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Overconfidence, Risk Perception and the Risk-Taking Behavior of Finance Professionals
Abstract
This paper highlights the role played by overconfidence and risk perception in the risk-taking behaviors of finance professionals. We interviewed 64 high-level professionals and demonstrate that they are overconfident in both the general and the financial domains. Using a recent measure proposed by Glaser et al. (forthcoming), we indicate that respondents are overconfident in forecasting future stock prices. We demonstrate that the risk they are willing to assume is positively influenced by overconfidence and optimism and negatively influenced by risk perception. However, the stock return volatility anticipated is, in most cases, an insignificant determinant of the risk that professionals are ready to assume.
... As individuals place trust, they tend to invest in financial markets; this trust is reflected in their investment decisions and increases their risk preferences (Zeffane, 2015). Similarly, confidence causes investors to be unconcerned about uncertainty in financial markets (Mota et al., 2015) and make riskier choices (Broihanne et al., 2014;Rougier, 2019;Yao & Rabbani, 2021). ...
... Due to this feature, it causes the uncertainty in financial markets to be ignored (Mota et al., 2015). A large body of literature refers to the positive relationship between self-confidence and risktaking behaviour (Broihanne et al., 2014;Campbell et al., 2004;Marafon et al., 2018;Rougier, 2019;Yao & Rabbani, 2021). However, its effects are not limited. ...
... Similarly, in parallel with the findings of previous studies (Dariotis & Chen, 2020;Steinberger et al., 2016), this study found a positive correlation between coping strategies and risky investment intention. In addition, a result consistent with the large literature that found a positive relationship between risk taking and trust (Breuer et al., 2020;Colquitt et al., 2007;Cook et al., 2005;Cruwys et al., 2021;Kanagaretnam et al., 2019;Klein & Shtudiner, 2016;Masoud & Albaity, 2021;Sun, 2020) and confidence (Broihanne et al., 2014;Campbell et al., 2004;Marafon et al., 2018;Rougier, 2019;Yao & Rabbani, 2021) was also obtained in this study. ...
This study investigated the mediating effect of trust and self-confidence on the effects of both conscious processes (coping strategies) and unconscious processes (defence mechanisms) on risky investment intention. In this context, data were collected from 832 participants using an online survey. Exploratory factor and correlation analyses were performed on the collected data, and the research model was tested using structural equation modelling. According to the results of the analysis, both coping strategies and defence mechanisms have an effect on risky investment intention, and self-confidence has a mediating role in this relationship. This study is unique because it explores the effects of both conscious and unconscious processes on financial decisions.
... Yet, there are factors which may induce signal providers to enter lottery trades when a corresponding account has outperformed its peers. The increased share of traded lotteries by good performing signal providers may be related to the well-documented connection between overconfidence and risk taking (Barber & Odean, 2001;Broihanne, Merli, & Roger, 2014;De Long, Shleifer, Summers, & Waldmann, 1991;Odean, 1999). In the context of social trading, Czaja and Röder (2020) provide evidence for overconfidence due to biased self-enhancement. ...
... Furthermore, the observed results might be explained by the welldocumented relationship between overconfidence and risk taking (Barber & Odean, 2001;Broihanne et al., 2014;De Long et al., 1991;Odean, 1999). Regarding social trading, Czaja and Röder (2020) provide evidence that signal providers become overconfident due to biased selfenhancement. ...
... Using panel regression analyses, we provide empirical evidence of a quadratic relationship between previous relative trader account performance and the traded lottery share: Signal providers with bad relative performance and signal providers with good relative performancein comparison to their peerstrade a higher monthly share of lotteries. Our results are in line with previous research in behavioral finance (Broihanne et al., 2014;De Long et al., 1991;Odean, 1999) as well as with research in the relatively nouvelle area of social trading (Czaja & Röder, 2020). ...
We argue that certain currency pairs, similar to stocks, are perceived and employed as gambling opportunities. We define currency pairs with extreme positive daily returns as lotteries. By analyzing data from a popular foreign exchange focused social trading platform, we provide empirical evidence of a U-shaped relationship between previous relative trader performance and the traded lottery share: Traders with bad performance and traders with good performance, in comparison to their peers, are more prone to gamble, i.e. trade a higher monthly share of lotteries. Regarding both sides of the relative performance spectrum, we link our results to well-documented behavioral phenomena. Furthermore, we relate our results to remuneration design features common to social trading, where only outperformers gain visibility and may become eligible for receiving compensation form the platform vendor. In consequence, especially signal providers at the lower end of the performance spectrum are incentivized to gamble; after (repeatedly) performing poorly, traders might be willing to take gambles for a small chance to get a declining account back on track.
... Retail investors indulge in the provision of estimates for a given parameter that are different from the actual performance yardstick. (Broihanne et al., 2014) showed that overconfidence and optimism have a favourable impact on the risk that investors are ready to take, while risk perception has a negative impact. The subjective lack of probability drill, intent to start with extreme estimations (low and high), and tendency to circumvent central tendency anchors; often crystallise as an overconfidence exhibition in risk assessment (Costa et al., 2017). ...
... Ishfaq et al. (2017) mentioned the mediative role of risk perception between overconfidence and investment decisions. Broihanne et al. (2014) carried out the study in context of finance professionals, and found similar results of overconfidence and optimism influenced by risk perception. The phenomenon of "anchoring" bias has also been observed to be significantly related to the risk perceived by investors. ...
... High-risk perception is negatively related to risk-taking-behavior [47] and the domain of risky financial choices is no exception [46]. This was demonstrated in the case of individual investors [48], as well as in the case of finance professionals [49]. Perceived risk also predicts risky gambling choices [45]. ...
... It was also demonstrated that optimism induces a greater tendency to take risks and lowers risk perception [35]. Risk perception in turn was demonstrated to be negatively related to risk-taking-behavior [46][47][48][49]. ...
The research aimed to further develop knowledge on the mechanisms that enhance risk-taking propensities among powerful people. Three studies (N1 = 328, N2 = 388, N3 = 267) investigated the role of optimism in the relationship between sense of power and financial risk-taking, controlling for the state of power. Study 1, correlational, analyzed whether the relationship between sense of power and risky financial choices is serially mediated by general optimism and financial risk perception. The results confirmed the initial hypotheses. The second, experimental, study investigated the role of states of power and lack of power in explaining people's financial decisions as well as their influence on people's situational optimism and perception of risk. The results indicated that people in a state of power differed from people lacking power in terms of their situational optimism and the riskiness of their financial choices; however, they did not differ in terms of risk perception. People having power were more optimistic, invested more, and made riskier gambling choices than those in control conditions and those who lacked power. The third, experimental, study investigated the single and joint moderating effects of the states of optimism and power in explaining the positive relationship between sense of power and risky investing and gambling choices. In line with our expectations, the results of the study showed that the states of power and optimism jointly moderated the positive relationship between the sense of power and risky financial choices. This effect was the strongest under the state of power and optimism conditions and the weakest when lack of power and pessimism were induced; thus boundary conditions for previously observed mechanisms were identified. The results of the research shed light on the way optimism mediates and moderates the effect of power on financial risk-taking and thus contributes to theoretical knowledge of the consequences of power.
... People with overconfidence assume that their observation s more correct as compared to that of others (Ahmad Sabir et al., 2019). They overreact to the information of the market (Broihanne et al., 2014). It is also concluded that male investors are more confident as compared to their female counterparts that leads them to an excessive transaction, which results in fewer profits (Abreu and Mendes, 2012;Broihanne et al., 2014;Metwally and Darwish, 2015). ...
... They overreact to the information of the market (Broihanne et al., 2014). It is also concluded that male investors are more confident as compared to their female counterparts that leads them to an excessive transaction, which results in fewer profits (Abreu and Mendes, 2012;Broihanne et al., 2014;Metwally and Darwish, 2015). Moreover, Bessière and Elkemali (2014) evaluated overconfidence and self-attribution bias together and concluded that on the basis of personal knowledge, investors portray more confidence. ...
This study aims to investigate the influence of psychological biases on the investment decision of Chinese individual investors after the pandemic of COVID-19 with a moderating role of information availability. A cross-sectional method with a quantitative research approach was employed to investigate the hypothesized relationships among variables. The snowball sampling technique was applied to collect the data through a survey questionnaire from individual investors investing in the Chinese stock market. Smart-PLS statistical software was used to analyze the data and for the estimation of hypotheses. Results indicated that overconfidence, representative bias, and anchoring bias have a significant and positive influence on investment decisions during the post-Covid-19 pandemic; however, the availability bias has insignificant and negative effects on the investment decision during the post-COVID-19 pandemic. Moreover, findings indicated that information availability has a significant moderating role in the relationship of psychological biases with the investment decision during the post-COVID-19 pandemic. This study contributes to the body of knowledge regarding behavior finance, psychological biases, and investment decision in emerging stock markets. The findings of the present study improve the understanding that how investors’ psychology affects their investment decisions.
... For this reason, although the relationship between risk perception and risk tolerance and risky investment is accepted, the effect of confidence on this relationship (Marafon et al., 2018;Yao and Rabbani, 2021) should not be ignored. Broihanne et al. (2014) investigated the effect of risk perception and overconfidence on risky behavior using the data collected through interviews with 64 finance professionals. As expected, they found that overconfidence had a positive effect on risky behavior and risk perception had a negative effect. ...
