When Bad is Good and Good is Bad
34 Pages Posted: 26 Jun 2017
Date Written: June 21, 2017
This paper shows a non-linear convex relationship between an investor’s experience and overconfidence. While the literature argues that overconfidence increases at first owing to bias in self-attribution, such as taking credit for success, this paper demonstrates that investor overconfidence steadily declines in the first years of investing. The intuition of our results rests on seminal psychology research which demonstrates that for the majority bad events have stronger impact than good events, and given the natural market fluctuations of the stock market, the longer investing in the stock market the greater the propensity to face bad events, and hence cause less overconfident. Furthermore, we find that as investors earning experience become more averse to risk and more pessimistic; only after decades of investing experience, the effect of bad events diminishes (desensitization effect) and investors then take more risk and become less pessimistic and regain their overconfidence. Collectively, investors overweight bad events in the first years of investing, and this has implications on overconfidence level and risk tolerance.
Keywords: Overconfidence, Investor experience, Stock market performance, over optimism
JEL Classification: G02, G11
Suggested Citation: Suggested Citation