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Investor overconfidence and the security market line: New evidence from China

Xing Han, Kai Li and Youwei Li

Journal of Economic Dynamics and Control, 2020, vol. 117, issue C

Abstract: This paper documents a highly downward-sloping security market line (SML) in China, which is more puzzling than the typical “flattened” SML in the US, and does not reconcile with existing theories of the low-beta anomaly. We show that investor overconfidence offers some promises in resolving the puzzle in China: In the time-series dimension, the slope of the SML becomes more “inverted” when investors get more overconfident. This dynamic overconfidence effect is intensified with biased self-attribution. As a general symptom of overconfidence in the cross section, high-beta stocks are also the mostly heavily traded. After accounting for trading volume, there is no longer the low-beta anomaly at both the firm and portfolio levels. Mutual fund evidence reinforces the view that institutional investors actively exploit the portfolio implications of a downward-sloping SML by shying away from high-beta stocks and betting on low-beta stocks for superior performance.

Keywords: Security market line; Beta anomaly; Betting against beta; Overconfidence; Mutual fund (search for similar items in EconPapers)
JEL-codes: G11 G12 G15 G40 (search for similar items in EconPapers)
Date: 2020
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DOI: 10.1016/j.jedc.2020.103961

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Journal of Economic Dynamics and Control is currently edited by J. Bullard, C. Chiarella, H. Dawid, C. H. Hommes, P. Klein and C. Otrok

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