... We also determined that there are strong positive relationships between the self-confidence of the individual and the trust of the instrument and risky investment intention. This finding is also consistent with the literature that states that confidence and trust are related (Reid, 2009) and emphasizes that confidence increases risk taking (Broihanne et al., 2014;Campbell et al., 2004;Tajeddini and Tajeddini, 2008;Marafon et al., 2018;Rougier, 2019;Yao and Rabbani, 2021). ...
Purpose
There is strong excitement during Ponzi schemes and financial bubble periods. This emotion causes investors to turn to “unknown and new investment instruments”. This study, the factors that made “unknown and new investment instruments” preferable to “known and experienced investment instruments” were investigated.
Design/methodology/approach
It was taken into account unconscious like phantasy, emotional like emotional intelligence, both affective and cognitive like financial literacy and subjective beliefs like trust and overconfidence. In addition, risk preferences were measured with four different risk variables. In this context, data were collected by online survey method between November 2020 and May 2021 with convenience sampling. First, the data were collected from 832 participants in the pilot study. Additional data were also collected using convenience sampling and online surveys, and a total of 1,692 participants were obtained. Data were analyzed using Statistical Package for the Social Sciences (SPSS) 25 and AMOS 24.
Findings
As a result of the analyses made, the variables that lead investors to choose “unknown and new investment instruments” were determined as risky investment intention, phantasy, risk taking/risk avoidance, confidence, risk tolerance and subjective financial literacy. Trust and risk perception have a very weak effect on preferences. However, no effect of emotional intelligence and objective financial literacy was detected. In addition, a moderately positive and significant relationship was found between objective and subjective financial literacy. Subjective financial literacy was found to have a strong and significant relationship with emotional intelligence, confidence, trust, risky investment intention and phantasy.
Originality/value
This study investigates the factors underlying individuals' investment preferences from a broad perspective. We think that this study is unique in this structure and wide variables. We believe that the findings obtained in this manner are unique to both academics and practitioners. We also believe that the findings of the study will make an important contribution to understanding participation behavior in various Ponzi schemes and financial bubbles.
... Risk plays a comprehensive role in financial decisions and AMDs (Moosa, 2007;Zheng & Shen, 2008). Broihanne et al. (2015) focused on the relationship between risk, agent's behavioral biases and RISKP, and found that risk is positively related to OVERCB and negatively related to RISKP. Therefore, it can be said that OVERCB is negatively related to RISKP of managers, and high RISKP is further positively related to optimal CSDs. ...
... The correlation between OVERCB and RISKP was high compared with other variables. Previous studies also confirm the results depicting that manager's OVERCB and its relation to variables in the light of risk (Broihanne et al., 2015). Results show the significant positive correlation between CSD and AMD (r = .28), ...
The study is an attempt to find the reasons for biased behavior of overconfident managers while making financial decisions on behalf of shareholders. The study further seeks the ways to resolve the problems faced by firms due to such biased decision-making. For this purpose, quantitative research method is used to uncover the new information for better understanding of study. The comparative analysis has been done through survey-based data collected from executives/managers of firms listed on Pakistan Stock Exchange and New York Stock Exchange. The results indicate that overconfidence bias plays a significant role in managerial decisions for Pakistan compared with U.S. managers. This study applied mediation and moderation tests and found the significant mediating role of risk perception for overconfidence bias and manager decisions. The study further checked moderating role of cultural value, that is, the role of uncertainty avoidance between overconfidence bias of managers and risk perception. Hence, the role of cognitive biases and bounded rationality is undeniable for managerial decision-making and ultimate behavioral cost that firms have to pay due to undesired outcomes of situations. Consequently, this study has reached to extract the hidden facts and solutions to the observed issues for developed and emerging economy’s firms through cultural differences.
... In Malaysia, Lai et al. (2013) examines the behavior of retail and institutional investors during bull and bear markets and find that both investors are overconfident during these periods. Broihanne et al. (2014) interviewed 64 high-level professionals and demonstrated that they are overconfident. They indicated that respondents are overconfident in forecasting future stock prices and demonstrated that the risk they are willing to assume is positively influenced by overconfidence and optimism and negatively influenced by risk perception. ...
... In line with our finding, Oehler et al. (2008) come up with supported evidence of heuristic bias (home bias) in mutual fund composition. Broihanne et al. (2014) and Kiymaz et al. (2016) found that finance sector professionals are positively influenced by heuristics (overconfidence). In addition, Pikulina et al. (2017) tested 114 finance professionals and found that heuristic (strong overconfidence) results in excess investment, while moderate overconfidence leads to accurate investment. ...
Purpose
The purpose of this paper is to identify whether heuristic and herding biases influence portfolio construction and performance in Greece. The current research determines the situation among investors in Greece, a country with several economic problems for the last decade.
Design/methodology/approach
A survey has been conducted covering a group of active private investors. The relationship between private investors' behavior and portfolio construction and performance was tested using a multiple regression.
Findings
The authors find that heuristic variable affects private investor's portfolio construction and performance satisfaction level positively. A robustness test on a second group, consisting of professional investors, reveals that heuristic and herding biases affect investment behavior when constructing a portfolio.
Practical implications
The authors recommend investors to select professional's investment portfolio tools in constructing investment portfolios and avoid excessive errors, which occur due to heuristic. The awareness and understanding of heuristic and herding could be helpful for professionals and decision-makers in financial institutions by improving their performance resulting in more efficient markets.
Originality/value
The main contribution of this paper lies in the fact that it is the first study on two major behavioral dimensions that affect the investor's portfolio construction and performance in Greece. The rationale of the current research is that the results are helpful for investors in order to take rational, reliable and profitable decisions.
... Croson and Gneezy (2009) argue that confidence relates to risk-taking. Whereas Hardies, Breesch, and Branson (2013) cannot find this relationship in survey data of students and auditors, Broihanne, Merli, and Roger (2014) confirm that finance professionals' overconfidence leads to increased risk-taking. The willingness to take risks describes the fundamental preference of individuals to force or avoid risky behavior options (Kam 2012). ...
We analyze the impact of psychological pressure on performance with over 5500 handball
penalties thrown in either the decisive stage or the rest of the game during matches of the
2019/2020 season in the first three German handball leagues. Contrary to the choking under
pressure phenomenon, most of the analyzed players perform best when it matters the most.
The positive effect of pressure on performance is highest when the score is even or when the
thrower’s team is lagging. We control for gender and psychological traits assessed with
a survey. In our sample, female players score with a higher probability than male players. The
positive impact of pressure is not significantly higher for female players.
... Research has already related overconfidence, in general, to risky behavior (Broihanne et al., 2014;Robinson & Marino, 2015;Nosić & Weber, 2010;Glaser & Weber, 2007). However, studies relating confidence in one's factual knowledge about a topic to risk or benefit perception of the said topic to our knowledge do not currently exist. ...
... Overconfident people strongly believe they are above-average individuals, and such people usually have positive perceptions about themselves, which is unrealistic (Cooper et al. 1988;Taylor and Brown 1988). Overconfidence and risk perception both have a strong impact on the risk-taking behaviour of professionals (Broihanne et al. 2014). Overconfidence bias lowers an individual's risk perception about a strategy's riskiness (Russo and Schoemaker 1992;Barnes 1984). ...
In the last two decades, research on behavioural biases has grown dramatically, fuelled by rising academic interest and zeal for publication. The present study explores the mediating role of risk perception on the relationship between heuristic biases and individual equity investors’ decision-making. The study uses Partial Least Square Structural Equation Modelling (PLS–SEM) to examine the survey data from 432 individual equity investors trading at the National Stock Exchange (NSE) in India. Risk perception is found to play a partial mediating role in the relationship amid overconfidence bias and investment decision-making, availability bias and investment decision-making, gamblers’ fallacy bias and investment decision-making and anchoring bias and investment decision-making, whereas it is found to play the full mediating role in the relationship between representativeness bias and investment decision-making. The result of the present study provides valuable insights into the different behavioural biases of capital market participants and other stakeholders such as equity investors, financial advisors, and policymakers. The present study solely relied on the heuristic biases of individual equity investors. However, in the real world, many other factors may impact the investment decision of individual equity investors. This has been considered a limitation of the study. The present study solely relied on the heuristic biases of individual equity investors. However, in the real world, many other factors may impact the investment decision of individual equity investors. This has been considered a limitation of the study.
... Overconfidence: It is the overvaluation of an individual's knowledge and ability (Aren & Canikli, 2018a). It is accepted to be positively related to risk-taking (Lambert, Bessiere, & N'Goala, 2012;Broihanne, Merli, & Roger, 2014;Mota, Moreira, & Cossa, 2015) Findings regarding the amount of knowledge possessed and the relationship with financial literacy are complex. Menkhoff, Schmeling, & Schmidt (2013) and Mota et al. (2015) stated that there is a positive relationship with the amount of knowledge. ...
