Financial Overconfidence Over Time — Foresight,

Hindsight, and Insight of Investors∗

Christoph Merkle†

August 2013

Abstract

Overconfidence leads to increased trading activity, higher risk taking, and less diversification.

In a panel survey of online brokerage clients, we ask for stock market and portfolio expectations

and derive several overconfidence measures from the responses. Overconfidence is present in

our sample in various forms. By matching survey data with investors’ actual transactions and

portfolio holdings, we find an influence of overplacement on trading activity, of overprecision

and overestimation on degree of diversification, and of overprecision and overplacement on risk

taking. We explore the evolution of overconfidence over time and identify a role of past success

and hindsight on subsequent degree of overconfidence.

JEL-Classification Codes: G02, G11

Keywords: Overconfidence, Trading, Diversification, Risk Taking, Expectations

∗
I am grateful to Barclays Stockbrokers for providing access to their online investor client base, and to Barclays
Wealth Behavioural Finance team for joint design and execution of the survey. I thank Greg Davies, Daniel Egan,
Simon Gervais, Markku Kaustia, Thomas Post, Martin Weber, and participants of the AFA 2013 annual meeting,
the EFA 2012 annual meeting, the BDRM 2012 conference, the SGF 2012 conference, the DGF 2012 conference,
the ZEW 2012 conference, and seminar participants in Maastricht and Mannheim. For research assistance, I thank
Robin Cindori. Research reported in this article was supported by the European Institute of Savings (OEE), Deutsche
Forschungsgemeinschaft (DFG, grant We993), and Stiegler Foundation.
†
Department of Banking and Finance, University of Mannheim, (chmerkle@mail.uni-mannheim.de).
1 Introduction

Overconfidence is now for more than a decade among the most popular psychological explanations

for investing behavior of private households. It has been linked to portfolio turnover (Odean 1998b,

Glaser and Weber 2007a), diversification (Goetzmann and Kumar 2008) and risk taking (Dorn

and Huberman 2005, Nosić and Weber 2010) of investors. The implications of overconfidence in

this context are mostly viewed negatively, leading to excessive trading, underdiversification, and

increased risk taking. However, past research is incomplete in both the empirical measurement of

overconfidence and the covered aspects of investing behavior. Moreover, little is known about the

development of financial overconfidence over time and its dynamic interaction with trading behavior.

We fill these gaps by providing for the first time a comprehensive study of financial overconfidence

in its different facets, its consequences for various aspects of actual investing behavior, and its

development over time.

In a panel survey of private investors at a large UK bank, we ask participants for their return

expectation and risk perceptions regarding the UK stock market and their own portfolios. From

these expectations we construct measures of overconfidence related to the three types of overconfi-

dence commonly identified in the literature: overestimation, overplacement, and overprecision (cp.

Moore and Healy 2008). The survey is administered every three months between September 2008

and September 2010 resulting in a total of nine survey rounds, which cover one of the most inter-

esting times in recent stock market history. Participants are affluent, self-directed investors, who

own on online brokerage account at the bank. Their transactions are recorded, which allows us to

combine the survey responses with the actual trades and portfolio holdings of participants. The

trading and portfolio data include information about trading frequency, turnover, diversification,

1
and risk taking of investors. This enables us to analyze in a dynamic setting the most prevalent

phenomena that have been linked to overconfidence.

We first document the presence of overconfidence in its various facets in our panel. Participants

on average overestimate their portfolio returns and Sharpe ratio by a large degree compared to

realized values. They further believe that their own portfolios will outperform the market, while

at the same time they perceive these portfolios as less risky. This finding of overplacement is

supported by survey responses in which participants describe themselves to be better informed, more

experienced and more skillful in investing than the average person. Overprecision is also widespread

in the investor population. Depending on whether return confidence intervals are compared to

historical volatilities or option implicit volatilities, elicited confidence intervals are too narrow by

a factor of two to four. This miscalibration tends to be worse for own portfolios than for the

market in general. While for most measures a majority of participants exhibit overconfidence, we

still observe great cross-sectional heterogeneity, which is the prerequisite to explain differential

behavior in trading and risk-taking.

We show a positive relationship between overplacement and trading activity, as well as between

overplacement, overprecision, and risk-taking. At the same time, there is a negative influence of

overestimation and overprecision on the degree of diversification. We do not find overprecision to

be relevant for trading activity, which is in contrast to the theoretic literature on overconfidence

in finance (Odean 1998b, Daniel, Hirshleifer, and Subrahmanyam 1998), but in line with previous

empirical results (Glaser and Weber 2007a, Graham, Harvey, and Huang 2009). All findings are

established in panel regression designs, suggesting a dynamic relationship between overconfidence

and trading behavior which goes beyond the view of overconfidence as a stable personality trait.

2
The findings suggest a nuanced role of financial overconfidence for all examined aspects of investing

behavior, and they round off and clarify the previous view on this complex relationship.

To learn more about the dynamics of overconfidence, we examine the individual variability of

overconfidence over time and its possible causes. It has been proposed that this variability is driven

by past investment success and failure, with success leading to an increase in overconfidence through

a self-attribution bias (Gervais and Odean 2001, Daniel, Hirshleifer, and Subrahmanyam 1998). We

indeed find a strong influence of past investment success on overprecision and overestimation for

the subsequent estimation period, but no effect on overplacement. This means that after having

outperformed the market investors overestimate their returns in the future and submit more narrow

confidence intervals.

Alternatively, perceived success not necessarily backed by reality might affect overconfidence

(cp. Barberis and Thaler 2003). While we observe a positive correlation between perceived and

actual portfolio returns, which shows that investors have some idea about their realized perfor-

mance, still estimation errors are large and wide-spread. Although investors do not consistently

overrate their past performance, perceived past success nevertheless contributes to increased levels

of overconfidence in foresight. We find that investors, who hold inflated views about past portfolio

returns are subsequently subject to higher levels of overplacement.

We extend the existing literature in two major ways, first by a systematic and multi-dimensional

treatment of overconfidence and investing behavior. We establishing a relationship between over-

confidence (in its various types) on the one hand and trading activity, portfolio diversification,

and risk taking on the other. Before, this link has often been only theoretically postulated

(Odean 1998b), verified by proxies such as gender (Barber and Odean 2001), or the analysis has

been restricted to one particular form of overconfidence (Graham, Harvey, and Huang 2009, Grin-

3
blatt and Keloharju 2009). In rare cases two types of overconfidence were considered (Glaser and

Weber 2007a), but with the dependent variable limited to trading volume. Secondly, we aim for a

better understanding of the dynamic development of overconfidence as suggested by Gervais and

Odean (2001). We confirm that financial overconfidence increases after an actual or perceived in-

vestment success. This question is empirically mainly unstudied, with the exception of Deaves,

Lüders, and Schröder (2010) for the case of overprecision.

2 Literature and Hypotheses

Overconfidence is a well-documented bias in the psychology of judgment and has readily found its

way into finance literature. While the notion of overconfident investors seems to have some immedi-

ate appeal in describing the behavior of financial market participants, recent evidence suggests that

the underlying mechanisms are more complex. First of all, the term overconfidence encompasses

at least three distinct phenomena to which we will refer to as “types of overconfidence”. In ana-

lyzing these different types, we adopt the terminology of Moore and Healy (2008), who distinguish

between overestimation, overplacement, and overprecision.1

Overestimation: People can be overconfident with regard to their absolute ability or perfor-

mance in a domain. They overestimate their personal outcome, for example the grade they will

achieve in an exam or the time they will need to run a Marathon (Grieco and Hogarth 2009).

Overestimation is often demonstrated in performance judgments after experimental tasks, and it

has been shown that levels of overestimation increase with difficulty and personal importance of

the tasks (Moore and Healy 2008, Frank 1935). Investing ranks high on both dimensions, therefore

we expect considerable overestimation in judgments of financial performance.

1
Often also overoptimism (Weinstein 1980) and illusion of control (Langer 1975) are associated with overconfidence
in a broad interpretation of the term.

4
Overplacement: When it comes to relative comparisons within a group, the counterpart to over-

estimation is overplacement, also known as the better-than-average effect (for a review cp. Alicke

and Govorun 2005). It describes the tendency of people to view themselves above average in many

domains, for example almost 90% of a sample of US drivers claim to be better than the average

person with regard to driving safety (Svenson 1981). Overplacement is present in judgments of skills

and abilities (Kruger and Dunning 1999) as well as personality traits (Alicke, Klotz, Breitenbecher,

Yurak, and Vredenburg 1995). In contrast to overestimation, levels of overplacement are highest

for easy tasks (Kruger 1999, Moore and Cain 2007).

