Overconfidence can influence investor behaviours in China

Abstract

Overconfidence is a common psychological condition defined as the irrational belief that one's chances of success are higher than they really are. The damage that overconfidence can do in the world of finance is even more glaring. Small and medium-sized investors lack the information collection, professional skills, and trend-following behaviour of large shareholders, firm management, and institutional investors. In China, the stock market is dominated by small and retail investors. They lack information and often make a decision based on the limited knowledge and information that they have. Still, owing to hubris, many small and medium-sized investors falsely assume that making money is simple or that they can consistently outperform the market as a whole. Small and medium-sized investors frequently trade to provide liquidity to the market, but their overconfidence often leads them to set unrealistically high-profit targets, incorrectly attribute gains to their operating skills, and fail to adequately account for losses as a result of events outside their control. Transaction costs can eat into earnings. Overconfidence among investors has been shown to increase market risk and volatility.