... Lakonishock et al. (1992), Grinblatt, Titman, Wermers (1995), Wermers (1999), Sias (2004), Hong, Kubik and Stein (2003), Fong et al. (2004), Chan, Hwang and Mian (2005) Home bias Suh (2005), Lütje and Menkhoff (2007), Oehler et al. (2008), Fong et al. (2008), Parwada (2008), Menkhoff and Nikiforow (2009), Ke et al. (2010), Menkhoff et al. (2010), Anderson et al. (2011), Mishra and Ratti (2011), Giofr e (2013), Hamberg et al. (2013), Fedenia et al. (2013), Hochberg and Rauh (2013), Beracha et al. (2014) Disposition Barber et al. (2007), Susai and Moriyasu (2007), Choe and Eom (2009), Menkhoff et al. (2010), Chou and Wang (2011), Cici (2012), Kudryavtsev et al. (2013), Sun et al. (2013), Bodnaruk and Simonov (2014). Shapira and Venezia (2001), Garvey and Murphy (2004), Dhar and Zhu (2006), Rzeszutek (2016) Overconfidence Menkhoff et al. (2006), De Venter and Michayluk (2008), Waweru et al. (2008), Menkhoff (2010), Puetz and Ruenzi (2011), Eshraghi (2011Eshraghi ( ), (2014, Eshraghi and Taffler (2012), Braihanne et al. (2014), Rzeszutek (2016) Short-termism Suto and Toshino (2005), Lütje (2009), Menkhoff (2010) Loss-aversion Olsen (1997), Waweru et al. (2008), Bodnaruk and Simonow (2016) Ambiguity aversion, uncertainty avoidance Bantwal and Kunreuther (2000), Beckmann et al. (2008) Confirmation bias Menkhoff and Nikiforow (2009 Bodnaruk and Simonov (2014) Emotion Tuckett and Taffler (2012) Do investment fund managers behave rationally Regardless of how institutional investors are classified, strong evidence of biases in this group of market participants was identified in earlier literature [see Menkhoff et al. (2010), Barber et al. (2007), among others]. Grinblatt and Keloharju (2000), Luo and Li (2008) and Dichtl and Drobetz (2011) further confirmed the lack of rationality among institutional investors, although some other studies showed evidence indicating that they exhibit rational behaviour [see Keim and Madhavan (1995) or Chang and Wei (2011)]. ...
Purpose
This study aims to answer the question whether investment funds managers exhibit behavioural biases in their investment decisions. Furthermore, it investigates if fund managers, as a group of institutional investors, make decisions in response to central bank’s communication as well as other information in relation to various behavioural inclinations.
Design/methodology/approach
A comprehensive study was conducted based on a questionnaire, which is composed of three main parts exploring: (1) general information about the funds under the management of the surveyed group of fund managers, (2) factors that influence the investment process with an emphasis on the National Bank of Poland communication and (3) behavioural inclinations of the surveyed group. Cronbach’s alpha statistic was applied for measuring the reliability of the survey questionnaire and then chi-squared test was used to investigate the relationships between the answers provided in the survey.
Findings
The central bank’s communication matters for investors, but its impact on their decisions appears to be only moderate. Interest rates were found to be the most important announcements for investment fund managers. The stock market was the most popular market segment where the investments were made. The ultra-short time horizon played no, or only small, role in the surveyed fund managers’ decisions as most of them invested in a longer horizon covering 1 to 5 years. Moreover, most respondents declared that they considered in their decisions the information about market expectations published in the media. Finally, majority of the fund managers manifested limited rationality and were subject to behavioural biases, but the decisions and behavioural inclinations were independent and, in most cases, they did not influence each other.
Practical implications
The results reported in this study can be used in practice to better understand and to improve the fund managers’ decision-making processes.
Originality/value
Apart from the commonly tested behavioural biases in the group of institutional investors in the existing literature, such as loss aversion, disposition effect or overconfidence, this paper also focuses on the less intensively analysed behavioural inclinations, i.e. framing, illusion of the control, representativeness, sunk cost effect and fast thinking. The originality of this study further lies in the way the research was conducted through interviews with fund managers, who were found to be subject to behavioural biases, although those behavioural inclinations did not influence their investment decisions. This finding indicates that professionalism and collectivism in the group of institutional investors protect them from irrationality.
... It was the aim of the study was whether, because of the specific objectives and risks faced by governments, SOEs deviate from the benchmark of deals involving private firms on both sides of the merger and acquisition (M&A) transaction [13,14]. They show that larger assets and high solvency ratios of state-owned enterprises make each deal involving them special. ...
The object of research is management system of the country's economic security and the consequences of the influence of the shadow economy on it. Research is carried out on the example of Ukraine, as a country with a fairly high level of shadow processes in business. Shadow incomes and agreements are currently one of the main problems of the management system of income distribution and redistribution. The global scale of the economy and the deregulation of international mergers and acquisitions take shadow capital beyond individual countries, giving them global importance for the economic security of different countries. An analysis of the influence of the shadow economy on all stages of merger and acquisition agreements in Ukraine was carried out. The negative effects of shadowing on attracting foreign and national investments, which reduces the effectiveness of the country’s economic security management system, were analyzed. The article presents a comparative analysis of the dynamics of economic development indices of the country and the level of the shadow economy. In the process of the research methods of analysis and synthesis, methods of logical design, tabular and graphical methods of data presentation are used. Correlation-regression analysis was used to study the relationship between the indicators of the shadow economy and the level of economic security of the state. On the basis of statistical indicators, the comparison of indicators of development of shadow economy and separate indicators of economic security of Ukraine is carried out. Correlation-regression analysis was used to study the relationship between the indicators of the illegal economy and the level of economic security of the state in the conditions of geopolitical transformation. The results of the calculations showed that for most indices of economic security and the level of the shadow economy there is a direct relationship. The established dependencies can be the basis for determining the key vectors of the state policy of counteracting the development of the shadow economy and tools for influencing the most sensitive indicators of Ukraine’s economic development. The research conducted in this article can be useful for scientists who research economic security management systems, for government institutions with the aim of forming an economic security program. The methodology can be used to determine investment priorities based on the analysis of the impact of the illegal economy on the economic security of society.
... Vijaya (2014) shows that one of the behavioral factors Overconfidence has a significant and positive relationship with investment performance. This study is consistent with the results of the study by The results of this study are in line with the results of studies that show a significant correlation between overconfidence bias on investment decisions, including Waweru (2008), Qureshi et al. (2012), Bashir et al. (2013), Qadri & Shabbir (2013), Broihanne et al (2014), Bakar and Yi (2016), Khan et al. (2017) and . Therefore, the hypothesis can be formulated as follows: H1: Overconfidence bias has a positive and significant effect on investment decisions. ...
This research is intended to determine the effect of overconfidence bias and representative bias on investment decisions with risk tolerance as a mediating variable. The object of this research is investors who invest in the Indonesian Capital Market. The technique of collecting data is by using a questionnaire through online media and a literature study with the criteria of active investors with a sample of 200 investors. Data analysis in this study uses an alternative method of Structural Equation Modeling (SEM) version 3.0. The first stage in this research is to test the validity of each variable's questions along with their reliability. The second stage examines the relationship between overconfidence bias and representativeness bias on investment decisions with risk tolerance as a mediating variable. The results of this study indicate that the overconfidence bias variable and the representative bias have a significant positive effect on investment decisions either directly or through the mediating risk tolerance variable.
... Furthermore, since the perception of time is influenced by emotional factors (McLoughlin 2019; Droit-Volet and Meck 2007), clarifying how it affects decision-making can help to investigate the relationship between financial assets and investor sentiment (Schmeling 2009). Since risk can be seen as a feeling (Loewenstein et al. 2001) , the integration of subjective time in the study of financial behaviour can improve the description of risk propensity or aversion (Wang et al. 2011;Broihanne et al. 2014;Sun and Li 2010). In this regard, our contribution would make it possible to quantify the extent to which hyperbolic time deviates from empirical time and can provide a new criterion for the classification of the investor, in addition to personality traits (Conlin et al. 2015;Tauni et al. 2015). ...
The interval effect refers to the phenomenon in which the discount rate decreases as the interval considered increases. It represents one of the many anomalies of the decision-making process in the context of intertemporal choices. This paper suggests that the latter anomaly is due to the perceived time and emotional drives involved in the moment of choice and their interaction. The study is developed through a direct comparison between empirical preferences and those predicted by the normative model, respectively determined by proper time, i.e., empirical time and normative time, which are different from objective time. Although it was known in the literature that the perception of time has a substantial impact on preferences and the phenomenon of temporal inconsistency, our study presents a measure that quantifies the decision-making bias caused by the subjective perception of time and contributes to the normalisation of choices defined as irrational. By the term normalisation, we mean to clarify the extent to which the cognitive structures of the decision-maker respect the principles of economic rationality. From an operational point of view, the present work's originality lies in proving that the same description of subjective time is not constant in the context of the interval effect. The experimental implementation provides empirical evidence of the latter considerations. The contribution of this work refers mainly to the field of behavioural finance as it aims to describe anomalies as inevitable consequences of individual cognitive processes.
