Overconfidence in Currency Markets

This paper tests the influential hypothesis, typically attributed to Friedman (1953), that irrational traders will be driven out of financial markets by trading losses. The paper’s main finding is that overconfident currency dealers are not driven out of the market. Traders with extensive experience are neither more nor less overconfident than their inexperienced colleagues. We first provide evidence that currency dealers are indeed overconfident, which is notable since they get daily trading practice and face intense financial incentives to accuracy.Overconfidence, imperfect rationality, currency dealers, survival of imperfect rationality

Too much right can make a wrong: Setting the stage for the financial crisis

The financial crisis that started in 2007 exposed a number of flaws in the financial system. Many of these flaws were associated with financial instruments that were issued by the shadow banking system, especially securitized assets. The volume and complexity of securitized assets grew rapidly during runup to the financial crisis that began in 2007. The paper discusses how the financial crisis can be viewed as a possible but logical outcome of a system where investors are overconfident, busy, and investing other peoples’ money and intermediaries are set up to take advantage of investors’ tendencies. The investor-intermediary risk cycle in this crisis is common to other crises. However, there are a number of factors that may have made the 2007 crisis more severe. Among them are the length of the pre-crisis period, the shift from financial intermediaries to the shadow banking system, the increasing interconnectedness among financial firms, and the increased leverage at some financial firms.Financial crises

Overreaction and investment choices : an experimental analysis

We study the degree of overreaction and the relation of overreaction and psychological biases as well as financial consequences of overreaction in a controlled experimental setting with 104 participants. The majority of participants tend to overreact, however, the degree of overreaction is heterogeneous. A few subjects even underreact. We also measure the overconfidence of the participants with a miscalibration scale. In line with theoretical predictions we find that more overconfident subjects overreact more. We also find that overreaction is associated with higher levels of risk taking after good signals and lower levels of risk taking after bad signals. Finally, overreaction harms portfolio efficiency, as measured by the Sharpe ratio

Using behavioral economics to analyze credit policies in the banking industry

2008 world financial meltdown highlighted significant shortcomings on procedures used by the banking sector to provide credit to the real economy. A long period of indulgence granting personal loans and mortgages that boosted a credit bubble all over the world has been followed by an era of suspicion within the banking sector, precipitating the liquidity crunch and the credit squeeze to private agents. Behavioral Finance has emerged as an alternative approach to analyze efficiency on financial markets, revealing a world with less than fully rational investors and arbitrageurs limited by risk aversion, short time horizons and agency problems. In this paper we consider the possibility to extend Behavioral Finance topics such as investor sentiment, overconfidence, heuristics or herd instinct to analyze banks behavior when providing credit to private agents, and how the absence of arbitrageurs in the credit market could justify the role of public banking as a countercyclical policy maker.peer-reviewe

The impact of a managerial overconfident narrative on capital structure decisions

Capital Structure, which consists on the financing mix used by corporations in order to maximize their value, represents one of the most controversial topics on the corporate finance field. Despite the innumerous studies on this topic there is not yet a consensual theory on what is the ideal capital structure a firm should adopt. As a consequence, a stream of research began to apply psychological and social based conventions in order to focus on the aspect that can possible help decode the capital structure puzzle: The cognitive and behavioral biases that influence the decision-making process. This empirical study intends to examine the relationship between the overconfidence bias and the capital structure decisions. The sample comprises UK non-financial firms from 2004 and 2014 and the variables that will proxy for the overconfidence were adapted from Alves et al. (2016). The results provide evidence of a negative relation between overconfidence and debt levels. Similar results were obtained for different specifications on the dependent and independent variables.A Estrutura de Capitais, que consiste na determinação da combinação ótima de financiamento usada pelas empresas de modo a maximizarem o seu valor, representa um dos temas mais controversos na área das Finanças Empresariais. Não obstante os inúmeros estudos acerca deste assunto, não existe ainda uma teoria consensual sobre qual a estrutura de capitais ótima a adotar pelas empresas. Como consequência, uma linha de investigação começou a aplicar conceitos da área da psicologia e das ciências sociais de modo a aproximarem-se dos aspetos que podem ajudar a decifrar o puzzle da estrutura de capitais: Os desvios comportamentais e cognitivos que influenciam o processo da tomada de decisão. Este estudo empírico tenciona examinar a relação existente entre o desvio comportamental do excesso de confiança e as decisões relacionadas com a estrutura de capitais. A amostra estudada consiste em empresas não financeiras do Reino Unido de 2004 a 2014 e a variável que servirá como medida para o excesso de confiança foi adaptada do estudo de Alves et al. (2016). Os resultados evidenciam a existência de uma relação negativa entre o excesso de confiança e os níveis de divida apresentados pelas empresas. Resultados idênticos foram obtidos quando foram testadas diferentes especificações para a variável dependente e as variáveis independentes

