When Trading is Hazardous to Your Wealth: Financial Sophistication and Stock Selling During the 08/09 Financial Crisis

Abstract

We study the motivations for stock selling in a context where this was (at least from an ex-post perspective) hazardous to investors' wealth. Making use of a unique feature of the Cognitive Economics Study (CogEcon) that allows us to elicit domain-specific stock literacy and corresponding confidence, we find that independent of their actual knowledge, investors were more inclined to sell stocks during the financial crisis with high levels of confidence. This was the case even when trading was apparently not motivated by liquidity demands, risk-bearing capacities or expectations about future asset market developments. Even more importantly, and in line with the literature that relates the discrepancy between financial knowledge and confidence to making investment mistakes, we find that overconfidence was associated with a higher propensity to realize stock losses - that is, selling assets whose value had deteriorated. Male as well as female investors in our sample were overconfident on average shortly before the outbreak of the crisis. Strikingly, however, only female investors traded to their detriment as a result of their overconfidence. We do not find, in contrast, male investors to be at a real disadvantage of high levels of confidence not warranted by actual knowledge. We take a number of steps in response to endogeneity concerns including an alternative identification method recently introduced by Lewbel (2012) that exploits information from the heteroscedastic structure of the data. Further research is needed to understand the long-term consequences of our findings concerning stock-market participation and finally wealth levels of females, who are already at a high risk of hitting poverty at old-age.