Investor Overconfidence and the Security Market Line: New Evidence from China
62 Pages Posted: 27 Nov 2018 Last revised: 18 Jun 2020
Date Written: December 29, 2019
This paper documents a highly downward sloping security market line (SML) in China, which is more puzzling than the typical “flattened” SML in the US, and does not reconcile with existing theories of low-beta anomaly. We show that investor overconfidence offers some promises in resolving the puzzle in China: In the time-series dimension, the slope of the SML becomes more “inverted” when investors get more overconfident. This dynamic overconfidence effect is intensified with biased self-attribution. As a general symptom of overconfidence in the cross section, high-beta stocks are also the mostly heavily traded. After accounting for trading volume, there is no longer the low-beta anomaly at both the firm and portfolio levels. Mutual fund evidence reinforces the view that institutional investors actively exploit the portfolio implications of a downward sloping SML by shying away from high-beta stocks and betting on low-beta stocks for superior performance.
Keywords: Beta Anomaly, Betting Against Beta, Overconfidence, Trading Volume, Mutual Fund
JEL Classification: G11, G12, G15, G40
Suggested Citation: Suggested Citation