Excessive Arbitrage Trading by Overconfidence

67 Pages Posted: 29 Apr 2014 Last revised: 2 Feb 2020

See all articles by Min Hwang

Min Hwang

George Washington University - Department of Finance

Soosung Hwang

Sungkyunkwan University - Department of Economics

Sanha Noh

Korea Capital Market Institute

Date Written: February 18, 2015

Abstract

We investigate the effects of arbitrageurs’ behavioral biases on cross-sectional equity returns. We find evidence that profits of equity market neutral hedge portfolios are positively affected by overconfidence, the effects of which are not subsequently reversed. Further we discover that signals which have signs inconsistent with arbitrageurs’ confidence are treated as of low quality and thus ambiguous. When equity market neutral hedge portfolios are sorted according to arbitrageurs’ overconfidence levels on these hedge portfolios, anomalous return difference between high and low overconfidence-sorted hedge portfolios is on average 9.6% a year in the 2000s, and has increased over the past four decades. Arbitrage trading in the 2000s is excessive in the sense that it has not eroded away the profit opportunities of the hedge portfolios, but instead, create economically and statically significant anomalous temporal profits.

Keywords: Overconfidence, Ambiguity aversion, Excessive arbitrage trading, Market efficiency

JEL Classification: G02, G12

Suggested Citation

Hwang, Min and Hwang, Soosung and Noh, Sanha, Excessive Arbitrage Trading by Overconfidence (February 18, 2015). Available at SSRN: https://ssrn.com/abstract=2430655 or http://dx.doi.org/10.2139/ssrn.2430655

Min Hwang

George Washington University - Department of Finance ( email )

2023 G Street
Washington, DC 20052
United States

Soosung Hwang (Contact Author)

Sungkyunkwan University - Department of Economics ( email )

25-2 Sungkyunkwan-ro
Jongno-Gu
110-745 Seoul
+82 (0)2 760 0489 (Phone)
+82 (0)2 744 5717 (Fax)

Sanha Noh

Korea Capital Market Institute ( email )

45-2 Yeoeuido-dong
Yeongdeungpo-gu
Seoul
Korea, Republic of (South Korea)

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