Overprecision: Another variant of overconfidence occurs in the estimation of unknown values,

specifically in questions for ranges in which this value will fall with a certain probability. Usually

people show overprecision and submit far too narrow intervals (Alpert and Raiffa 1982, Klayman

and Soll 2004), regardless whether general knowledge questions (e.g. “length of the Nile”, cp. Russo

and Schoemaker 1992) or financial values (e.g. “value of the Dow in one year”, cp. Glaser, Langer,

and Weber 2009) are target of the estimation. Often less than 50% of the true values fall within

90% confidence intervals, indicating severe miscalibration.

While it has been argued that the three presented types of overconfidence share a common

psychological basis (Larrick, Burson, and Soll 2007), correlations are often found to be low or

even negative (Glaser, Langer, and Weber 2009, Moore and Healy 2008). General statements of

overconfidence causing investment biases might thus be too imprecise, and it seems worthwhile to

document and to study the different types of overconfidence separately. As our first hypothesis, we

predict that overconfidence is present in our sample.

5
H1: Private investors are overconfident with regard to their financial market expec-

tations. Overconfidence materializes in the form of overestimation, overplace-

ment, and overprecision.

H1a: Different types of overconfidence are unrelated.

Overconfidence has been introduced to finance to explain long-standing anomalies in in-

vestor behavior such as underdiversification (Blume and Friend 1975) and excessive trading

(Odean 1999, Barber and Odean 2000). The economic intuition is that overconfident investors

believe in their investing skills and their private information, and therefore they engage in fre-

quent trades, concentrate on few favorable assets, and take on additional risk. In financial mod-

els, overprecision has been linked to increased trading volume and overreaction in stock markets

(Odean 1998b, Daniel, Hirshleifer, and Subrahmanyam 1998). This theoretic link is used by Odean

(1999) and Barber and Odean (2000) to motivate their findings of high individual trading activity,

but the relationship is established on argumentative grounds rather than on direct empirical ob-

servation. Barber and Odean (2001) introduce gender as a proxy for overconfidence and find that

men trade more frequently than women. However, gender might as well proxy for risk-aversion or

other properties.

More recent studies relate empirical measures of overconfidence from surveys to trading behavior

of investors. Glaser and Weber (2007a) find a positive effect of overplacement on individual trading

volume, but contrary to theory they do not observe an influence of overprecision. Graham, Harvey,

and Huang (2009) confirm the role of overplacement using a measure based on return expectation.

They further demonstrate a strong effect of investors’ perceived competence, which might be related

to overconfidence. Dorn and Huberman (2005) also report a positive impact of overplacement on

turnover, while they find no effect of measures for biased self-attribution and illusion of control.

6
Finally, Grinblatt and Keloharju (2009) show a positive influence of overconfidence (self-confidence

corrected for competence) on trading activity.

None of the three overconfidence measures in Dorn and Huberman (2005) is found to be related

to portfolio diversification, and results for risk-taking are mixed, depending on whether fraction

of risky investments or portfolio volatility is analyzed. Goetzmann and Kumar (2008) employ a

different strategy to identify an effect of overconfidence on diversification: They use turnover as a

proxy for overconfidence and find a negative effect of turnover on diversification. This result relies

on a robust relationship between overconfidence and turnover and leaves open which type of over-

confidence drives the effect. Nosić and Weber (2010) experimentally test for a relationship between

overconfidence and risk-taking and show an increase in risk-taking with higher overprecision.

Finance literature in general supports the view that there is a fairly established effect of over-

confidence (in particular overplacement) on trading volume, while its role for diversification and

risk-taking is less well understood (cp. a recent review by Barber and Odean 2011). We systemati-

cally analyze the effect of all types of overconfidence on the different aspects of investing behavior

and predict a detrimental influence of overconfidence.

H2: Overconfident investors trade more frequently, hold underdiversified portfolios

and take more financial risk.

The panel structure of our data allows us to explore the evolution of overconfidence among

investors over time. The models of Gervais and Odean (2001) and Daniel, Hirshleifer, and Sub-

rahmanyam (1998) suggest that overconfidence will change dynamically with success and failure.

Outcomes that confirm a person’s beliefs and actions tend to elevate confidence too much, while

contradicting outcomes weaken confidence too little. This biased self-attribution leads to greater

overconfidence after successes and reduced overconfidence after failure. Or, as Gervais and Odean

7
(2001) put it, investors “learn to be overconfident”. Deaves, Lüders, and Schröder (2010) provide

some evidence for financial professionals that indeed success in estimating returns of a stock mar-

ket index leads to higher overprecision in the subsequent period. The alternative hypothesis that

feedback helps people to become less overconfident or better calibrated has found little support

even in controlled experiments under ideal feedback conditions (cp. Pulford and Colman 1997, and

the literature therein).

While financial market outcomes can be measured objectively, it is possible that subjectively

perceived success is more important for the genesis of overconfidence. In particular, when actual and

perceived values fall apart and investors view the past rosier than justified. Hindsight effects have

been assumed to contribute to overconfidence (Hoch and Loewenstein 1989, Hawkins and Hastie

1990). Winman, Juslin, and Björkman (1998) show a systematic relation between hindsight bias

and overconfidence in foresight, which they describe as the confidence-hindsight mirror effect. In a

financial context, Barberis and Thaler (2003) suggest a similar effect to contribute to overconfidence.

However, Biais and Weber (2009) experimentally do not find an interaction between hindsight

and overconfidence. We adopt a broad notion of hindsight, which includes overestimation of past

investment success. We expect hindsight to contribute to overconfidence.

H3: Overconfidence depends on previous outcomes. Success (whether actual or

merely perceived) leads to increased overconfidence.

3 Data

To test for overconfidence and its consequences for investing behavior, we obtain survey responses

and transaction data for a sample of clients at Barclays Stockbrokers, a UK direct brokerage

8
provider. Barclays is one of the largest banks in the UK and attracts a wide variety of customers

(for demographic characteristics of its clients see Egan, Merkle, and Weber 2010). The accounts are

self-directed in the sense that customers receive no direct investment advice, but they can inform

themselves on special web pages provided by the bank; most transactions are processed online.

In cooperation with Barclays Wealth, we conduct a repeated survey, which takes place every

three months, starts in September 2008 and ends in September 2010. For the initial survey a sample

of the banks client base is invited via e-mail to participate in the online questionnaire.2 In total

617 clients of the bank participate in the survey, 394 of which participate multiple times. We have

a minimum of 130 observations for each of the nine rounds.

Our data also include the trading records of all investors, who at least once respond to the panel

survey. For the time period between June 2008 and December 2010, we observe 49,372 trades with

a total trading volume of £258,940,694.3 . Of these trades about 75% are in stocks, the remaining

trades include bonds, derivatives, mutual funds, and ETFs. Panel A of table 1 shows descriptive

statistics of investors trading activity on a per round basis (3 months). On average 70% of investors

trade within each survey period, among those who trade the mean trading frequency is 11.9 (median

5) and mean trading volume is £62,943 (median £9,499). Trading activity is highly skewed with

some very frequent and high volume traders. We calculate turnover by dividing trading volume

through the sum of the portfolio value at the beginning and the end of each survey period.4 Average

three-month turnover is 39% of portfolio value (median 9.8%), if investors who do not trade are

taken into account this value drops to 28% (3.1%). We will later use the variables of Panel A as

our measures for trading activity.

2
The stratified sampling procedure is described in detail in Weber, Weber, and Nosić (2012). Note, however, that
they only use the first four rounds of the survey, and thus numbers on multiple participants will differ from ours.
3
We include three month prior to our first survey round and three month after our last survey round
4
The convention to use twice the portfolio value (or half of trading volume) has been introduced by Odean (1999).
He finds average monthly turnover of 6.5%, while Dorn and Huberman (2005) report 18%. Scaled down to one month,
our value lies between these results.

9
 Combining trading data with a snapshot of investors’ portfolios we are able to calculate portfolio

statistics for our survey period. The median portfolio is worth £41,687 (mean £314,663). Panel B of

table 1 shows our measures for degree of diversification. A simple indicator is the number of portfolio

positions investors hold. Most investors own less than 20 assets, with the average (median) at 15.7

(12). This exceeds typical values in other studies on individual investors (Barber and Odean (2000):

average 4.3, Goetzmann and Kumar (2008): 4.7, Glaser and Weber (2009): 6.8), but is still less

than theoretically necessary to obtain a “well-diversified” portfolio (> 30 stocks, Statman 1987).

