Overconfidence and turnover - Evidence from the Hong Kong stock market

Abstract: High trading volume is a common phenomenon in global financial markets, and it seems to go against the paradigm of classic economic theory based on rational agents and efficient markets. In this thesis, we turn to behavioral finance, as we try to explain this anomaly as a consequence of the so-called overconfidence bias. According to previous research, market return influences the level of overconfidence and overconfidence is the key factor leading to excessive trading. This thesis aims at investigating empirically whether overconfidence exists in the Hong Kong stock market. We construct a market-wide VAR model to investigate the lead-lag relationship between return and turnover, the presence of which can be considered as evidence of overconfidence. Our results suggest that investors are indeed overconfident in the Hong Kong market. To distinguish overconfidence from the disposition effect, we develop an individual security model by using a panel data approach. The empirical findings from the individual security model suggest that the overconfidence found in the Hong Kong market is not just an aggregation of individual disposition effects. Although the disposition effect may also be used as an explanation of the interaction between return and turnover, we find that overconfidence dominates in the Hong Kong stock market.