... The above could provide an additional criterion, in addition to personality traits [41,42], for the classification required by MiFID 2. With respect to the emotional sphere, on the other hand, the proposed measure of inconsistency, because it expresses the subjective perception of time, is linked related to emotional factors that interact with decision-making [43,44] and can help investigate the relationship between investor sentiment and financial activity [45]. For example, assuming risk as a feeling [46], assessing the influence of subjective time in the description of decision inconsistency can improve the description of risk aversion and perception of risk [47][48][49], elements on which MiFID 2 places so much emphasis on when designing customized plans. The transition between measurement and individualized plan design can be guided using decision support techniques, such as multicriteria methods [50,51]. ...
Intertemporal choices are those decisions structured over several periods in which the effects only manifest themselves with the passage of time. The main mathematical reference for studying the behavior of individuals with respect to this type of decision is the Discounted Utility Model which hypothesizes completely rational individuals. The empirical evidence that deviates from normative expectations has motivated the formulation of alternative models with the aim of better describing the behavior of individuals. The present paper investigates the characteristics behind hyperbolic discounting starting from the phenomenon of decision inconsistency, i.e., when individuals’ preferences vary over time. The mechanisms of inconsistency will be explored through the physical concept of relative time, proving the importance of uncertainty aversion in the hyperbolic trend of the discount function. The analysis of the mathematical characteristics of hyperbolic discounting and the relationship between decision inconsistency and subjective perception of time defines the maximum distance between rational and non-rational preferences. An experimental part empirically proves the relationship between uncertainty aversion and time inconsistency. The present paper contributes to the literature by defining a new characteristic of hyperbolic discounting and quantifying the impact of the subjective perception of time in the decision-making process.
... While a narcissistic person may take additional risks because of their striving for success, an overconfident person may rely on their inflated expectation of successful outcome probability [or low risk-percep-tion]. M.H. Broihanne et al. [92] show that among finance professionals, overconfidence and underestimation of risk play a crucial role in explaining risk-taking decisions, more specifically, that overconfidence has a positive impact on risk-taking behavior. ...
In our paper we discuss how different personal characteristics of a CEO, being affected by CEO power, may in turn affect personal risk-taking. Agency theory states that managers have non-changing risk preferences and are either risk-averse or risk-neutral. In contrast to that, there may be cases, when managers are risk-seekers and power of executives is positively related to excessive risk-taking. Additionally, agency theory assumes that CEOs are homogenous in power use and ignores difference of CEOs in term of personality traits as well as its impact on corporate decisions. Therefore, our aim is to focus specifically on factors that connect CEO power with CEO risk-taking and to analyze possible effects of that relationship on firm. Based on both psychological and managerial studies, we conclude that, on the one hand, CEO’s power can affect CEO’s personal traits by producing [in the case of overconfidence or hubris] or by enhancing them [in case of narcissism]. On the other hand, CEO’s personal traits affect CEO’s risk-taking. It can be either by changing the perception of risk or because of behavior patterns inherent to those traits. Finally, we hypothesize that CEO power can affect CEO personal risk-taking through personality traits. By examining relationship between CEO power and CEO risk-taking based on individual-level determinants, our paper adds to the behavioral corporate finance and corporate governance literature.
... Because risky decisions involve balancing potential costs and benefits (e.g., Bernoulli, 1738;Friedman & Savage, 1948;Real & Caraco, 1986;Rubin & Paul, 1979), calibration of one's capacities can help people assess when a risk is worth taking, whereas overconfidence can lead to unnecessary or excessive risk (e.g., Krueger & Dickson, 1994;Malmendier & Tate, 2005. This logic suggests that overconfidence can drive greater risk-taking, but evidence for this causal inference remains unclear (Broihanne et al., 2014;Camerer & Lovallo, 1999;Ronay et al., 2016). ...
Biological differences between men and women mandate that women’s obligatory investment in reproduction is significantly greater than that of men. As a result, women have evolved to be the “choosier” of the two sexes and men have evolved to compete for female choice. To the degree that overconfidence is an effective tool for attracting mates and driving away competitors, greater competition among men suggests that they should express more overconfidence than women. Thus, sexual selection may be the primary reason why overconfidence is typically more pronounced in men than it is in women. Sexual selection may also be a distal, causal factor in what we describe as a cult of overconfidence pervading modern organizations and institutions. Whereas overconfidence was once regulated and constrained by features of ancestral life, levels of social mobility and accountability in contemporary society and modern organizations make it increasingly difficult to keep this gendered bias in check.
... With regard to signal providers operating wikifolios at the upper end of the peer performance range, overconfidence might be a suitable explanation for the observed results. Barber and Odean (2001), Broihanne et al. (2014), De Long et al. (1991), and Odean (1999) document a positive relation between overconfidence and risk taking. When their overconfidence is increased due to good relative past performance (Gervais and Odean 2001;Odean 1999;Statman et al. 2006), signal providers might be drawn to assets exhibiting more risk and thus increase the proportion of traded lottery-like stocks. ...
Social trading—also referred to as copy trading—is an interactive platform-based
innovation facilitating visibility and traceability of signal provider trading activities. Based on published portfolio transaction and return track records, platform
users can copy one or several signal providers, i.e. delegate their investment decisions, and thereby become signal followers. Allowing signal providers to administer purely virtual portfolios, in combination with a remuneration scheme based on
performance fees and high watermarks, creates convex or option-like incentives
(Carpenter, J Finance 55:2311–2331, 2000; Doering and Jonen, SSRN J, 2018). We
argue that the incentive structure imposed by social trading providers, including a
very limited monetary downside risk for signal providers, may motivate traders to
gamble. In this context, we assess the factors that have an impact on signal provider lottery-like stock transactions (Bali et al., J Financ Econ 99:427–446, 2011;
Kumar, J Finance 64:1889–1933, 2009). We provide empirical evidence that signal
providers tend to increase the traded relative share of lottery-like stocks when being
located at an extreme end of the relative performance spectrum. Furthermore, we
provide evidence that underperforming signal providers increase their net exposure
towards lottery-like stocks, in turn exposing signal followers to a lottery-like return
structure—triggering gambling.
... Research has already related overconfidence, in general, to risky behavior (Broihanne et al., 2014;Glaser & Weber, 2007;Nosić & Weber, 2010;Robinson & Marino, 2015). However, studies relating confidence in one's factual knowledge about a topic to risk or benefit perception of the said topic to our knowledge do not currently exist. ...
Artificial intelligence (AI) applications are increasingly used in everyday life. Whereas some of them are widely accepted (e.g., automatically compiled playlists), others are highly controversial (e.g., use of AI in the classroom). While public discourse is dominated by perceptions of the risks associated with AI, we take a fundamentally different approach of measuring the perceived risks and opportunities of AI applications considering people's knowledge and confidence in their own knowledge. To this end, we assessed in two studies (N = 394 and N = 437) how knowledge about AI as well confidence in AI knowledge is related to participants risk-opportunity perception of AI scenarios from three domains: media, medicine, and autonomous driving. Results showed that both AI knowledge and confidence in AI knowledge are important predictors regarding people’s risk-opportunity perception beyond people's attitudes towards AI. More specifically, people with more knowledge about AI exhibited a so-called risk blindness in that they were underestimating the risks. On the other hand, higher confidence in ones’ AI knowledge impacted participants opportunity perception. Knowledge and confidence thus open a new dimension of understanding people’s perception of risks and opportunities in AI.
... Investorspecific behavioural factors such as the perception of risks, projected returns and preference affect the investment decision (Liu et al., 2017). The risk-taking behaviour of individual investors has an important and influential effect on investment decision (Broihanne et al., 2014). People could increase their trust in selecting a product or service with lower risk perception (Finucane et al., 2000). ...
... Studies that focus on cognitive biases note: (a) selection bias (Baik, 2006, (b) overconfidence (Dittrich et al., 2005;Martinez, 2007a;Broihabnne et al., 2014;Kafayat, 2014;Lima and Almeida, 2015;Du and Budescu, 2018;Machado, 2018); (c) optimism (Easterwood and Nutt, 1999;Lim, 2001;Gervais and Odean, 2001;Ciccone, 2003;Martinez, 2007b;Corredor et al., 2014;Kafayat, 2014;Lima and Almeida, 2015;Galanti and Vaubourg, 2017); (d) anchoring bias (Brown, 1997;Marsden et al., 2008;Campbell and Sharpe, 2009;Silva Filho et al., 2018); (e) CEOs' personal traits (Hernández-Pérez et al., 2019); (f) representativeness (Amir and Ganzach, 1998). ...
The objective of this study was to jointly analyze the importance of cognitive and financial factors in the accuracy of profit forecasting by analysts. Data from publicly traded Brazilian companies in 2019 were obtained. We used text analysis to assess the cognitive biases from the qualitative reports of analysts. Further, we analyzed the data using statistical regression learning methods and statistical classification learning methods, such as Multiple Linear Regression (MRL), k -dependence Bayesian ( k -DB), and Random Forest (RF). The Bayesian inference and classification methods allow an expansion of the research line, especially in the area of machine learning, which can benefit from the examples of factors addressed in this research. The results indicated that, among cognitive biases, optimism had a negative relationship with forecasting accuracy while anchoring bias had a positive relationship. Commonality, to a lesser extent, also had a positive relationship with the analyst’s accuracy. Among financial factors, the most important aspects in the accuracy of analysts were volatility, indebtedness, and profitability. Age of the company, fair value, American Depositary Receipts (ADRs), performance, and loss were still important but on a smaller scale. The results of the RF models showed a greater explanatory power. This research sheds light on the cognitive as well as financial aspects that influence the analyst’s accuracy, jointly using text analysis and machine learning methods, capable of improving the explanatory power of predictive models, together with the use of training models followed by testing.