We calculate a Herfindahl-Hirschmann-Index (HHI) of portfolio diversification by taking for each

investor the sum of squared portfolio weights. We follow the methodology of Dorn and Huberman

(2005) in treating mutual funds as if they consisted of 100 equally-weighted positions. The median

HHI amounts to 0.14, which corresponds to a portfolio of seven equally weighted securities. The

above reported number of portfolio positions thus overstates the degree of diversification among

investors. As a further measure of portfolio diversification, we consider normalized variance as

defined by Goetzmann and Kumar (2008). Normalized variance is the ratio of portfolio return

variance and average return variance of assets in the portfolio. The mean value of 0.55 suggests

that portfolio diversification reduces variance by about one half; again there is great cross-sectional

heterogeneity.

Panel C of table 1 displays measures of portfolio risk we use to analyze financial risk taking of

investors. We calculate portfolio return volatility over a one-year horizon. The mean of 0.37 is well

above average UK stock market volatility during the same period of time (0.26). This is reflected

also in relative volatility, which we define as portfolio volatility divided by market volatility. But

higher risk taking is not explained by higher exposure to market risk, as the average portfolio beta

is just 0.84. Instead, the lack of diversification is responsible for high risk levels of investors. Dorn

and Huberman (2010) argue that portfolio based measures are hard to evaluate for investors, as

10
they orient themselves at individual securities and disregard correlations between securities; they

instead propose a value-weighted average of the return volatilities of portfolio components. This

average component volatility (ACV) with a mean of 0.47 exceeds portfolio volatility, as already the

related measure of normalized variance suggested.

4 Financial Overconfidence

4.1 Overprecision

We begin our analysis of investor overconfidence with overprecision (or miscalibration), as it is con-

stituent for financial models of overconfidence. In Odean (1998b) traders overestimate the precision

of a private signal they receive, which then renders their posteriors more precise than those of a well-

calibrated trader. They consequently underestimate the volatility of assets. Empirically, confidence

intervals are frequently used to elicit a measure for precision (e.g. Glaser and Weber 2007a, Deaves,

Lüders, and Schröder 2010, Glaser, Langer, and Weber 2009). Our survey questions are designed

similarly to those studies:

We would like you to make three estimates of the return of the UK stock market (FTSE all-share)
by the end of the next three month.

- Your best estimate should be your best guess.

- Your high estimate should very rarely be lower than the actual outcome of the FTSE all-share
(about once in 20 occasions)
- Your low estimate should very rarely be higher than the actual outcome of the FTSE all-share
(about once in 20 occasions)

Please enter your response as a percentage change.

Participants are asked to submit a best estimate for the return of the UK stock market and, in

an additional question, also for their own portfolios. Both estimates are made for a time horizon

of three months to avoid overlapping observations. The best estimate is in each case followed by

11
questions for a high and a low estimate, which together yield a 90%-confidence interval. Applying

the method of Keefer and Bodily (1983), it is possible to back out implicit expected volatility from

these confidence intervals. We prefer this indirect way of elicitation to direct volatility estimates,

as it is simpler and more intuitive (cp. Dave, Eckel, Johnson, and Rojas 2010).

The width of predicted confidence intervals for stock market returns is on average about 23%-

points. Participants submitted slightly larger confidence intervals for own portfolios, but the median

confidence interval is in both cases 20%-points wide. This translates into a volatility of 0.12 on a

yearly basis. Given that people hold very different portfolios, it is no surprise that the standard

deviation of confidence intervals is larger for portfolio returns. To assess whether these confidence

intervals are well calibrated, we use historical volatility of the stock market and of investors’ portfo-

lios as a benchmark.5 Our miscalibration measures are defined as the difference between benchmark

volatility and estimated volatility from confidence intervals.6 The descriptive statistics in table 2

reveal that investors exhibit strong overprecision. Their volatility estimates fall short benchmark

volatilities by on average 0.14 (market) to 0.23 (portfolios), meaning that their confidence intervals

are too narrow by a factor 2 to 2.5. Miscalibration significantly exceeds the neutral value of zero

(p < 0.001). Almost 83% of all observations are overprecise for the stock market and 85% for own

portfolios.

Another way to assess calibration are hit rates, which should be close to 90% for 90% confi-

dence intervals. We calculate hit rates in the cross section of investors: Only about half of the time

do confidence intervals cover the later realized value. This shows that miscalibration is not only

present compared to some abstract benchmark, but also leads to investors frequently missing the
5
For the market additionally option implied volatility is available. As implied volatility reacts more quickly to
crisis events, miscalibration is even slightly stronger for this alternative benchmark.
6
While Glaser, Langer, and Weber (2009) simply use one divided by estimated volatility as a measure for over-
precision, in a panel study a benchmark volatility is crucial, as the same estimated volatility can be appropriate or
overprecise depending on the current market environment.

12
real outcome by their estimates.7 It has been argued that experts give more precise (and thus more

informative) estimates, while hit rates remain constant (McKenzie, Liersch, and Yaniv 2008). If

this was the case, our miscalibration measure would punish these more knowledgeable investors.

However, the correlation between miscalibration and hit rate is significantly negative (-0.37), sug-

gesting that narrower confidence intervals are not more informative. In general, our results support

H1 with regard to overprecision.

4.2 Overplacement

Measures for overplacement (or the better-than-average effect) involve a comparison to other in-

vestors. Graham, Harvey, and Huang (2009) propose the difference between forecasts of own portfo-

lio return and forecasts of the stock market return as a proxy for the better-than-average effect. The

interpretation is straightforward: Market returns define the average an investor can expect to earn

and any expected outperformance means to be better than this average. The above stated questions

for best estimates of portfolio return and stock market return allow us to calculate this expected

outperformance. Table 2 shows descriptive statistics for this variable. On average investors expect

to outperform the market by 2.9%-points (p < 0.001); given the time horizon of three months this

amount appears large. About 48% of the time investors expect that their portfolios returns will

exceed market returns, in further 33% of the cases they expect portfolio returns to match market

returns.

One may object that this measure does not take portfolio risk into account, and investors who

take more financial risk are correct in expecting higher returns. To accommodate for this possi-

bility we consider expected volatility of investors, both for their portfolio and the stock market.
7
In a strict sense the 90%-criterion applies only on an intra-personal basis, for which we have too few observations.
We nevertheless calculate the personal hit rate for those who participated at least five times. The average individual
hit rate is 0.48 and thus close to the overall hit rate.

13
We construct an expected Sharpe ratio for portfolios and the stock market.8 The difference be-

tween expected portfolio Sharpe ratio and expected market Sharpe ratio is an alternative proxy

for overplacement. On a risk-return basis 49% of investors expect to beat the market, with an

average Sharpe ratio difference 0f 0.3. The overplacement in portfolio expectations is perhaps best

illustrated in figure 1: consistently over all survey rounds average portfolio return expectations are

above average market return expectations (solid lines) and vice versa for risk expectations (dashed

lines). Investors thus believe to achieve higher returns while taking less risk. This outperformance

expectation is further backed by (unreported) survey responses about investment skills and finan-

cial.

4.3 Overestimation

While in finance there has been the casual observation that investors or managers are too op-

timistic about their return on investment (Dimson, Marsh, and Staunton 2004, Heaton 2002), a

formal empirical treatment of overconfidence in the form of overestimation is still missing. The

relationship between overestimation and optimism is obvious: those who are most optimistic are

most likely to fall short of their expectations, in particular if performance involves a large chance

element. Overestimation is defined as the difference between expected performance and actual per-

formance (cp. Moore and Healy 2008), in our case the difference between expected portfolio return

and realized portfolio return. Even though it is possible to define this variable also for market re-

turns, overestimation involves the notion of personal achievement, which is only present in portfolio

returns.

On average investors in the panel overestimate their portfolio return by 4.3 percentage points

(median 1.7, see table 2). While these figures are large and significant (p < 0.001), the propor-
8
We use the 3m-LIBOR as risk-free rate and set negative Sharpe ratios to zero, as these are not well-defined.

14
tion of overconfident investors is with 55% not overwhelmingly high. There is great heterogeneity

with strong overestimation and strong underestimation both present in the data. Given the partly

random nature of realized returns, one might suspect that effects in the time series drive this het-

erogeneity. For instance in the first round of the survey investors predict returns for Sep–Dec 2008,

which turn out to be catastrophic due to the progress of the financial crisis. Indeed in this round

overestimation reaches highs with an average of 17.9%-points and a proportion of 88% overconfi-

dent investors. However, within rounds the standard deviation is only slightly smaller than for the

whole panel, indicating that also differences between individuals are large and might contribute to

explain investing behavior. We confirm H1 with respect to the presence of overestimation in the

investor population.

