The Role of Financial Literacy in Mediating Overconfidence Bias Among Retail Investors

ABSTRACT The research concentrated on evaluating the role of financial literacy on investment decisions among retail investors. Further, the overconfidence bias is used as the mediator, which is connected with investment decisions and financial literacy. Prospect theory highlights that investors assess outcomes based on losses or gains in relation to a reference point rather than the overall wealth and explains how overconfidence leads to irrational trading and excessive risk‐taking. The current research uses the quantitative method. The research displays that risk tolerance, investment experience, and financial literacy have an optimistic impact on investment decisions in retail investors. Additionally, overconfidence bias has positively mediated the connection between the dependent and the independent variable. The prospect theory, efficient market hypothesis, and investor rationality theory are integrated in the study, which strengthens the theoretical background of unbiased decision‐making and also improves the significance of financial literacy. Financial advisors should use the study to better profile clients, using literacy levels to determine how to approach overconfident investors, especially regarding risk assessment and portfolio diversification.