... We assume that agent 1 has a higher risk-taking behaviour, therefore α (1) < α (2) . Higher-risk investments may be driven from overconfidence [9]. Consequently, we assume ...
We have studied a discrete time dynamical model with four variables and delays, describing
the interaction between a three-sector real economy and a financial market with four assets.
Investors and financial intermediaries have heterogeneous beliefs. We show that complexity
related to the evolution of state variables emerges and we investigate interdependence among
economic fluctuations and assets volatility. By means of stability analysis we have found
that real economy influences the existence of equilibrium prices in financial markets and
that risky asset prices as well as capital per capita reach zero only when the elasticity of
substitution between capital and labour is low enough. Bifurcation analysis shows that an
increase of bond return would decrease the price of all the assets, conversely when the bond
return decreases fluctuations and complex dynamics may arise. Due to the complexity of the
model, computational tools are used to investigate long run dynamics, thus showing that for
sufficiently high values of the interest rate bifurcations with repetitive structure emerge. In
addition, we show how the total number of shares in each sector influences its price volatility.
Finally, when fluctuations appear, economic policy intended to increase employment could
stabilise the model only in sufficiently developed economies.
... Entrepreneurs suffer emotional bias likely due to their entrepreneurial orientation. (Broihanne et al., 2014;Miller et al., 2012) find that risk-loving entrepreneurs tend to exhibit emotional bias in making decisions. Besides, information asymmetry between entrepreneurs and fund suppliers may motivate entrepreneurs to make decisions based on their emotional beliefs (Gibson & Sanbonmatsu, 2004). ...
There have been numerous studies investigating the dynamics of micro, small and medium enterprises (MSME) development. However, this research topic still offers several interesting research gaps to be explored. Accordingly, the purpose of this research is to test the effects of entrepreneurial orientation and asymmetric information that affect MSME entrepreneurs’ emotional biases, as well as the relationships between these variables and MSME’s financing and performance. Our research objects are MSMEs located in four urban villages in Salatiga City, Central Java that engage in various business sectors, such as the food and beverage, the service industry, the groceryw, and the horticulture sector. We analyze the research data with the Partial Least Square (PLS) software. The research results reveal that entrepreneurial orientation and asymmetric information positively influence MSME entrepreneurs’ emotional bias. Meanwhile, emotional bias has a significantly positive influence on financing. Finally, we also find that financing positively affects MSMEs’ performance. In sum, our study demonstrates the importance of the behavioral aspect (emotional bias) in explaining MSMEs’ performance through its indirect impact through financing.
... Overconfidence is excessive self-confidence. This investment bias is familiar to many investors and often leads to mistakes in investment decisions [7]. Overconfidence makes investors overestimate their abilities, knowledge and underestimate the predictions [8]. ...
... First, several studies report an association between overconfidence and financial risk taking in diverse samples ranging from retail investors [14,15] to high-level finance professionals [16]. Overconfident investors are more likely to predict future stock prices to rise and to trade more excessively, both leading to higher risk taking. ...
The tendency to be overly confident in one’s future and skills has long been studied. More recently, a correlate of this overconfidence, the tendency to overclaim knowledge, has been in the focus of research. Its antecedents and downstream behavioral consequences are still in question. In a sample of undergraduate students (N = 168), we tested whether a set of characteristics of the person (e.g., age, gender) and personality traits (i.e., the Dark Triad) is related to overclaiming knowledge. Moreover, we investigated whether overclaiming, in turn, predicts risk preferences. To this end, we asked individuals to rate their confidence in solving a set of different math problems and their familiarity with a set of math concepts. Some of these concepts were nonexistent, thereby allowing participants to overclaim knowledge. Participants then stated their general risk preference and performed three tasks revealing their general, financial, and social risk preferences. We demonstrated the hypothesized relationship between overclaiming and confidence. Furthermore, we observed that the assessed characteristics of the person were not correlated with overclaiming. If anything, height and digit ratio, a phenomenological correlate of hormonal differences during development, tended to be associated with overclaiming. Surprisingly, overclaiming was not at all related to risk preferences or personality traits. This set of results shows the need for relevant theoretical and methodological refinements.
... Croson & Gneezy (2009) argue that confidence relates to risk taking. Whereas Hardies et al. (2013) cannot find this relationship with students and auditors, Broihanne et al. (2014) confirm that finance professionals' overconfidence leads to increased risk taking. In the next subsection, we review the role of risk taking under pressure. ...
We analyze the impact of psychological pressure on individual performance with handball penalties thrown in the decisive stage vs. the rest of the game. Contrary to the phenomenon of choking under pressure, we observe that most of the analyzed players perform best when it matters the most. The positive effect of pressure on performance is especially pronounced when the score is level or when the thrower’s team is lagging. We control for gender and psychological traits assessed with a survey. Female players score with a higher probability than male players in our sample. The positive impact of pressure is not significantly higher for female players.
... It would be a good future avenue to use the neuroticism score as a continuous predictor variable and test its relationship with risk-taking behaviors. Moreover, many studies have revealed that other individual factors, such as overconfidence, are important predictors of risk-taking among professionals such as fund managers (Broihanne et al., 2014). One future avenue for research is to explore the relation between neuroticism and overconfidence in affecting risk propensity, especially for such professionals. ...
Although many studies have explored the relationship between neuroticism and risk-taking, only a few have assessed the manner in which neuroticism shapes risk propensity under competition. This study attempted to specify two kinds of competition according to former performance and sought to investigate the interaction effect of neuroticism and competition on risk propensity. Participants (N = 134) were defined as high-level neurotic individuals (HN) or low-level neurotic individuals (LN) based on their scores on the neuroticism subscale of the revised Neuroticism-Extraversion-Openness Personality Inventory. In a lab experiment, participants completed a 2-round Balloon Analogue Risk Task wherein they competed against an opponent in the second round, whose performance was superior or inferior to them in the first round. The results showed that HN exhibited risk-taking when facing superior competitor, while they were more risk-averse when faced with inferior competitor. LN demonstrated risk aversion when competing with inferior competitor, and their risk propensity remained unaffected with superior ones. These findings provide evidence that the circumstantial factor of competition can alter how the personal trait of neuroticism influences individuals' risk-taking behaviors.
... Saurabh and Nandan (2018) supported his arguments and stated that the financial risk attitude affects the financial satisfaction or else leads to dissatisfaction towards an investment. Broihanne et al. (2014) also found that the risk perception and the risk-taking behaviour amplify or reduce the tenacity of investment decision. ...
It is eminent to understand, be aware of and encourage domestic retail investors towards investment in the capital market in a developing economy such as India for tackling the situation of capital insufficiency and financial instability. Therefore, the study was purposed to find out the different dimensions of cognition that affect investment attitude and the different characteristics of risk absorption affecting the investment decision making. The study also intended to find the direct and the mediating impact of investors’ cognition directly and through risk-absorption scenarios on the level of interest on investment. The study used the causative research design and by using stratified random sampling, received 392 responses from investors with risk-absorption characteristics from four strata of Odisha (a state of India) through a self-constructed questionnaire. Factor analysis was used to find out the factor of cognition and risk absorption. Multiple linear regression was used to find out the effect of both factors of cognition and risk absorption on the intensity of purchase financial product or level of interest in investment. Mediation analysis was used to find the mediating impact showing the direct and indirect impact of cognition on interest in investment and through the factors risk absorption. The study found that the dimensions of cognition (hot, cold, social and meta) have a significant impact on the level of interest towards investment, so financial product sellers must use these dimensions and sources of cognition to bring up interest from the domestic investor to invest in the domestic capital market. It has also been found that the risk-absorption characteristics play a mediating and vital role in the relation between investors’ cognition and level of interest in investment. Therefore, it is imperative to uplift the risk-absorption capacity through different dimensions of cognition and sources of information, which can reflect in a better understanding of the market and investment scenarios.
It is the Edited Book. Articles Contributed in view of Industrial Era conducted by Department of Commerce, St.Xavier's College (Autonomous) Palayamkottai and complied as a book.
Do more intelligent investors take better economic decisions than less intelligent ones? Is risk attitude, in particular risk/loss aversion, linked to cognitive ability? Does an investor's cognitive ability impact his/her patience? Is financial performance positively linked to investor's intelligence? These research questions have become highly relevant with the development of behavioral economics and behavioral finance, following the recognition that humans are not homo economicus. This paper reviews the several strands of literature devoted to answering the above questions. We first discuss the barely debated definitions and measures of intelligence/cognitive ability used in psychology, economics, and finance. We then review the results related to the (controversial) link between risk aversion and cognitive ability. We observe that the literature provides clear results for patience; individuals with a higher level of cognitive ability being more patient on average. Finally, we review the contributions linking (successfully or not) portfolio choice and financial performance to cognitive ability.