As we have now collected evidence about all three types of overconfidence, we examine the rela-

tionship between these measures. Deaves, Lüders, and Luo (2009) report positive but low and not

significant correlations between different types of overconfidence, while Glaser and Weber (2007a)

find even a negative correlation between overprecision and overplacement (also not significant).

Panel B of table 2 shows a correlation matrix for the measures defined in this section. Overpreci-

sion variables are highly correlated among each other (0.71), but show slightly negative correlations

to other types of overconfidence. Not surprisingly, expected outperformance and the expectation to

beat the market Sharpe ratio are highly correlated (0.62). Overestimation is positively correlated

to expected outperformance (0.16), as both measures share portfolio return expectations as one

ingredient. But altogether, we can confirm H1a in the sense that different types of overconfidence

are at most very weakly related.

15
5 Investing Behavior and Overconfidence

We now bring together the two parts of our analysis: the investing behavior as portrayed in section

3 and the overconfidence measures as defined in section 4. Our goal is to systematically study

their relationship, whereas previous literature has mostly examined only parts of this picture.

Either the attention was limited to one aspect of investing behavior, or an incomplete typology of

overconfidence was considered. Our main contribution is to fill this gap in a dynamic panel setting.

5.1 Trading activity

As excessive trading has been most prominently related to overconfidence, we begin with trading

activity measures as our dependent variables. We use a trade dummy, which equals one if an investor

trades in the respective period, the number and volume of trades, and turnover (all variables as de-

fined in table 1). We take the natural logarithm of number of trades, volume of trades, and turnover

as these variables are strongly skewed. Miscalibration with respect to market returns serves as our

measure for overprecision. Due to the high correlation with portfolio miscalibration, we abstain

from including both variables simultaneously into the regression. However, our results are robust

to the use of other specifications, which also includes implied volatility as alternative benchmark.

For overplacement, we report results for both previously defined variables, based on return outper-

formance as well as based on Sharpe ratio outperformance. Finally, we include overestimation as

defined in table 2.

Besides our overconfidence measures, we account for self-reported risk tolerance, which was

identified by Dorn and Huberman (2005, p.437) as the “single most important determinant of both

portfolio diversification and turnover”. We measure risk tolerance as agreement to the statement

“It is likely I would invest a significant sum in a high risk investment” (on a seven-point scale).

16
Weber, Weber, and Nosić (2012) show that responses in this format are consistent with a more

complete assessment of risk attitudes. Further control variables include gender, age, family status,

income, wealth, and financial literacy. We also use time fixed effects based on rounds of the survey.

On average about 70% of all investors trade within a three-month period. We first examine this

decision to trade at all in a panel probit model. Columns (1) and (2) of table 3 show the results

of this regression. The propensity to trade seems not to be explained by overconfidence. As only

significant effect, men are more likely to trade, which confirms earlier results of gender and trading

activity (Barber and Odean 2001, Deaves, Lüders, and Luo 2009).

We next consider number of trades and trading volume in a panel GLS model with random

effects, which extends a simple OLS to a dynamic context and allows for dependencies in error

structure. We cluster standard errors by participant to account for heteroscedasticity and within-

panel autocorrelation. Columns (3) to (6) show a strong impact of risk attitude: more risk tolerant

investors trade more frequently and trade higher volumes. Among the overconfidence measures,

overplacement has a positive influence. Investors who expect to beat the market engage in more

trades and also trade higher volumes. This holds for both the return and Sharpe ratio measure.

Overprecision, contrary to our expectations, turns up with a significantly negative effect in some

regressions. This would mean that more overprecise investors actually trade less. Not surprisingly,

wealthy investors place larger trades, but do not trade more often. Turnover, which we analyze in

columns (7) and (8), represents the relation between trading volume and portfolio value. Results

confirm that investors who expect to outperform the market churn their portfolio more often.

Effects for risk tolerance and overprecision become insignificant. Male and more wealthy investors

also exhibit higher turnover.9

9
The latter result is in contrast to previous literature (e.g. Dorn and Huberman 2005); however, the effect turns
around if we use portfolio value as a wealth proxy (similar to Glaser and Weber 2007a). Our interpretation thus is
that especially investors with large outside wealth churn their portfolios often.

17
 In summary, except for propensity to trade, measures of overplacement (return outperformance

and Sharpe ratio outperformance) exert a positive effect on trading activity. Intuitively, investors

who feel more skillful than others engage more heavily in trading. The effect is also economically

meaningful, an investor, who believes to outperform the market by 5%-points, will trade about 2.7%

more often, has 6% higher trading volume and about 1.8% higher turnover. By now, there seems to

emerge a consensus that overplacement is the facet of overconfidence which is most predictive for

trading activity (Glaser and Weber 2007a, Graham, Harvey, and Huang 2009, Dorn and Huberman

2005, Deaves, Lüders, and Luo 2009). With this finding, we confirm hypothesis 2 that overconfidence

has a positive effect on trading activity.

5.2 Diversification

With number of portfolio positions, a Herfindahl-Hirschman-Index of portfolio weights, and normal-

ized variance, we introduced three indicators of portfolio diversification. For the regression analysis,

we take the natural logarithm of positions and HHI as these variables are skewed. As the measures

represent different aspects of diversification, we derive a common component by performing a prin-

cipal component analysis (PCA). The first principal component of this PCA captures about two

thirds of the variance and is highly correlated to the other diversification measures. We thus con-

sider it as an additional diversification proxy. To facilitate the interpretation of our results, it is

important that diversification decreases with higher values of HHI and normalized variance, while

it increases with number of portfolio positions and the PCA-measure. Again a GLS panel regression

with random effects is our main model, for normalized variance, which is bounded at 1, a tobit

regression is used.

18
 The set of independent variables remains the same as in our analysis of trading activity. One

exception is that we replace miscalibration with respect to market return by miscalibration of

portfolio returns, as diversification is a matter of how the own portfolio is perceived. Table 4

show the regression results for the different diversification measures. We observe a strong effect of

overprecision in portfolio return expectations on all diversification variables. Overprecision reduces

the number of portfolio positions, increases HHI and normalized variance, and decreases the PCA-

proxy of diversification. The intuition behind this effect is that investors who hold overly precise

beliefs about future portfolio returns are unaware of the benefits of diversification, which mainly

consist in reducing non-systematic portfolio risk and hereby narrowing the distribution of potential

outcomes. However, it is the very nature of overprecision that investors underestimate the width

of this distribution and are thus likely to underdiversify. Deaves, Lüders, and Luo (2009) argue

that calibration measures must be highly specific to explain investing behavior. Indeed, when we

replace miscalibration of portfolio returns by miscalibration of market returns, we do not find a

similar effect. Underestimating stock market volatility seems not to have as direct consequences for

portfolio diversification as underestimating portfolio volatility.

As a second overconfidence variable, overestimation contributes to portfolio underdiversification.

The sign of the overestimation coefficients is consistent for all diversification measures, and attains

significance except for number of positions. This means that investors who believe to be able to

identify some very profitable stocks tend to neglect diversification. In terms of economic magnitude,

an overestimation of portfolio returns by 10%-points will increase HHI by 2.4%. For overplacement,

we find mixed and mostly insignificant results. Hypothesis 2 thus also holds for diversification, in

this case with overprecision and overestimation as relevant types of overconfidence.

19
 Among the remaining variables, risk tolerant investors tend to hold more positions, and are also

better diversified with respect to the other measures (although not significantly so for HHI). This

result stands in contrast to the finding of Dorn and Huberman (2005) that risk averse investors hold

better diversified portfolios. An explanation could be that in a panel setting rounds of high trading

activity often coincide with a more diverse inventory of assets, a connection that is much weaker

for a longer time span. Indeed, when we run a static regression on average portfolio positions, the

effect turns around. With respect to demographics, older investors tend to hold better diversified

portfolios, as do wealthier investors. For wealth the relation is particularly strong for number of

portfolio positions, which is not surprising as wealthy investors hold larger portfolios. The weaker

result for other diversification measures leaves open, whether the mechanical accumulation of assets

or a genuine understanding of diversification drives this influence. With age it remains unclear,

whether older investors become indeed wiser or if they just through the course of their lives have

collected a larger number of portfolio holdings. Similar age and wealth effects on diversification are

observed by Goetzmann and Kumar (2008) and Dorn and Huberman (2005).

