COVID-19 and overconfidence bias: the case of developed, emerging and frontier markets

Abstract

PurposeThe main purpose of the present study is to delve into the overconfidence bias in global stock markets during both pre COVID-19 and COVID-19 phases.Design/methodology/approachThe present study makes use of daily adjusted closing prices and volume of the broad market indices of 46 global stock markets over a period ranging from July 2015 till June 2020. The sample period is split into pre COVID-19 and COVID-19 phases. In order to test the overconfidence fallacy in the chosen stock markets, bivariate market-wide vector auto regression (VAR) models and impulse response functions (IRFs) have been employed in both phases.FindingsA highly significant contemporaneous relationship between market return and volume appears to be more pronounced in the Japanese, US, Chinese and Vietnamese stock markets in the pre COVID-19 era for the relevant coefficients are positive and highly significant for most lags. Coming to the period of turbulence, the present study discovers strong overconfident behavior in the Chinese, Taiwanese, Turkish, Jordanian and Vietnamese stock markets during COVID-19 phase.Practical implicationsA stark finding is that none of the developed stock markets reveal strong overconfidence bias during pandemic, suggesting a loss or decline in the investors' confidence. Therefore, the regulators should try to regain the investors' trust and confidence in the markets by ensuring honest, fair and transparent practices. The money managers should reduce the transaction cost to encourage trading and educate investors to hold a well-diversified portfolio to mitigate risk in the long run. The governments may launch recovery packages focusing on sustaining and improving economic activities. Finally, a better investment culture may be built by the corporate houses through good corporate governance practices to regain lost trust.Originality/valueThe present study appears to be the very first attempt to gauge overconfidence bias in the wake of a recent COVID-19 pandemic.

Overconfidence bias and stock market volatility in Ghana: testing the rationality of investors in the Covid-19 era

“…Overconfident economic agents underestimate their risk and trade more, and this is evident in high volume of trading activities or excessive turnover documented on financial markets (Statman et al, 2006;Chuang and Lee, 2006;Prosad et al, 2017). Shrotryia and Kalra (2021) and Statman et al (2006) argued that overconfident market players trade more after market gains. Thus, one strand of the overconfidence bias framework suggests that the market players are overconfident, they ascribe market gains to their skills and astute to select securities and as a result, they trade more aggressively and excessively in the ensuing market periods.…”

“…Several studies have also tested this hypothesis on different markets. For instance, Metwally and Darwish (2015), Alsabban and Alarfj (2020), Shrotryia and Kalra (2021) and Kunjal and Peerbhai (2021) found evidence of overconfidence bias in the Egyptain stock market, options market, Saudi equity market, developed, emerging and frontier markets and South Africa exchange traded fund market, respectively.…”

“…With the exception of Shrotryia and Kalra (2021), none of these studies has examined the presence of overconfidence bias of market players during the Covid-19 pandemic period, and such studies are required to understand overconfidence bias of market agents during pandemic crisis period. Based on the empirical evidence supporting the overconfidence bias hypothesis of lead-lag relationship between market trading volume and market returns, the first testable hypothesis (H1) of overconfidence bias framework in this study is given as follows:…”

“…Second, this paper assesses how overconfidence bias contributes to the observed volatility on the Ghana stock market during the Covid-19 pandemic period. This is motivated by previous studies that document overconfidence bias on financial markets (Statman et al, 2006;Shrotryia and Kalra, 2021;Kunjal and Peerbhai, 2021) and the empirical evidence that overconfidence bias contribute to stock market volatility (Mushinada, 2020;Jlassi et al, 2014;Chuang and Lee, 2006). This study focuses on the market level due to the argument of Fama (1998) cited in Chuang and Lee (2006) that valid finance theory should be able to explain the market as a whole rather than a specific group or type of investors.…”

“…In the behavioral finance literature, several studies have been conducted to understand the erratic market movements and psychological variables triggering such moves (Liu et al, 2020). Shrotryia and Kalra (2021) examined the existence of overconfidence bias on emerging and frontier markets in the Covid-19 pandemic period and found evidence of overconfidence bias in the Covid-19 pandemic period. Similarly, Parveen et al (2021) revealed that the Covid-19 pandemic had an effect on the investor's behavior, investment decisions and trading volumes.…”