This paper explores how investor overconfidence impacts reactions to stock market crashes. Using the 2018 Investor Survey dataset from FINRA we measure respondent’s self-perceived and actual investment knowledge and thus are able to identify overconfident investors from other investors. In our analysis, we find overconfident investors were significantly more likely to sell after a stock market crash than other investors, and thus more likely to lock-in the losses from the crash and miss subsequent upswings in the market. Moreover, these overconfident investors were significantly more likely than other investors to pursue risky investment strategies such as cryptocurrencies, margin accounts, options, and penny stocks that can also lead to large losses. Finally, we find that accurately aware investors, investors who have both high perceived and actual knowledge, buy significantly more after a crash.
In many domains, imitating others’ behaviour can help individuals to solve problems that would be too difficult or too complex for the individuals. In collective decision making tasks, people have been shown to use confidence as a means to communicate the uncertainty surrounding internal noisy estimates. Here, we show that confidence alignment, namely, shifting average confidence between dyad members towards each other, naturally emerges when interacting with others’ opinions. This alignment has a measurable impact on group performance as well as the accuracy of individual members following information exchange. It is suggested that confidence alignment arises among individuals from the necessity of minimising confidence variation arising from task-unrelated variables (trait confidence), while at the same time maximising variation arising from stimulus characteristics (state confidence).
There is a growing body of research on social trust in the literature in business and economics. This study adopts the conceptual and empirical relationship between trust behaviour and risk-taking propensity, and further extends the frontier of research on social trust by examining whether social trust can influence country risk in international business settings. Using a panel data set consisting of developing and developed countries over the period 1995–2019, the study performs a battery of empirical tests, and finds robust evidence that developing countries with a higher level of social trust appear to display a greater degree of financial uncertainty. The findings are consistent with recent experimental studies documenting a significant positive association between trust and risk-taking behaviour. The study provides new insights into the role of social trust in country risk assessment, and offers meaningful implications for international business.
Purpose
Financial professionals are increasingly important in the Indian financial system. Our study examines the association between the Big Five personality traits and Indian financial professionals' behavioral biases when making investment decisions.
Design/methodology/approach
After testing our questionnaire's reliability and validity, we used it to obtain the sample responses. We used multiple regression analysis and other statistical tools to identify the relationships between the Big Five personality traits and behavioral biases.
Findings
Our findings reveal a high level of extraversion and conscientiousness, a moderate level of agreeableness and openness and a low neuroticism level among financial professionals. The results show a significant association between neuroticism, extraversion, openness and all behavioral biases except anchoring bias. The neuroticism trait has a statistically significant relationship with all behavioral biases examined, whereas agreeableness and conscientiousness traits lack a significant association with behavioral biases. The openness trait is associated with many emotional biases and cognitive heuristics, while the extraversion trait has a significantly positive relationship with availability bias.
Research limitations/implications
Future researchers could analyze primary (survey) and secondary investor data from brokerage houses. Using a larger sample could provide more generalizable findings. Researchers could also consider other aspects of investment decision-making using various asset classes. Understanding financial professionals' personality traits and behavioral biases could help them develop strategies to suit client needs.
Originality/value
This study provides the first comprehensive examination of the association between personality traits and behavioral biases of Indian financial professionals.
This article re-examines key explanations of the Global Financial Crisis—product complexity, behavioural biases in decision making, systemic risk, and regulatory arbitrage and capture—and finds a common underlying cause, namely gaming by personnel at all levels in the banking sector and its regulators. This has enabled banks to use highly leveraged, maturity-mismatched investment strategies, which were designed so that the banks retained the upside rewards, but transferred the downside risks to taxpayers, leading to the privatization of profits and the socialization of losses—behaviour that has been described as ‘banksterism’. Although governments have introduced some significant mitigatory measures, they will not be effective in preventing future financial crises, because they do not and, indeed, cannot provide the appropriate incentives to end the Great Game between bankers and taxpayers, which would involve making bankers, rather than taxpayers, personally liable for losses.
This article re-examines key explanations of the Global Financial Crisis—product complexity, behavioural biases in decision making, systemic risk, and regulatory arbitrage and capture—and finds a common underlying cause, namely gaming by personnel at all levels in the banking sector and its regulators. This has enabled banks to use highly leveraged, maturity-mismatched investment strategies, which were designed so that the banks retained the upside rewards, but transferred the downside risks to taxpayers, leading to the privatization of profits and the socialization of losses—behaviour that has been described as ‘banksterism’. Although governments have introduced some significant mitigatory measures, they will not be effective in preventing future financial crises, because they do not and, indeed, cannot provide the appropriate incentives to end the Great Game between bankers and taxpayers, which would involve making bankers, rather than taxpayers, personally liable for losses.
Decision-making processes occur with the interaction of some cognitive and psychological variables. Neoclassical theories deal with rational reactions in these processes. However, in an environment where there is no information or where there is uncertainty instead of risk, decisions cannot be made rationally as the mind indicates. In this direction, firm managers have to make many decisions under uncertainty. For this reason, managers resort to various simple and useful shortcuts called bias for different reasons. In this study, it was aimed to reveal the effects of behavioral biases on management decisions. In this context, five biases in the behavioral finance literature, namely overconfidence, status quo, anchoring, hindsight and availability, were evaluated with theoretical and empirical studies and their effects on managerial decisions were discussed. It was seen that raising awareness of these biases in terms of managers provides benefits such as realistic evaluation of themselves, giving more realistic weights to events when making decisions, reaching rational judgments more easily and being open to innovations.In addition, this awareness, when combined with the emotional competencies of managers, helps them make successful decisions.
The purpose of the study was to analyze the degree to which categories of financial risk-tolerance miscalibration are associated with portfolio choices made by financial decision-makers. A differential prediction model was applied to investment risk tolerance data from 2017-2018 to assess the presence of miscalibration. Results from Tobit regressions showed that some survey respondents did engage in the miscalibration of their financial risk tolerance. Although results varied by sub-samples, those who systematically under-estimated their financial risk tolerance were observed to hold portfolios that were less risky than those who were able to match their self-assessed risk tolerance to their psychometrically reliable score. No clear pattern of portfolio choice for those who over-estimated their financial risk tolerance was noted. Being female and between the age of 55 to 64, having an income of $100,000 or more, and working with a financial advisor were found to be more consistent descriptors of portfolio risk compared to risk-tolerance miscalibration.
The study intends to identify the factors that affect the risk perception of investors towards equity shares and further identifies the association between the identified factors. The study aims to conduct a thorough analysis of the factors affecting risk perception along with measurement of their influence on risk perception in respect of equity shares using Social Network Analysis (SNA). The factors influencing risk perception in equity shares have been identified through review of literature. Delphi technique was employed to determine the association between the factors and the significance of the impact of each of the factors was analysed using SNA. The study found that culture and education are most critical factors among the other factors influencing risk perception in respect of equity shares. While the factors such as capacity of investors, framing effect and loss aversion does not have much impact on the risk perception. The study will help the investors in making decision to invest in equity shares. The present study also gives avenues for the future research by providing the area where more research is needed.
Objective: According to the variety and diversity of research conducted in the field of internal auditing, the purpose of this research is to gain a deeper understanding of the topic by conducting a systematic review of existing studies to classify topics and outline some potential future research directions.
Methods: In order to achieve our purpose and to more efficiently examine a large number of articles, the "Computational Literature Review (CLR)" approach is used, and through this, the content of abstracts is analyzed automatically to provide a set of research topics within internal audit literature (Topic Modeling). The required information is collected from the Thomson Reuters Web of Science (WoS) database for 1401 articles over almost one hundred years (1920 to 2021).
Results: The results of Topic Modeling show the focus of seven areas in internal audit research as follows: internal audit in the healthcare industry; internal audit in the areas of risk management, fraud, and internal controls; competence and training and internal audit quality; and the relationship between the external auditor and the internal auditor. A separate review of each of these identified issues related to internal audit reveals the most critical research conducted in this area and identifies some avenues for future research.
Conclusion: The results of this study indicate that throughout the evolution of internal auditing during its history (almost 100 years), its philosophy has evolved from ensuring the accuracy of financial statements and accounts and preventing the misuse of corporate funds or assets by helping to create and add value to companies. Internal auditing services have been upgraded from assuring financial statements and responding to its limited stakeholders (i.e., senior managers), giving assurance, consulting, forecasting risk, and being accountable to all stakeholders. Also, the change in the accountability direction of internal audit and its greater cooperation with external auditors, and the growth of technology and increasing the complexity of organizations have led to changes in competencies and skills required and improving and promoting its independence and objectivity; also engaging internal auditors in other areas of expertise (other than accounting and auditing), then it is expected that the trend will continue in the future.
Bu çalışmada, davranışsal finansın İslami perspektifte varsayımları değerlendirilmekte e İslami ve geleneksel davranışsal finans muvazenesi yapılmaktadır. Çalışmada pozitivist finans yaklaşımına alternatif olarak geliştirilen davranışsal ve İslami finans kavramları ve bu alanda yapılan çalışmalar eleştirel bir bakış açısıyla ele alınmaktadır. Alternatif yaklaşımlar ve çözüm önerileri sunulmaktadır.