5.3 Risk taking

Compared to other aspects of investing behavior, the relationship between overconfidence and risk

taking has found less attention in finance literature. Using the same dataset, Merkle and Weber

(2012) and Weber, Weber, and Nosić (2012) identify determinants of risk taking behavior. They

find a strong influence of return and risk expectations on actual portfolio risk and hypothetical

risk taking. As our overconfidence variables are mainly based on expectations, we need to carefully

control for these effects. As defined in section 3, risk taking measures are portfolio volatility, relative

volatility, average component volatility (ACV), and portfolio beta. We take the natural logarithm

20
of volatility and ACV, as they are skewed. We again rely on a panel regression with random effects,

clustered standard errors, and time dummies.

Table 5 displays regression results of risk taking behavior explained by overconfidence and con-

trols. We find an influence of overprecision and overplacement, which both contribute to increased

risk taking. Participants who underestimate the range of possible market returns and those who

expect to beat the market on a risk adjusted basis invest more riskily. There is no effect of over-

estimation. The strength of the result varies with the different risk measures and is weakest for

portfolio beta and ACV. A possible explanation is that these concepts are less able to capture

how investors actually manage the riskiness of their portfolios. Risk taking also increases for higher

return expectations, but there is little effect of risk attitude and risk expectations (cp. Merkle and

Weber 2012). The coefficients for demographic variables show that older and wealthier investors

take less risk, while male and financially less sophisticated participants invest more riskily.

The analysis of portfolio risk is marred by a potential reverse causality problem, as investors

who take higher risk will as a consequence expect higher portfolio returns and higher portfolio risk.

Therefore using portfolio expectations to explain risk taking can easily lead to wrong conclusions.

We instead included market expectations into the regressions, which are less vulnerable to this

reverse causality. Similarly, instead of portfolio return overprecision, we relied on market return

overprecision as explanatory variable. This strategy is not available for expected outperformance,

as it is based on the difference between portfolio and market expectations. Therefore the results

have to be interpreted with caution: investors who take higher portfolio risk might reasonably

expect higher portfolio returns. However, they have no reason to anticipate higher Sharpe ratios as

this variable takes portfolio risk into account. We find the positive influence on risk taking also for

21
overplacement based on Sharpe ratio, which supports the view that overconfidence indeed induces

risk taking.

We thus confirm hypothesis 2 by establishing a positive relation between overprecision, over-

placement and actual portfolio risk. For overprecision, Nosić and Weber (2010) come to the same

conclusion in an experimental setting. But unlike overtrading and underdiversification, higher risk

taking per se is not an investing bias. We nevertheless believe that overconfidence leads to some

unintended results also in the domain of risk taking. Considering the miscalibration in the assess-

ment of possible outcomes, it seems that in particular those who invest more riskily are not fully

aware of the potential consequences. Compared to a realistic appraisal of possible outcomes, they

invest too much given their risk preferences. In addition, inflated Sharpe ratio expectations suggest

a better risk-return trade-off than actually available on the market. Therefore, it may be justified

to conclude that overconfidence induces excessive risk taking.

6 Dynamics of Overconfidence

6.1 Investment Success

Given the impact of different types of overconfidence on various aspects of investing behavior, it

is important to understand the dynamic development of overconfidence over time. Hypothesis 3

suggests a role of past outcomes, in particular investment success, for future overconfidence. We

divide participants into two groups, those who experienced portfolio returns that exceeded market

returns in the past three months (survey period) and those who experienced portfolio returns

lower than market returns. According to the learning-to-be-overconfident hypothesis, those who

outperformed the market are expected to become more overconfident (Gervais and Odean 2001).

22
Table 6 shows levels and changes of portfolio expectations and overconfidence measures for the two

groups of investors.

Successful investors expect higher portfolio returns in the future (7% vs. 6%), and they increase

their return expectations compared to the previous round more strongly. This gives rise to more

pronounced overplacement: levels and changes of expected outperformance and Sharpe ratio outper-

formance are always higher for previously successful investors. However, differences are in general

not large and only marginally significant, for instance successful investors expect to outperform

the market by 3.1% and unsuccessful investors by 2.7%. We find stronger results for overprecision,

where previously successful investors become more miscalibrated both for the overall market and

their own portfolios. While their increase in overprecision is between 1.4 and 2%-points, there is a

slight decrease for unsuccessful investors. The differences in levels are also large. The effect of suc-

cess on overestimation is ambiguous, while it does decrease more strongly for unsuccessful investors,

their levels for overestimation are higher.10

A more sophisticated approach to evaluate investment success is to calculate investor’s alphas

from a one-factor model. Investment success measured by alpha is highly correlated with simple

outperformance (ρ = 0.70), and results with respect to overconfidence are very similar. In both

cases, investment success might either represent skill or luck and can thus be easily linked to the

attribution bias often assumed to be responsible for dynamic overconfidence. Investors with positive

outperformance or alpha believe it to result from skill, while investors with negative outperformance

or alpha attribute it to bad luck. Table 6 shows slight evidence for the suggested asymmetry, the

changes measures (except overestimation) are not significantly different from 0 in case of under-

performance, i.e. no downward adjustment of expectations takes place. This is consistent with
10
Persistence in portfolio return might be a reason, as both the measure of investment success and overestimation
are partly based on realized portfolio returns. Investment success increases in (past) portfolio performance, while
overestimation decreases in (future) portfolio performance.

23
investors interpreting negative outcomes as bad luck. On the other hand, overconfidence increases

after investment success in line with a stronger belief in own skills.

We use a fixed-effects model to regress levels of overconfidence on investment success and con-

trols. This specification removes the influence of individual investor characteristics and focuses

on within-effects. It is thus most suitable to analyze the learning-to-be-overconfident hypothesis.

For investment success, we use the difference between portfolio returns and market returns for

the previous three months. We control for changes in market return and market volatility, which

characterize the current market environment.11 Panel A of table 7 reports the results of these re-

gressions. Columns (1) and (3) show that the level of overprecision is higher for investors, who

were previously successful. There is a strong effect of market volatility, which illustrates that with

rising volatility investors become more miscalibrated, as they adjust their confidence intervals too

little. When market returns rise, overprecision is also more common. In columns (2) and (4), we

add the lagged level of overprecision, which means that we now concentrate on the change in over-

precision. We still find a positive effect of investment success on overprecision. This implies that

investment success and overconfidence are not just related in the sense of a correlation, but the

level of overconfidence will increase when successful.

For overplacement, there is no comparable result, as already the descriptive statistics suggested.

The effect of investment success remains insignificant (see columns 5–8). The control variables

show that with rising market return and volatility, investors feel less able to beat the market. A

somewhat different picture emerges for overestimation (columns 9–10), while investment success

does not significantly increase the level of overestimation, it has a strong effect on the change
11
We cannot include time fixed effects in this regression as we already use individual fixed effects. Cp. Deaves,
Lüders, and Schröder (2010) for a similar regression design.

24
of overestimation.12 The results for market return and volatility are similar to those found for

overplacement.

6.2 Perceived success

One reason for the mixed relevance of previous outcomes for subsequent overconfidence might be

that investors are not fully aware of the realizations of these outcomes. The survey does not provide

them with information on past returns, and investors’ beliefs in retrospect might differ from the

returns we calculate. Therefore, a survey questions asks investors explicitly for past market returns

and portfolio returns. We can thus compare investors’ hindsight on returns and the actual values,

which for a fully rational investor should be perfectly correlated. Taking into account bounded

rationality or limited information, we still expect a positive correlation. We indeed find a positive

Pearson-correlation of 0.50 for portfolio returns and of even 0.68 for market returns. This is contrary

to Glaser and Weber (2007b), who report no correlation between hindsight portfolio return estimates

and realized values. A possible explanation is that during our survey period attention to investment

returns is amplified due to the financial crisis. Moreover, Glaser and Weber (2007b) use a time period

of three years, which renders estimation harder.

Despite this better ability to assess past performance, there are still severe estimation errors.

The absolute difference between estimates and realizations indicates their magnitude. Median esti-

mation errors are large, 5.3%-points for market returns and even 8.5%-points for portfolio returns.

However, one has to take into account that in the volatile market environment at the time of our

survey, any errors of investors are exacerbated.13 The sign of the calculated difference indicates
12
In column (10) we modify the previous econometric strategy by not including lagged overestimation, but instead
using the change of overestimation as the dependent variable. This is due to the fact that past levels of overestimation
are not independent of past investment success (both use realized portfolio return as an ingredient).
13
A source of estimation error participants are not responsible for is potential imprecision in calculation of realized
returns. We use price data from Thomson Reuters Datastream which covers more than 90% of portfolio holdings,

25
whether investors systematically over- or underestimate past performance. Investors overestimate

past market returns by on average 2.4%-points (p < 0.01), but show no systematic bias for their

own past portfolio performance.

