Does Sign Matter More Than Size? An Investigation into the Source of Investor Overconfidence

Sankar De, Naveen R. Gondhi and Bhimasankaram Pochiraju
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Sankar De: Centre of Analytical Finance, Indian School of Business
Naveen R. Gondhi: Centre of Analytical Finance, Indian School of Business
Bhimasankaram Pochiraju: Centre of Analytical Finance, Indian School of Business

Working Papers from University of Pennsylvania, Wharton School, Weiss Center

Abstract: Using a unique and large dataset, the present paper contributes new insights to the growing literature on behavioral biases in portfolio decisions of individual investors. We find that the sign of the outcomes of recent past stock trades, where a positive sign indicates a profitable trade and a negative sign an unprofitable trade, influences the current trading decisions of investors strongly. Further, the influence of the sign of past trades is significantly stronger than the size of the gains or losses from the same trades. We also find that, on an average, trading under the influence of the sign of past trades consistently results in decline in profits for the investors. Our findings are consistent with a behavioral explanation suggested by recent research in experimental psychology that the investors are more sensitive to the affective intensity of a stimulus than to its magnitude. The effects of the behavioral pattern in question are economically large as well as statistically significant. We introduce several methodological innovations in this paper.

Date: 2010-11
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