The Design of Financial Systems: Towards a Synthesis of Function and Structure

This paper proposes a functional approach to designing and managing the financial systems of countries, regions, firms, households, and other entities. It is a synthesis of the neoclassical, neo-institutional, and behavioral perspectives. Neoclassical theory is an ideal driver to link science and global practice in finance because its prescriptions are robust across time and geopolitical borders. By itself, however, neoclassical theory provides little prescription or prediction of the institutional structure of financial systems that is, the specific kinds of financial intermediaries, markets, and regulatory bodies that will or should evolve in response to underlying changes in technology, politics, demographics, and cultural norms. The neoclassical model therefore offers important, but incomplete, guidance to decision makers seeking to understand and manage the process of institutional change. In accomplishing this task, the neo-institutional and behavioral perspectives can be very useful. In this proposed synthesis of the three approaches, functional and structural finance (FSF), institutional structure is endogenous. When particular transaction costs or behavioral patterns produce large departures from the predictions of the ideal frictionless' neoclassical equilibrium for a given institutional structure, new institutions tend to develop that partially offset the resulting inefficiencies. In the longer run, after institutional structures have had time to fully develop, the predictions of the neoclassical model will be approximately valid for asset prices and resource allocations. Through a series of examples, the paper sets out the reasoning behind the FSF synthesis and illustrates its application.

Exploring Financial Literacy and Overconfident Investor Behavior

This study examined the factors predicting overconfidence in U.S. investors and the relationship between overconfidence and seeking financial advice. This study adopted a quantitative research method using the 2018 NFCS Investor Survey data to explore the relationship between financial literacy and investor behavior in the U.S. stock market. Theories in financial literacy and overconfident behavior are combined to identify factors that predict overconfident behavior in U.S. investors. A logistic regression model was utilized to understand the relationship between financial literacy, demographics, and overconfident investor behavior. The results show a positive relationship between overconfident behavior and portfolio value, seeking financial advice, and conducting research activity. Results also showed that overconfidence is higher in male investors, younger investors, and investors with lower incomes. These findings are useful to individuals and corporations across several applications. Individuals can increase self-awareness regarding their own behaviors to identify certain biases, such as overconfidence, to help them avoid making large financial mistakes. Financial advisors can utilize these findings to become more aware of their clients that are likely to demonstrate overconfident behavior and help them mitigate these risks. Government entities can incorporate financial literacy programs that will establish baseline financial literacy competency in primary and secondary education programs

Heuristics and Stock Buying Decision: Evidence from Brazil, Pakistan, and Malaysia Stock Markets

Applying both qualitative and quantitative approaches, we investigate the influence of anchoring and adjustment, representativeness, and availability heuristics on stock buying decisions of individual investors at the Brazilian stock market and their relations with demographic aspects. We also compared the results with investors from Pakistan and Malaysia. To collect the data, a survey was administered. Data were analyzed by description, correlation, and regression analysis. The results show that all three heuristics are likely to affect the Brazilian investor’s stock buying decisions. The effect of heuristics is similar across genders, type of subscriber, and level of education groups. However, for the older group and those with income higher than BRL15,000.00 per month (about USD 3,000.00), the anchoring heuristic exhibit a more extreme effect. From these findings, this paper reveals the presence of the heuristics in stock market decisions in developing countries, such as Brazil, as well as Pakistan and Malaysia. However, the effect on Asian’ individual investors is more prevalent

Farmers' Subjective Yield Distributions: Calibration and Implications for Crop Insurance Valuation

This paper examines the role of overconfidence in explaining farmer crop insurance purchasing decisions. The authors hypothesize that overconfidence could influence the participation decision and test this hypothesis. The preliminary results indicate that farmers are overconfident; however, the relationship between overconfidence and the insurance use remains uncertain.Risk and Uncertainty,