Behavioral Biases, Tax Policy Perceptions, and Investment Decision-Making: The Mediating Role of Risk Perception

Abstract

This study examines how behavioral finance factors shape investment decision-making in the presence of tax-related considerations in Pakistan. Specifically, it analyzes the influence of three independent variables overconfidence bias, herding behavior, and perceptions of tax policy on investment decision-making, with risk perception tested as a mediating variable. The research addresses how taxation, when intertwined with behavioral biases, impacts financial choices in emerging economies. Data are collected through a structured questionnaire administered to individual investors, small business owners, and salaried individuals actively involved in investment activities in Pakistan. Established scales from behavioral finance and tax perception literature are adapted and validated for the Pakistani context. Structural Equation Modeling (SEM) is employed to assess direct effects and the mediating role of risk perception. The study found that overconfidence and herding behavior will positively influence aggressive investment decisions, while unfavorable perceptions of tax policy may discourage investment activity. Risk perception is hypothesized to mediate these relationships, explaining why investors respond differently to similar tax and financial contexts. The results will help policymakers and financial advisors understand how behavioral biases and tax perceptions jointly shape investment decisions. Findings can guide the design of tax incentives, investor education programs, and behavioral interventions to encourage rational investment and improved compliance in Pakistan’s financial markets