Emotional Finance, Financial Literacy, and Investment Decisions:

Evidence from the Pakistan Stock Exchange

Abstract

While financial theory assumes rational markets, behavioral finance suggests that investment decisions are often driven by emotions, particularly during periods of macro-financial uncertainty. This study investigates whether financial literacy moderates the relationship between emotional finance and individual investment decisions at the Pakistan Stock Exchange (PSX), Karachi. Emotional finance is measured through four established behavioral biases: overconfidence, the disposition effect, herding, and risk aversion. The findings reveal that emotional finance has a significant negative effect on investment decisions (β = −0.29, p < 0.001), whereas financial literacy significantly weakens this adverse relationship by reducing behavioral biases and improving decision quality. The analysis is contextualized within the April 2025 KSE-100 market sell-off triggered by a global tariff shock, providing real-world evidence of how external policy shocks amplify investor biases in a retail-dominated emerging market. This study contributes to the emerging-market behavioral finance literature by being the first PSX study to integrate all four dimensions of emotional finance within a single PLS-SEM framework. It concludes with theoretical, methodological, and policy implications, highlighting the importance of financial literacy initiatives by the SECP and PSX and recommending longitudinal, cross-market, and AI-based research to further advance the field.