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Disposed to Be Overconfident

Author

Listed:
  • Katrin Gödker
  • Terrance Odean
  • Paul Smeets

Abstract

We show that the disposition effect–the tendency of investors to hold losers and sell winners–can be a source of overconfidence. We find experimental evidence that individuals update beliefs about their own investment ability based on realized gains and losses rather than the overall performance of their portfolio. We also find supporting field evidence. Dutch retail investors who realized more gains than losses believe they have higher portfolio performance relative to other investors, even after controlling for their actual portfolio performance. We develop a formal model demonstrating how the disposition effect leads to overconfidence and examine model implications for investors’ trading behavior and expected profit.

Suggested Citation

  • Katrin Gödker & Terrance Odean & Paul Smeets, 2023. "Disposed to Be Overconfident," CESifo Working Paper Series 10357, CESifo.
    • Handle: RePEc:ces:ceswps:_10357
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    References listed on IDEAS

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    Cited by:

    1. Barron, Kai & Huck, Steffen & Jehiel, Philippe, 2019. "Everyday econometricians: Selection neglect and overoptimism when learning from others," Discussion Papers, Research Unit: Economics of Change SP II 2019-301, WZB Berlin Social Science Center.

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    More about this item

    Keywords

    investor beliefs; disposition effect; overconfidence; experimental finance;
    All these keywords.

    JEL classification:

    • D01 - Microeconomics - - General - - - Microeconomic Behavior: Underlying Principles
    • G40 - Financial Economics - - Behavioral Finance - - - General

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