The purpose of this paper is to systematically review the literature published on various aspects of risk perception about equity investment. It also aims to raise specific questions for future research. A comprehensive and systematic literature review is done to get the insights of the available literature with an objective to identify the determinants of equity-share-related risk perception and identify its impact that influences equity investment behavior. The study found that risk perception can be measured mainly by using the axiomatic approach, socio cultural group approach, emotional reactions, marketing mix approach, and psychometric approach. It is also found that the main determinants of risk perception are demographic factors, emotional reactions, economic crisis, framing effects, loss aversion, heuristics, etc., which leads to some impact on investment behavior such as good portfolio choice, market-linked investment, entrepreneurial success, and retirement planning. A better understanding of risk perception will help the policymakers to improve the risk perception level of investors, which in turn will help in improving the investment culture of the nation.
This paper focuses on determining the factors influencing investors’ risk-taking through empirical evidence from Vietnam. This study investigates risk perception, expected return and herding behavior, and other determinants such as historical volatility and subjective financial risk attitude; according to previous studies, these are the main components affecting risk-taking behavior among investors. Overconfidence (better than average, miscalibration, and excessive optimism) is also taken into consideration. We employ pooled-OLS and quantile regression to overcome the shortage of research models in this field. In addition, we demonstrate how risk-taking behavior can be affected by those factors with the application of measures across four different investment channels. This study suggests implications for investors who wish to control risk.
In two studies, stock market professionals (N1 = 22, N2 = 21) and laypeople (N1 = 29, N2 = 34) provided thirty-day forecasts for twenty stocks and estimated the size of their own errors as well as their own and the other group's mean errors. Both groups predicted that the errors made by professionals would be half the size of the errors made by laypeople. In reality, the errors of both groups were about the size predicted for the laypeople. Participants also estimated their ability to pick the best performing stock from two options. Both groups proved to be overconfident. Professional predictions were only successful 40% of the time, a performance below what could be expected from chance alone. Self reports and correlations between forecasts and price movements sug- gested that the professionals based their predictions on specific information of the stocks without sufficient awareness of the unreliability of this information, while the laypeople used simple heuristics based on previous price movements. During the recent worldwide stock market turbu- lence, fortunes were rapidly made and just as rapidly lost. The great majority of participants did not antici- pate either the magnitude or the pace of these events. The bewilderment has been hard to hide. This paper addresses two questions raised by more than a few people in the aftermath: "How much do stock market professionals really know about the fu- ture development of stock prices, and how much do they think they know?" We first discuss psychological findings concerning expert judgments and experts' and laypeople's confidence in their own judgments.
In this study, respondents from the P.R.C., U.S.A., Germany, and Poland were found to differ in risk preference, as measured by buying prices for risky financial options. Chinese respondents were significantly less risk-averse in their pricing than Americans when risk preference was assessed in the traditional expected-utility framework. However, these apparent differences in risk preference were associated primarily with cultural differences in the perception of the risk of the financial options rather than with cultural differences in attitude towards perceived risk. In all cultures, an equal proportion (the majority) of respondents was willing to pay more for options perceived as less risky, i.e., were perceived-risk averse. These results are most naturally explained within a risk-return conceptualization of risky choice. They have practical implications for cross-cultural negotiation and commerce by suggesting the locus of cultural differences in risky choice that may allow for the creation of joint gains.
By integrating elements of both marketing and finance, we show how risk influences channel contract behavior. We model risk behavior as the interaction between risk attitude and risk perception (IRAP). An analysis of the joint channel decisions of 208 producers, wholesalers, and processors provides three results. First, risk attitudes significantly vary across different levels of channel members. Second, IRAP in combination with the channel member's market structure on the buying and selling side is a strong predictor of contract behavior. Third, increases in channel power strengthen the impact of IRAP on channel contract behavior.
The authors present a reconciliation of 3 distinct ways in which the research literature has defined overconfidence: (a) overestimation of one's actual performance, (b) overplacement of one's performance relative to others, and (c) excessive precision in one's beliefs. Experimental evidence shows that reversals of the first 2 (apparent underconfidence), when they occur, tend to be on different types of tasks. On difficult tasks, people overestimate their actual performances but also mistakenly believe that they are worse than others; on easy tasks, people underestimate their actual performances but mistakenly believe they are better than others. The authors offer a straightforward theory that can explain these inconsistencies. Overprecision appears to be more persistent than either of the other 2 types of overconfidence, but its presence reduces the magnitude of both overestimation and overplacement.
We develop a one-period model of investor asset holdings where investors have heterogeneous preference for skewness. Introducing
heterogeneous preference for skewness allows the model's investors, in equilibrium, to underdiversify. We find support for
our model's three key implications using a dataset of 60,000 individual investor accounts. First, we document that the portfolio
returns of underdiversified investors are substantially more positively skewed than those of diversified investors. Second,
we show that the apparent mean-variance inefficiency of underdiversified investors can be largely explained by the fact that
investors sacrifice mean-variance efficiency for higher skewness exposure. Furthermore, we show that idiosyncratic skewness,
and not just coskewness, can impact equilibrium prices. Third, the underdiversification of investors does not appear to be
coincidentally related to skewness. Stocks most often selected by underdiversified investors have substantially higher average
skewness—especially idiosyncratic skewness—than stocks most often selected by diversified investors.
This paper provides questionnaire evidence on the role of flow analysis for professional traders and fund managers. This evidence suggests that besides fundamental information and technical analysis, the analysis of flows provides an independent third type of information for professionals. The view that flows can be used to learn about fundamentals is not consistent with the data. Instead, evidence indicates that flows more likely provide insight into semi-fundamental private information.
We analyze 1,607 investors who switched from phone-based to online trading during the 1990s. Those who switch to online trading
perform well prior to going online, beating the market by more than 2% annually. After going online, they trade more actively,
more speculatively, and less profitably than before—lagging the market by more than 3% annually. Reductions in market frictions
(lower trading costs, improved execution speed, and greater ease of access) do not explain these findings. Overconfidence—augmented
by self-attribution bias and the illusions of knowledge and control—can explain the increase in trading and reduction in performance
of online investors.
This paper provides questionnaire evidence on the role of flow analysis for professional traders and fund managers. This evidence suggests that besides fundamental information and technical analysis, the analysis of flows provides an independent third type of information for professionals. The view that flows can be used to learn about fundamentals is not consistent with the data. Instead, evidence indicates that flows more likely provide insight into semi-fundamental private information.
Overconfidence is often regarded as one of the most prevalent judgment biases. Several studies show that overconfidence can lead to suboptimal decisions of investors, managers, or politicians. Recent research, however, questions whether overconfidence should be regarded as a bias and shows that standard "overconfidence" findings can easily be explained by different degrees of knowledge of agents plus a random error in predictions. We contribute to the current literature and ongoing research by extensively analyzing interval estimates for knowledge questions, real financial time series, and for artificially generated charts. We thereby suggest a new method to measure overconfidence in interval estimates which is based on the implied probability mass behind a stated prediction interval. We document overconfidence patterns which are difficult to reconcile with rationality of agents and which cannot be explained by differences in knowledge as differences in knowledge do not exist in our task. Furthermore, we show that overconfidence measures are reliable in the sense that there exist stable individual differences in the degree of overconfidence in interval estimates, thereby testing an important assumption of behavioral economics and behavioral finance models: stable individual differences in the degree of overconfidence across people. We do this in a "field experiment," for different levels of expertise of subjects (students on the one hand and professional traders and investment bankers on the other hand), over time, by using different miscalibration metrics, and for tasks which avoid common weaknesses like a non-representative selection of trick questions.
Most so-called “errors” in probabilistic reasoning are in fact not violations of probability theory. Examples of such “errors” include overconfidence bias, conjunction fallacy, and base-rate neglect. Researchers have relied on a very narrow normative view, and have ignored conceptual distinctions—e.g. single case versus relative frequency—fundamental to probability theory. By recognizing and using these distinctions, however, we can make apparently stable “errors” disappear, reappear, or even invert. I suggest what a reformed understanding of judgments under uncertainty might look like.
This paper compares a number of approximations used to estimate means and variances of continuous random variables and/or to serve as substitutes for the probability distributions of such variables, with particular emphasis on three-point approximations. Numerical results from estimating means and variances of a set of beta distributions indicate surprisingly large differences in accuracy among approximations in current use, with some of the most popular ones such as the PERT and triangular-density-function approximations faring poorly. A simple new three-point approximation, which is a straightforward extension of earlier work by Pearson and Tukey, outperforms the others significantly in these tests, and also performs well in related multivariate tests involving the Dirichlet family of distributions. It offers an attractive alternative to currently used approximations in a variety of applications.
This paper studies risk attitudes using a large representative survey and a complementary experiment conducted with a representative subject pool in subjects' homes. Using a question asking people about their willingness to take risks “in general”, we find that gender, age, height, and parental background have an economically significant impact on willingness to take risks. The experiment confirms the behavioral validity of this measure, using paid lottery choices. Turning to other questions about risk attitudes in specific contexts, we find similar results on the determinants of risk attitudes, and also shed light on the deeper question of stability of risk attitudes across contexts. We conduct a horse race of the ability of different measures to explain risky behaviors such as holdings stocks, occupational choice, and smoking. The question about risk taking in general generates the best all-round predictor of risky behavior.