To mirror the earlier analysis, we measure perceived investment success as the difference be-

tween perceived portfolio return and perceived market return, both for the previous 3 months (one

survey period). Hypothesis 4 claims that this perceived outperformance in hindsight will induce

overconfidence in foresight. In Panel B of table 7, we replace investment success by perceived suc-

cess. The impact of perceived success on overconfidence is positive in all but one regression, and

attains significance for the overplacement measures. Investors, who believe in having outperformed

the market, think they can repeat this feat in the future. The results for the control variables

are similar to those of Panel A. When we include investment success and perceived success in the

regressions simultaneously, results for both variables remain largely unchanged. In some situations

it is more important for investors, how successful they think to be than how successful they really

are. We at least partly confirm the relevance of hindsight effects for overconfidence in support of

hypothesis 3.

There are of course many different ways to define perceived success, among them to compare

estimates of past portfolio return to realized portfolio returns, which is how much investors over-

estimate their returns in hindsight. With this alternative specification we find similar results for

overplacement and also a positive effect on future overestimation. Even stronger effects are obtained

by just using past perceived returns without any adjustments. Ideally, one would also want success

measures to account for risk, as measures based on outperformance do not capture different portfo-

lio risk levels. However, due to frequent negative returns within our survey period, success in terms
and fill in the last observed transaction price for securities without available price data. This should guarantee fairly
accurate portfolio return calculations.

26
of Sharpe ratios is not feasible. Instead, we control for portfolio risk directly in the regressions of

table 7, which does not change our results.

7 Robustness Tests

7.1 Selection

As with any survey study, selection effects are a potential concern for the external validity of our re-

sults. Selection might operate on different levels, beginning with the question who holds an account

at a direct broker. Clearly, Barclays brokerage clients are not representative for the general UK

population and maybe not even for UK stock market investors. Weber, Weber, and Nosić (2012)

provide an explicit comparison for our sample and find that participants are predominantly male

(93%), older (median age 53) and rather affluent (median income £60,000). They hereby signif-

icantly differ from UK population statistics, but very much resemble other samples of brokerage

investors (cp. Odean 1998a, Dorn and Huberman 2005). It can be argued that online brokers are

particularly attractive for overconfident investors, who see little value in investment advice but care

for cheap and quick execution of trades. Online trading itself might also contribute to overconfi-

dence (Barber and Odean 2002). While overall levels of financial overconfidence might thus be lower

among other groups of investors, we believe that the cross-sectional and dynamic implications of

our results can still be generalized.

Another potential source of selection is the endogenous choice to participate in the survey. This

is reflected in a relatively low response rate of 3%, which is however not uncommon in finance

surveys (Graham and Harvey (2001) report a response rate of 9%, Glaser and Weber (2007a) of

7%, Dorn and Sengmueller (2009) of 6%). Additionally, we have to deal with panel attrition and

27
the possibility that participants leave and rejoin the sample in a non-random way. We have only

limited data on non-participants, which includes age and gender and some portfolio information

(portfolio value, number of positions, number of transactions).14 We use these items as explanatory

variables in a probit regression of survey participation. Results reported in column 1 of table 8

show that male investors and investors with more transactions and a higher portfolio value are

more likely to participate in the survey. These investors are probably more active and interested

in financial markets, which would explain this finding. It is possible that these investors are also

more overconfident than non-participants.

While selection on observables is present in our sample, it may not affect our main results con-

cerning investor behavior. We use the participation regression as first stage in a two-stage selection

model to test for this possibility. In columns 2-4, we reproduce the regressions of trading, diversifi-

cation, and risk taking on overconfidence variables including the inverse Mills ratio of the first stage.

We are aware that this test is imperfect due to the limited data availability in the participation

regression, but it still provides an indication for potential selection problems. The inverse Mills ratio

is highly significant in all specifications, confirming a selection effect. Not surprisingly, the effect

is particularly strong for trading and diversification as the Mills ratio correlates with number of

trades and holdings. However, our main result regarding the influence of overconfidence on investor

behavior remains unchanged. We find the same relationships between the different types of over-

confidence and turnover, diversification, and risk taking as before. This result holds as well for the

remaining specifications of tables 3, 4, and 5 when including the inverse Mills ratio. It is also robust

to an inclusion of the set of variables from the participation regression (positions, portfolio value,

trades). These results suggest that despite selection being present in our sample, our results are
14
The remaining demographic variables such as income and wealth were self-reported survey items.

28
mainly unaffected by it. By making use of the in-sample variation over time, the dynamic analysis

is per se less vulnerable against this type of selection.

Finally, we analyze participation in the panel over time to detect signs of systematic attrition.

Among the demographic variables in a univariate comparison, older and wealthier investors are

significantly more likely to participate repeatedly in our survey, while higher income investors

participate less. An intuitive explanation is that high income investors have to deal with work-

related time constrains, while older and wealthier clients manage to participate more often. To

evaluate these relationships more completely, we run a panel probit model of participation regressed

on demographics and lagged survey variables (see column 1 of table 9). Lagged variables are included

as we are particular interested whether there is selection based on overconfidence. This multivariate

setting confirms wealth and income as significant predictors of participation. There is no evidence

for selection on survey items, we do not find that particularly overconfident (or underconfident)

investors are more likely to continue to participate.

To make sure that identified selection does not bias our main results we again use a Heckman

selection model. We follow Wooldridge (1995) in estimating the participation equation separately

for each round of the panel, including demographics and lagged survey variables. We then re-

estimate in the second stage the panel regressions as before, including now inverse Mills ratios

from the round-wise participation regressions (columns 2-4). This time we find significance for the

Mills ratio only for diversification, suggesting less strong evidence for selection effects in the sense

of systematic panel attrition. Our main results are unchanged; the influence of overconfidence on

investment behavior remains the same. In some cases (column 4 and in unreported specifications

with other dependent variables) the statistic significance is weaker than in the original regressions.

However, we attribute this less to a selection effect than to a loss of statistical power. The two-

29
stage model is costly in terms of observations as the use of lagged variables requires participation in

consecutive rounds. We thus conclude that while panel attrition is present in our sample, it seems

to have little influence on the effect of overconfidence on investing behavior.

7.2 Potential confounding effects

In our main regression, we control for a set of demographic variables and risk tolerance. One

can think of a number of other factors, which might influence investing behavior, overconfidence, or

both. We now address some of these potential confounding effects. For example, it is known that the

disposition effect induces investors to sell winning stocks and to keep losing stocks. This could lead

to increased turnover after good returns, which would establish a direct link between past returns

and trading activity. Instead, we proposed a rise in overconfidence after good returns, which then in

turn induces trading. When we control for past returns in the regressions of table 3, we find a positive

influence of past returns on trading activity, which is significant in some specifications. However,

the effect of overconfidence remains unchanged, irrespective whether we use actual past returns

or perceived past returns. This suggests that positive past returns may additionally contribute to

active trading, but overconfidence (overplacement) remains a main driver of trading.

A similar story can be imagined for risk taking behavior. Under the often made assumption

of CRRA-utility, absolute risk aversion decreases with wealth. If investment returns reflect general

wealth changes, investors will be more willing to take risks after positive returns.15 Again, we

control for (actual or perceived) past returns in our regressions of risk taking behavior. This time

we do not find a significant effect of past returns, results for overconfidence are unchanged.
15
In contrast, prospect theory predicts risk seeking behavior after losses and risk aversion after gains.

30
 There might be concerns with the way we translate confidence intervals into volatility estimates.

The method of Keefer and Bodily (1983) provides a technical solution to infer implicit volatilities,

but may not reflect what investors think about financial risk. However, the transformation pre-

serves the rank-order of participants, any overprecision in confidence intervals also translates to

volatilities. But in comparing these volatilities to historical or implied volatilities, we are able to

control for changing risk levels over time. This is important, as we observe investors to adjust their

confidence levels to these changes. By taking raw confidence intervals, we would misinterpret these

adjustments for changes in overprecision. Nevertheless, we run our regressions of table 4 and 5

with confidence intervals instead of miscalibration. Miscalibration was significant in 12 out of 16

regressions, while confidence intervals are significant in 8 out of 16 regressions. This confirms that

the basic relationship exists also for raw confidence intervals, but at the same time shows that to

control for time-series changes in risk-levels is necessary.

