What is overconfidence?
Tendency for people to overestimate their performances, abilities, & precision of their knowledge.
What is miscalibration?
- Form of overconfidence.
- Tendency for people to overestimate precision of their knowledge –> e.g. confidence intervals constructed too narrowly.
What is the better-than-average effect?
- Form of overconfidence.
- Phenomenon that people tend to rate themselves as above average on certain +ve personal attributes.
- Svenson (1981) surveyed samples of students in Sweden & US –> >50% in samples rated thesemlves in top 50% for driving skills & driving safety.
What is illusion of control?
- Form of overconfidence.
- Describes tendency that people overestimate their ability to control events compared to objective probabilities.
- Langer (1975) conducted an experiment in which students participated in a gambling contest, paired w either silly’ or ‘smart’-acting opponent –> subjects made significantly higher bets on their own card compared to that of ”silly” opponents –> however cards randomly assigned so does not depend on whether opponent ‘smart’/‘silly’.
What are the 2 factors affecting overconfidence?
1) Demographics –> men tend to be more overconfident than women; more educated people tend to be more confident than less educated –> e.g. Bhandari & Deaves (2006) found highly-educated males more subject to overconfidence despite not being more knowledgable on investing.
2) Expertise –> people tend to be more overconfident in their fields of expertise e.g. medical professionals, investment bankers (i.e. important players in financial mkts).
What is excess trading?
- Overconfidence can lead to excess trading –> investors may make trades based on mistaken beliefs about meaning or precision of info (i.e. miscalibration) –> can lead them to buy or sell securities potentially beyond what is justified by rational economic motives e.g. rebalancing or hedging needs –> can lead to increased trading volume & volatility.
- If trading volume rational, then profits earned from trading should at least exceed transaction costs.
How does Odean (1999) provide evidence for overconfidence causing excess trading?
Examines trading behavior of discount brokerage customers –> finds securities investors bought did not outperform securities they sell by enough to cover trading costs & on average securities they buy underperform compared to those they sell –> suggests these investors systematically misinterpret info available to them, rather than simply misconstruing precision of info.
How does Barber & Odean (2000) provide evidence for overconfidence causing excess trading?
- Suggests investor households w accounts at discount brokers exhibit better-than-average bias in stock selection & market timing, leading them to trade more frequently than is rational –> driven by miscalibration of their own knowledge & skill in investing –> consequent additional trading lead to v slight improvement in gross portfolio performance but net performance suffers –> hhs trading more frequently earn lower net annualised return compared to those trading more infrequently.
How does Barber & Odean (2001) provide evidence for overconfidence causing excess trading?
- Gender used as instrument for overconfidence.
- On average, men, who are more overconfident than women, trade more than women but experience reduced net annual returns compared to women –> may be miscalibrating info as a result & hence security returns not covering transaction costs.
How does Grinblatt & Keloharju (2009) provide evidence for overconfidence causing excess trading?
- Measure self-confidence (combo of competence & overconfidence) –> use regression analysis to control for competence & obtain overconfidence as residual effect.
- Overconfident investors trade more frequently & their portfolios exhibit -ve performance after transaction costs.
How does Oberlechner & Osler (2012) provide evidence for overconfidence causing excess trading?
- Found currency dealers overconfident due to miscalibration based on a survey asking to give forecasts of future FX rates w 90% confidence interval –> share of intervals excluding realized exchange rate >10% in all cases (confidence interval constructed too narrowly).
- Currency dealers found to exhibit better-than-average effect due to hubris (overestimating own success) by rating themselves as above average FX traders.
- Overconfidence not driven out of FX mkt –> experienced dealers still subject to miscalibration & hubris, & are as equally overconfident as those inexperienced currency dealers, despite fact that overconfident investors should exit mkt & experience should improve accuracy of forecasts.
