Beyond Fundamentals: How Investor Overconfidence Shapes Firm Valuation in India

Purpose: This study investigates the impact of investor overconfidence on firm valuation within India’s dynamic and rapidly evolving equity market. Anchored in behavioural finance theory, which posits that cognitive biases and limits to arbitrage generate persistent mispricing, the analysis explores how overconfident trading behaviour contributes to valuation distortions. Overconfident investors tend to trade excessively and react asymmetrically to gains versus losses, leading to systematic deviations from firms’ intrinsic values. Methodology: Utilizing a balanced panel of 1,367 continuously listed non-financial firms over the period April 2000 to March 2023, the study employs firm-fixed effects regressions and dynamic panel estimations using the Arellano-Bond Generalized Method of Moments (GMM). This methodological approach addresses potential issues of unobserved heterogeneity and endogeneity. To enhance empirical robustness, multiple proxies for investor overconfidence are implemented, including abnormal trading volume, turnover ratios, and changes in share issuance. Findings: The results reveal a statistically significant positive association between investor overconfidence and firm valuation. This indicates that behavioural biases among investors contribute to sustained pricing inefficiencies, with overconfidence playing a key role in driving firm valuations above their intrinsic worth. The findings underscore the persistence of behavioural anomalies in price formation, especially within the context of an emerging market like India. Unique Contribution to Theory, Policy, and Practice: Theoretically, this study enriches the behavioural finance literature by providing robust evidence that overconfidence-induced trading behaviour influences firm valuation, supporting the view that psychological factors can lead to systematic mispricing. From a policy perspective, the findings highlight the need for regulatory frameworks that mitigate sentiment-driven inefficiencies in capital markets.