Another incident where we interpret confidence intervals as risk expectations is the construction

of expected Sharpe ratios. Risk expectations backed out from confidence intervals represent the

denominator of the ratio, which is as close as possible to the original definition of Sharpe (1966).

Of course, this encounters the same concerns mentioned before, which is why we alternatively use

realized volatility from investors’ portfolios and the market as denominator of the Sharpe ratio.

We again calculate the difference between expected portfolio Sharpe ratio and expected market

Sharpe ratio as overconfidence measure. Obviously, this measure cannot be used in regression with

volatility or other portfolio risk characteristics as the left-hand side variable. It works well, however,

as explanatory variable for trading activity and for risk taking from the survey task. This supports

overplacement as a driver of trading and risk taking.

31
8 Conclusion

Investors are overconfident in various forms, for example they expect their portfolios to yield higher

returns than the market and to be less risky at the same time. They are also overprecise in their

predictions of future returns, when asked for 90% confidence intervals submitted ranges contain

the true value less than 50% of the time. And they do not only expect to outperform the market,

but frequently overestimate portfolio returns compared to actual outcomes. We document these

patterns in investor beliefs and ask the fundamentally important question: Is overconfidence in

beliefs relevant for investing behavior?

The response is yes, overconfidence contributes to explain excessive trading, underdiversification

and risk taking behavior. Our approach systematically relates different aspects of investing behavior

to all types of overconfidence; figure 2 summarizes our results. Trading activity is spurred by

overplacement, the belief to be able to outperform the market. This is intuitive as it appears sensible

to trade only if one expects higher returns than from a buy and hold strategy in the market index.

Additionally, a belief in less skillful or less informed counterparties makes it seem more likely to gain

from trades. Portfolio diversification in contrast is influenced by overprecision and overestimation,

investors who are not aware of the range of possible outcomes feel less need to diversify, and

those who expect overly high returns from their concentrated portfolio as well forgo diversification

opportunities. Finally, portfolio risk taking depends on overprecision and overplacement. Investors,

who believe to be better than others, take more risk, and those, who underestimate the variance of

returns, also take more risk.

The dynamics of overconfidence are driven by actual and perceived success of investors. In-

vestment success produces higher overprecision and overestimation in expectations about future

returns. However, the effect of realized investment performance is attenuated by the fact that in-

32
vestors are not fully aware of past outcomes. We identify estimation errors for past portfolio and

market returns, and find that perceived performance can differ a lot from actual performance.

As overconfidence is a psychological phenomenon, perceived performance might be at least as im-

portant as realized values. Indeed, perceived success in hindsight is an important determinant of

overplacement in foresight.

33
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36
Tables and Figures

Table 1: Trading and portfolio statistics

Panel A – Trading activity n Mean Median Std.Dev. 5th Perc. 95th Perc.
Trade dummy 6020 0.704 1 0.456 0 1
Number of trades 4241 11.92 5 26.31 1 46
Trading volume 4241 62,943 9,499 333,499 201 237,777
Turnover 3903 0.386 0.098 0.684 0.003 2.690
Panel B – Diversification n Mean Median Std.Dev. 5th Perc. 95th Perc.
Portfolio positions 6406 15.72 12 226.80 2 42
HHI 6384 0.242 0.144 0.253 0.021 0.936
Normalized variance 6264 0.545 0.481 0.260 0.195 1
Panel C – Risk taking n Mean Median Std.Dev. 5th Perc. 95th Perc.
Portfolio volatility 6472 0.370 0.301 0.306 0.137 0.824
Relative volatility 6472 1.410 1.148 0.851 0.672 2.885
Portfolio beta 6473 0.840 0.810 0.420 0.222 1.541
ACV 6304 0.472 0.418 0.292 0.077 1.016

Notes: The table shows descriptive statistics for measures of trading activity, degree of diversification, and risk taking.
The trade dummy equals one if an investor trades within a survey round (=time between two surveys), number of
trades is the number of sales and purchases, and trading volume is the value of all purchases and sales. Turnover is
trading volume divided by the sum of portfolio value at the beginning and end of survey round (we exclude portfolios
<£5,000 and winsorize turnover from above at the 5%-level). Portfolio positions is number of different securities
hold in portfolio, HHI is sum of squared portfolio weights, and normalized variance the ratio of portfolio variance
and average variance of portfolio components. Portfolio volatility is the volatility of portfolio returns over a one
year horizon, relative volatiliy is portfolio volatility divided by market volatility (winsorized at 1%-level from above),
portfolio beta is the covariance of portfolio and market returns divided by the variance of market returns, and ACV
is the average volatility of portfolio components.

37
 Table 2: Overconfidence measures

Panel A – Descriptives n Mean Median Std.Dev. Overconf.

Overprecision (market) 1997 0.142 0.119 0.191 82.7%
Overprecision (portfolio) 1981 0.228 0.157 0.363 84.9%
Overplacement (outperformance) 2106 0.029 0.000 0.086 47.8%
Overplacement (sharpe ratio) 1883 0.308 0.000 1.287 48.8%
Overestimation 2081 0.043 0.017 0.193 54.7%
Panel B – Correlations Overpr. mk Overpr. pf Outperf. Sharpe Overest.
Overprecision (market) 1
Overprecision (portfolio) 0.71∗∗∗ 1
Overplacement (outperformance) −0.04∗ −0.02 1
Overplacement (sharpe ratio) −0.06∗∗∗ 0.09∗∗∗ 0.62∗∗∗ 1
Overestimation −0.09∗∗∗ 0.00 0.16∗∗∗ 0.15∗∗∗ 1

Notes: Panel A of the table shows descriptive statistis for measures of overprecision, overplacement, and overesti-
mation. Overprecision for the stock market and for own portfolios is calculated as the difference between historical
volatility and estimated volatility (from confidence intervals). We exclude investors who violate the condition that high
estimate=>low estimate. Historical volatility is calculated over a one-year horizon and adjusted for the shorter time
horizon of estimates. Overplacement measured as expected outperformance is the difference between estimated port-
folio return and estimated market return for the next three month, alternatively as the difference between expected
portfolio Sharpe ratio and expected market Sharpe ratio. Overestimation is the difference between expected portfolio
return and realized portfolio return. Overplacement and overestimation are winsorized at 1%-level. Panel B shows
pairwise Spearman rank correlation coefficients between measures for different types of overconfidence. Correlations
are significant at *10%-level, **5%-level, or ***1%-level

38
 Table 3: Trading activity

trade dummy ln(# of trades) ln(trading vol.) ln(turnover)

probit gls gls gls
(1) (2) (3) (4) (5) (6) (7) (8)
Risk tolerance 0.023 0.010 0.047 0.046 0.090 0.092 0.009 0.009
(0.80) (0.35) (3.05)∗∗∗ (2.85)∗∗∗ (3.06)∗∗∗ (3.01)∗∗∗ (1.61) (1.55)
Overprecision (market) –0.453 –0.420 –0.295 –0.219 –0.854 –0.650 –0.082 –0.073
(–1.10) (–1.00) (–1.83)∗ (–1.36) (–2.37)∗∗ (–1.74)∗ (–1.11) (–0.90)
Overplacement (outperf.) 0.155 0.542 1.196 0.356
(0.27) (1.93)∗ (2.46)∗∗ (3.34)∗∗∗
Overplacement (sharpe) 0.008 0.039 0.074 0.012
(0.23) (2.26)∗∗ (2.42)∗∗ (1.66)∗
Overestimation 0.214 0.119 –0.167 –0.147 –0.204 –0.165 0.054 0.096
(0.77) (0.44) (–1.30) (–1.14) (–0.83) (–0.65) (1.06) (1.76)∗
Gender 0.604 0.724 0.178 0.054 0.191 –0.084 0.067 0.057
(2.24)∗∗ (2.63)∗∗∗ (0.93) (0.27) (0.54) (–0.24) (1.66)∗ (1.27)
Age 0.002 0.004 –0.002 –0.002 –0.001 –0.003 –0.001 –0.001
(0.35) (0.58) (–0.56) (–0.59) (–0.17) (–0.43) (–0.87) (–1.05)
Couple 0.007 –0.004 –0.005 –0.023 –0.254 –0.280 –0.004 –0.001
(0.04) (–0.03) (–0.04) (–0.21) (–1.21) (–1.30) (–0.11) (–0.03)
Dependents 0.035 0.041 0.072 0.075 0.149 0.144 0.025 0.025
(0.63) (0.73) (1.65)∗ (1.69)∗ (1.97)∗∗ (1.88)∗ (1.61) (1.62)
Income –0.021 –0.016 –0.010 –0.008 0.048 0.052 0.005 0.004
(–0.46) (–0.33) (–0.30) (–0.23) (0.71) (0.77) (0.36) (0.34)
Wealth 0.013 0.005 0.005 0.005 0.215 0.225 0.019 0.019
(0.38) (0.15) (0.22) (0.20) (4.57)∗∗∗ (4.79)∗∗∗ (2.08)∗∗ (2.06)∗∗
Financial literacy 0.064 0.100 –0.086 –0.093 0.187 0.162 0.013 0.017
(0.64) (0.99) (–1.27) (–1.29) (1.32) (1.10) (0.60) (0.74)
Constant 0.014 –0.207 2.066 2.228 7.009 7.428 0.023 0.028
(0.03) (–0.39) (6.16)∗∗∗ (6.28)∗∗∗ (9.82)∗∗∗ (10.31)∗∗∗ (0.20) (0.24)
R2 — — 0.034 0.034 0.124 0.123 0.092 0.079
Observations 1928 1833 1480 1411 1480 1411 1363 1300
Time fixed effects yes yes yes yes yes yes yes yes

