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Introduction
Overconfidence is probably one of the most scrutinized biases in the field of behavioral finance in terms of its existence, origination and consequences. The term refers to investors’ tendency to overrate their knowledge, ability and precision of knowledge about security values (Odean, 1998a). It is a well-documented fact in the field of psychology that most people are overconfident (Fischhoff and MacGregor, 1982), a situation reflected in numerous pricing anomalies in financial markets. For example, in different market settings, Lewellen et al. (1977), Odean (1998a, 1998b), Odean (1999), Gervais and Odean (2001) Statman et al. (2006), Chandra and Kumar (2012) and Sahi and Arora (2012) concluded that overconfidence among investors leads to high trading volume in financial markets. According to Lewellen et al. (1977), overconfident investors have a tendency to trade more, believing that returns are highly predictable and expect higher returns as compared to relatively less confident people. Similar results were documented by Odean (1999) and Barber and Odean (2000 and 2001), who provided evidence that investors who are overconfident indulge in heavy trading volumes in financial markets. Kahneman et al. (1998) developed a model based on overconfidence of investors and concluded that the overconfidence of individual investors leads to negative and unfavorable changes in stock markets. Hirshleifer and Luo (2001) investigated the persistence of overconfidence in financial markets and reported that overconfident traders trade more aggressively than their rational counterparts to exploit the mispricing. The study finds that two factors lie behind this behaviour:
the underestimation of risk; and
overestimation of the success of their own trading strategies.
According to Daniel Kahneman, “overconfidence has been called the most ‘pervasive and potentially catastrophic’ of all the cognitive biases to which human beings fall victim. It has been blamed for lawsuits, strikes, wars, and stock market bubbles and crashes.” However, as overconfidence is a cognitive bias, it has been associated with some favorable cognitive outcomes, such as financial satisfaction. Sahi (2017), in the market setting of a developing country such as India, concluded that the behavioral biases including overconfidence do not always lead to negative consequences. In her study, she found that overconfidence in investments leads to higher financial satisfaction.
Literature review: determinants of overconfidence
A vast amount of research has attempted to identify the...