000 0.840000 0.760000 -1.970000 -2.050000 6.670000

0.002000 0.000000 0.401000 0.451000 0.051000 0.042000 0.000000

logavgprft = log value of Average profit earned in the year 2007 Profession invdur = Long term investment Horizon logavgesav = log value of Average monthly savings dpvtbus = occupation (dummy single variable for both private service and business) stdur = Short term investment horizon .7173 .6608 t 0.51 2.17 -0.48 -1.96 -0.26 2.06 5.10 -1.58 0.48 -1.73 -1.22 3.65

B2: Second Estimation of OLS Impacting Variables Age Gender No. of Family Members Business Type Tenure of Investment Career Log Average Income Log Average Profit Log Average Savings Investment Horizon Dummy Business and Private Service Individual Confidence Score _cons Coef. .0084866 1.350741 -.0269794 -.6076181 -.0055638 .3792691 .4920767 -.159269 .111475 .7685767 -.0169915 5.473495

R-Squared Adjusted R-Squared Std. Err. .016776 .6218811 .0567002 .3099743 .0213384 .1840318 .0964964 .1005949 .2346049 .4434724 .0138796 1.500312

P>t 0.615 0.034 0.636 0.055 0.795 0.044 0.000 0.119 0.637 0.089 0.226 0.001

Logavginv logavgesav Bsnstype Strtyr Logavgprft invdur Stdur Age _cons

B3: First Estimation of 2SLS R-squared = 0.5516 Adj R-squared = 0.5381 Coef. Std. Err. t P>|t| 0.0717 0.0643 1.1200 0.2660 0.3184 0.3005 1.0600 0.2900 -0.0066 0.0178 -0.3700 0.7130 0.5544 0.0390 14.2100 0.0000 0.1456 0.1399 1.0400 0.2990 -0.4000 0.1672 -2.3900 0.0180 0.0219 0.0090 2.4300 0.0160 5.6703 0.6108 9.2800 0.0000

Instrumented: logavgesavnew, and Instruments: bsnstype strtyr logavgprft invdur1 stdur age gender fmlymem logavgmthin dpvtbus
B4: Second Estimation of 2SLS Impacting Variables Log Average Monthly Savings Age Business Type Tenure of Investment Career Log Average Profit Investment Horizon Individual Confidence Score _cons Coef. .2577605 .0082095 -.6872662 -.0181656 .4353302 -.1962157 -.0234343 7.577798 R- Squared Adjusted R- Squared Std. Err. .1374902 .0184519 .3322655 .0236692 .1115535 .2588075 .0158435 1.459626 0.6110 0.5649 t 1.87 0.44 -2.07 -0.77 3.90 -0.76 -1.48 5.19

P>t 0.066 0.658 0.043 0.446 0.000 0.451 0.144 0.000

Instrumented: logavgesavnew, and Instruments: bsnstype strtyr logavgprft invdur1 stdur age gender fmlymem logavgmthin dpvtbus