Specifying and validating overconfidence bias among retail investors: a formative index

Abstract

PurposeThe study explored various dimensions of overconfidence bias (OB) among retail investors in Indian financial markets. Further, these dimensions were validated through formative assessments for OB.Design/methodology/approachThe study applied exploratory factor analysis (EFA) to 764 respondents to explore dimensions of OB. These were validated with formative assessments on 489 respondents by the partial least square path modeling (PLS-PM) approach in SmartPLS 4.0 software.FindingsThe major findings of EFA explored four dimensions for OB, i.e. accuracy, perceived control, positive illusions and past investment success. The formative assessments revealed that positive illusions followed by past investment success among retail investors played an instrumental role in orchestrating the OBs that affect investment decisions in financial markets.Practical implicationsThe formative index of OB has several practical implications for registered financial and investment advisors, bank advisors, business media companies and portfolio managers, besides individual investors in the domain of behavioral finance.Originality/valueThis research provides a novel approach to provide a formative index of OB with four dimensions. This formative index can acts as an overview for upcoming researchers to investigate the OB of retail individual investors.Highlights Overconfidence bias is an important predictor of retail investors' behaviorFormative dimensions of the overconfidence bias index.Accuracy, perceived control, positive illusions and past investment success are important dimensions of overconfidence bias.Modern portfolio theory and illusion of control theory support this study.