This paper provides questionnaire evidence on the role of flow analysis for professional traders and fund managers. This evidence suggests that besides fundamental information and technical analysis, the analysis of flows provides an independent third type of information for professionals. The view that flows can be used to learn about fundamentals is not consistent with the data. Instead, evidence indicates that flows more likely provide insight into semi-fundamental private information. [forthcoming JIMF 2004] JEL-Classification:
Empirical research has shown that inexperienced fund managers yield significantly higher returns than their more experienced colleagues. If the portfolios of inexperienced are not more risky, this result would contradict the hypothesis of market efficiency. Therefore, it is an important question whether inexperienced fund managers tend to taker higher risks. Higher risk taking may be explained by a higher degree of overconfidence, less herding behavior, or a lower degree of risk aversion. Since the results concerning the relationship between experience and risk taking in previous studies are rather contradictory we provide complementary survey evidence of 117 German fund managers which can improve our understanding in this field. In line with the results of previous studies, we find that herding is decreasing with experience while the evidence concerning risk taking and overconfidence is mixed. Nevertheless, our results provide some support for the hypothesis that inexperienced managers do indeed take higher risks.
Our study analyzes the determinants of investors' risk taking behavior. We find that investors' risk taking behavior is affected by their subjective risk attitude and by the risk and return of an investment alternative. Our results also suggest that consistent with previous findings in the literature objective or historical return and volatility of a stock are not as good predictors of risk taking behavior as subjective risk and return measures. Moreover, we illustrate that overconfidence or more precisely miscalibration has an impact on risk behavior as predicted by theoretical models. However, our results regarding the effect of various determinants on risk taking behavior heavily depends on the domain the respective determinant is elicited. We interpret this as an indication for an extended domain specificity. In particular with the Markets of Financial Instruments Directive (MiFID) coming into effect we believe practitioners could improve on their investment advising process by incorporating some of the determinants we argue to influence investment behavior.
Miscalibration is a form of overconfidence examined in both psychology and economics. Although it is often analyzed in lab experiments, there is scant evidence about the effects of miscalibration in practice. We test whether top corporate executives are miscalibrated, and study the determinants of their miscalibration. We study a unique panel of over 11,600 probability distributions provided by top financial executives and spanning nearly a decade of stock market expectations. Our results show that financial executives are severely miscalibrated: realized market returns are within the executives’ 80% confidence intervals only 33% of the time. We show that miscalibration improves following poor market performance periods because forecasters extrapolate past returns when forming their lower forecast bound (“worst case scenario”), while they do not update the upper bound (“best case scenario”) as much. Finally, we link stock market miscalibration to miscalibration about own-firm project forecasts and increased corporate investment.
Theoretical models predict that overconfident investors trade excessively. We test this prediction by partitioning investors on gender. Psychological research demonstrates that, in areas such as finance, men are more overconfident than women. Thus, theory predicts that men will trade more excessively than women. Using account data for over 35,000 households from a large discount brokerage, we analyze the common stock investments of men and women from February 1991 through January 1997. We document that men trade 45 percent more than women. Trading reduces men's net returns by 2.65 percentage points a year as opposed to 1.72 percentage points for women. © 2000 the President and Fellows of Harvard College and the Massachusetts Institute of Technology
We study the asset pricing implications of Tversky and Kahneman's (1992) cumulative prospect theory, with a particular focus on its probability weighting component. Our main result, derived from a novel equilibrium with nonunique global optima, is that, in contrast to the prediction of a standard expected utility model, a security's own skewness can be priced: a positively skewed security can be "overpriced" and can earn a negative average excess return. We argue that our analysis offers a unifying way of thinking about a number of seemingly unrelated financial phenomena. (JEL D81, G11, G12)
Many prominent theorists have argued that accurate perceptions of the self, the world, and the future are essential for mental health. Yet considerable research evidence suggests that overly positive self-evaluations, exaggerated perceptions of control or mastery, and unrealistic optimism are characteristic of normal human thought. Moreover, these illusions appear to promote other criteria of mental health, including the ability to care about others, the ability to be happy or contented, and the ability to engage in productive and creative work. These strategies may succeed, in large part, because both the social world and cognitive-processing mechanisms impose filters on incoming information that distort it in a positive direction; negative information may be isolated and represented in as unthreatening a manner as possible. These positive illusions may be especially useful when an individual receives negative feedback or is otherwise threatened and may be especially adaptive under these circumstances.
Theoretical models predict that overconfident investors will trade more than rational investors. We directly test this hypothesis by correlating individual overconfidence scores with several measures of trading volume of individual investors. Approximately 3,000 online broker investors were asked to answer an internet questionnaire which was designed to measure various facets of overconfidence (miscalibration, volatility estimates, better than average effect). The measures of trading volume were calculated by the trades of 215 individual investors who answered the questionnaire. We find that investors who think that they are above average in terms of investment skills or past performance (but who did not have above average performance in the past) trade more. Measures of miscalibration are, contrary to theory, unrelated to measures of trading volume. This result is striking as theoretical models that incorporate overconfident investors mainly motivate this assumption by the calibration literature and model overconfidence as underestimation of the variance of signals. In connection with other recent findings, we conclude that the usual way of motivating and modeling overconfidence which is mainly based on the calibration literature has to be treated with caution. Moreover, our way of empirically evaluating behavioral finance models—the correlation of economic and psychological variables and the combination of psychometric measures of judgment biases (such as overconfidence scores) and field data'seems to be a promising way to better understand which psychological phenomena actually drive economic behavior. The Geneva Risk and Insurance Review (2007) 32, 1–36. doi:10.1007/s10713-007-0003-3
Explores the expectations of entrepreneurs in newlyestablished businesses regarding their own chances of success and theirpredictionsregarding the chances for success of others with similarstartup ideas, in one of the first such studies. Past research suggests that,at best, fewer than 50% of firms survive for more than five years with a givenowner/manager. Based on this past research, three hypotheses are posited:entrepreneurs will perceive their odds of success at less than or equal to 50%,entrepreneurs' prediction of others' success will not differ significantly fromtheir prediction of their own success, and entrepreneurs' expectations ofsuccess will be related to a number of personal factors including theirbusiness experience, prior ownership, and educational level. Data were gathered from surveys sent in 1985 to members of the NationalFederation of Independent Business (NFIB) who reported that they had openedtheir own businesses in the United States. Of those responding, 2994entrepreneurs were selected from the original sample. Findings did not support any of the three original hypotheses of cautiousoptimism (as prior research predicted). In fact, the results show thatentrepreneurs' perceptions of their own odds for success display a noteworthydegree of optimism. In addition, entrepreneurs believe their own odds ofsuccess to be greater than other new business owners with similar ideas.Furthermore, an analysis of the predicted factors for success showed aremarkable lack of relationship between an entrepreneur's belief of their ownpotential and the objective predictors. In fact, those who were poorly preparedseemed just as optimistic as those who were well prepared. One implication isthat business founders should seek advice from more objective outsiders.(SFL)
Judgmental expressions of uncertainty are widely used in decision making and are often required for decision analysis. This study examines the influence of two characteristics of time series graphs that affect the accuracy of judgmental estimates of forecast uncertainty estimates: scale of graphical presentation and level of variability in the series. The results indicate a strong effect on the accuracy of judgmental prediction intervals due to both the scale at which the time series are presented on the graphs and the variability of the series. At small (large) scales or low (high) variability the confidence intervals tended to be too wide (narrow). Furthermore, the provision of horizontal grid lines on the graphs and the magnitude of the values on the vertical axis were both found to influence the widths of the confidence intervals.
This paper provides a survey on studies that analyze the macroeconomic effects of intellectual property rights (IPR). The first part of this paper introduces different patent policy instruments and reviews their effects on R&D and economic growth. This part also discusses the distortionary effects and distributional consequences of IPR protection as well as empirical evidence on the effects of patent rights. Then, the second part considers the international aspects of IPR protection. In summary, this paper draws the following conclusions from the literature. Firstly, different patent policy instruments have different effects on R&D and growth. Secondly, there is empirical evidence supporting a positive relationship between IPR protection and innovation, but the evidence is stronger for developed countries than for developing countries. Thirdly, the optimal level of IPR protection should tradeoff the social benefits of enhanced innovation against the social costs of multiple distortions and income inequality. Finally, in an open economy, achieving the globally optimal level of protection requires an international coordination (rather than the harmonization) of IPR protection.
We examine changes in the stock trading behavior and investment performance of 1,607 investors who switch from phone based to online trading during the period 1991 to 1996. We compare their trading and performance to that of 1,607 investors with similar size accounts who did not trade online. We find that those who switch to online trading experience unusually strong performance prior to going online, beating the market by more than two percent annually. After going online, they trade more actively, more speculatively, and less profitably than before -- lagging the market by more than three percent annually. A rational response to reductions in market frictions (lower trading costs, improved execution speed, and greater ease of access) does not explain these findings. The increase in trading and reduction in performance of online investors can be explained by overconfidence augmented by self-attribution bias, the illusion of knowledge, and the illusion of control. 1 [The giant] tort...
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