Overconfidence And The Financial Markets Research

Extant studies have shown that many behavioral finance models based on the 'overconfidence' assumption of investors can be used to explain some financial anomalies such as the volume and the volatility puzzle, the long-term reversals effect of asset returns and the short-term momentum effect of asset prices, all of which are not able to be explained by classical financial theories. Also some empirical and experimental researches on securities markets of western developed countries have verified the existence of investors' overconfidence in financial markets. Accordingly, De Bondt and Thaler (1995) even stated that "perhaps the most robust finding in the psychology of judgment is that people are overconfidence." As a result, in recent years, overconfidence models have been widely applied in the behavioral finance economists and have become one of the focuses and standard assumptions of financial economists.Based on the data of Chinese Security Market (CSM), this paper intends to systemically investigate the influence of overconfidence effect on Chinese financial market. First of all, on the foundation of extant studies this paper theoretically analyzes the influence of overconfidence on security markets; then, for the first time in China, this paper from the whole securities markets view investigates the existence of overconfidence effect in CSM by applying various financial econometrical methods. The main conclusions and contributions of this paper are summarized as follows:1. This paper verifies that providing the coexistence of public and private information, the GSU irrelevance theorem is also true in some conditions. That is, if there are a positive fraction of rational agents who decide to obtain private information in equilibrium, the equilibrium price function of risk asset is irrelevant to the level of investors' overconfidence; as a consequence, investors' overconfidence does not affect informational efficiency, price volatility, rational traders' expected profits and their welfare. And all those variables are set as the same as those all investors were rational. In addition, one of the most important findings of this paper is that in short-term run, the existence and the quality improvement of public information does not always improve market efficiency in some conditions. In this case, the existence and the quality improvement of public information will make some rational agents exit the private information market because of the substitute effect of public information for private one. Hence, under some conditions, the information effect of public information will be smaller than the substitute effect of public information for private one, which will consequently worsen market efficiency. But the aforementioned problem can be avoided by the proper supervision of public information disclosure. As to the long-term run, because of the improvement of private information, the existence and the quality improvement of public information can always improve market efficiency.2. Based on the empirical framework of STV (2006), this paper from the whole market view shows that there is obvious overconfidence effect in Chinese A Share Market, especially in the small float cap stocks market. Furthermore, according to the analysis about individual stocks, this paper also indicates that there is not only overconfidence effect but also disposition effect in CSM, and the former effect is more significant than the latter one. In addition, further investigation into the features of the individual stocks which have overconfidence effect indicates that both the firm size and the weekly average turnover ratio of 'overconfidence' stocks are smaller than those of normal ones, but there is little distinction between their average year BM ratios.3. The further empirical investigation of this paper shows that:(1)From the whole market view, the increase of contemporary volume resulting from overconfidence effect will lead to the increase of market volatility, and the influence of excess volume raised by overconfidence effect on the market volatility is larger than the influence of volume caused by other factors.(2)In Chinese A Share Market, investors' overconfidence is not owing to the self attribution bias resulting from the short-term forecast ability of investors.(3)No matter what state Chinese A Share Market is (bull or bear), the overconfidence effect exists. Overconfidence has a more obvious effect in bull market than in bear one. In addition, whatever the market is, the excess volume resulting from overconfidence effect will cause stocks return volatility, but this kind of influence is not symmetric under different market conditions, generally the influence on bear market is more obvious than that on bull one.(4)Although overconfidence effect exists in Chinese A Share Market, from the whole market view, overconfident investors do not bear more risks than rational ones.(5)There are more than half of individual stocks whose return volatilities can be explained by overconfidence effect. Moreover, the firm size of those stocks is obviously smaller than that of the stocks whose return volatilities can not be explained by overconfidence effect. But there is not significant difference about the weekly average turnover ratios and the average year BM ratios between them.