Financial Education

Behavioral Finance suggests that overconfidence will cause investors to attribute market-related returns to their own skill level and trade more frequently when markets are rising than when they are falling. In the Winter 2006 Review of Financial Studies Statman, Thorley and Vorkink examine the relationship between past returns and stock turnover in portfolios. This is related to the disposition effect, in which investors will realize gains but delay realizing losses.

The authors find a statistically and economically significant positive relationship between market turnover and lagged market returns, consistent with the overconfidence hypothesis. They also find that individual security turnover is related to both market and security specific returns, supportive of both overconfidence and the disposition effect. Finally, they find that the effect was smaller after 1982 and in large cap stocks, which may be explained by larger institutional (rather than individual) participation in those subsets.

For more information, see all articles on: Behavioral Finance, Investing in Stocks, Investment Returns, Personal Finance, Research

See also:

Overconfidence Bias

Algorithmic Trading Methods

Using VWAP to Measure Transaction Costs

The Information Content of Option Volume

Equity Returns at the Turn of the Month