House Money and Overconfidence on the Trading Floor

Abstract

We examine the trading activity of a population of professional futures traders for evidence of the behavioral characteristics generally referred to as overconfidence and/or gambling with the house money. The results are broadly consistent with the Gervais and Odean (2001) model of overconfidence and learning, which predicts that successful and inexperienced traders are the most likely to be overconfident. We find little evidence of overconfidence in the general trading population - a group of largely experienced traders. However, we find that the most successful traders are more likely to take risk when winning than the less successful traders - providing support for the notion that the successful are more likely to be overconfident. We also find that trader experience is related to a measure of overconfidence: traders with more experience are less likely to take more risk after a period of abnormally good profits than their less experienced counterparts.