Notes: The table shows panel regressions of trading activity variables on overconfidence measures and controls (in-
cluding time fixed effects). Columns (1) and (2) display a panel probit model, the remaining columns a general least
squares model with random effects (standard errors are clustered by participant). Columns (3)-(8) are estimated for
those who trade only. Dependent variables are a trade dummy (=1 if investor trades), logarithm of the number of
trades, logarithm of trading volume and logarithm of turnover. Risk tolerance is measured on a seven-point scale,
overconfidence measures are as definded in section 4. Demographics: Gender dummy (male=1), age in years, couple
dummy (married or co-habiting=1), number of dependents, income, wealth, financial literacy (number of correct
answers using four of the basic literacy questions by van Rooij, Lusardi, and Alessie (2011)). Income and wealth
are measured in categories (for a full description see Egan, Merkle, and Weber 2010), missing values are imputed.
Coefficients are significant at *10%-level, **5%-level, or ***1%-level.

39
 Table 4: Diversification

ln(positions) ln(HHI) norm. variance PCA

gls gls tobit gls
(1) (2) (3) (4) (5) (6) (7) (8)
Risk tolerance 0.016 0.014 –0.007 –0.007 –0.005 –0.006 0.023 0.022
(2.99)∗∗∗ (2.61)∗∗∗ (–0.73) (–0.68) (–1.69)∗ (–1.67)∗ (2.07)∗∗ (1.87)∗
Overprecision (portfolio) –0.105 –0.131 0.201 0.224 0.134 0.137 –0.392 –0.436
(–2.22)∗∗ (–2.49)∗∗ (3.57)∗∗∗ (3.74)∗∗∗ (6.29)∗∗∗ (6.22)∗∗∗ (–6.26)∗∗∗ (–6.74)∗∗∗
Overplacement (outperf.) –0.020 0.222 –0.068 0.037
(–0.17) (1.17) (–1.20) (0.20)
Overplacement (sharpe) 0.013 –0.011 –0.002 0.021
(2.25)∗∗ (–1.28) (–0.63) (2.02)∗∗
Overestimation –0.091 –0.119 0.240 0.340 0.067 0.061 –0.272 –0.322
(–1.19) (–1.50) (2.87)∗∗∗ (3.82)∗∗∗ (2.39)∗∗ (2.15)∗∗ (–2.32)∗∗ (–2.67)∗∗∗
Gender 0.135 0.138 –0.185 –0.187 0.004 0.000 0.162 0.165
(0.82) (0.84) (–1.16) (–1.16) (0.09) (0.01) (0.68) (0.67)
Age 0.014 0.014 –0.013 –0.012 –0.002 –0.002 0.020 0.019
(4.30)∗∗∗ (4.16)∗∗∗ (–3.47)∗∗∗ (–3.30)∗∗∗ (–2.42)∗∗ (–2.09)∗∗ (4.15)∗∗∗ (3.91)∗∗∗
Couple –0.085 –0.078 0.178 0.161 0.039 0.029 –0.213 –0.182
(–0.96) (–0.87) (1.65)∗ (1.47) (1.43) (1.07) (–1.60) (–1.34)
Dependents –0.021 –0.020 0.026 0.029 –0.004 –0.001 –0.028 –0.034
(–0.74) (–0.71) (0.74) (0.81) (–0.46) (–0.13) (–0.61) (–0.75)
Income 0.002 –0.002 –0.065 –0.063 0.003 0.002 0.033 0.033
(0.06) (–0.06) (–1.88)∗ (–1.80)∗ (0.42) (0.24) (0.82) (0.79)
Wealth 0.079 0.080 –0.032 –0.033 –0.004 –0.003 0.077 0.077
(3.71)∗∗∗ (3.73)∗∗∗ (–1.32) (–1.35) (–0.67) (–0.59) (2.45)∗∗ (2.44)∗∗
Financial literacy 0.020 0.028 –0.033 –0.030 0.016 0.018 0.001 0.002
(0.40) (0.55) (–0.52) (–0.47) (0.96) (1.04) (0.02) (0.03)
Constant 1.099 1.084 –0.808 –0.829 0.598 0.587 0.229 0.147
(3.92)∗∗∗ (3.83)∗∗∗ (–2.58)∗∗ (–2.60)∗∗∗ (7.02)∗∗∗ (6.81)∗∗∗ (–3.73)∗∗∗ (–3.59)∗∗∗
R2 0.126 0.131 0.081 0.081 — — 0.146 0.154
Observations 1941 1800 1939 1798 1934 1793 1934 1793
Time fixed effects yes yes yes yes yes yes yes yes

Notes: The table shows panel regressions of diversification variables on overconfidence measures and controls (in-
cluding time fixed effects). Columns (1)-(4) and (7)-(8) display a general least squares model with random effects
(standard errors are clustered by participant), columns (5) and (6) a panel tobit model. Dependent variables are
logarithm of the number of portfolio positions, logarithm of a Herfindahl-Hirschmann-index of portfolio weights,
normalized variance, and the first principal component of a PCA involving the three other variables. The control
variables are as defined in table 3. Coefficients are significant at *10%-level, **5%-level, or ***1%-level.

40
 Table 5: Risk taking

ln(volatility) rel. volatility ln(ACV) portfolio beta

gls gls gls gls
(1) (2) (3) (4) (5) (6) (7) (8)
Risk tolerance 0.001 0.000 –0.000 –0.000 0.014 0.015 –0.004 –0.003
(0.32) (0.03) (–0.03) (–0.06) (3.12)∗∗∗ (3.23)∗∗∗ (–1.04) (–0.74)
Market return expect. 0.342 0.208 0.724 0.367 0.295 0.164 0.137 0.100
(5.10)∗∗∗ (4.35)∗∗∗ (4.35)∗∗∗ (3.68)∗∗∗ (4.27)∗∗∗ (2.93)∗∗∗ (1.95)∗ (2.26)∗∗
Market risk expect. 0.001 –0.000 –0.000 –0.003 –0.009 –0.009 –0.002 –0.003
(0.11) (–0.01) (–0.01) (–0.31) (–1.80)∗ (–1.73)∗ (–0.50) (–0.62)
Overprecision (market) 0.146 0.123 0.207 0.148 0.071 0.073 0.035 0.016
(3.32)∗∗∗ (2.84)∗∗∗ (2.38)∗∗ (1.87)∗ (1.19) (1.18) (0.86) (0.37)
Overplacement (outperf.) 0.359 0.948 0.342 0.070
(3.45)∗∗∗ (3.70)∗∗∗ (3.06)∗∗∗ (0.53)
Overplacement (sharpe) 0.011 0.028 0.004 0.009
(2.37)∗∗ (2.78)∗∗∗ (0.78) (1.86)∗
Overestimation –0.033 0.028 –0.101 0.065 –0.042 0.010 –0.069 –0.055
(–0.64) (0.58) (–0.78) (0.53) (–0.82) (0.19) (–1.02) (–1.03)
Gender 0.087 0.103 0.155 0.172 0.050 0.063 0.106 0.113
(1.58) (1.81)∗ (1.74)∗ (1.83)∗ (0.57) (0.71) (1.84)∗ (1.95)∗
Age –0.006 –0.006 –0.009 –0.009 –0.003 –0.003 –0.002 –0.002
(–4.05)∗∗∗ (–3.94)∗∗∗ (–4.38)∗∗∗ (–4.09)∗∗∗ (–1.87)∗ (–1.65)∗ (–1.28) (–1.16)
Couple –0.028 –0.026 –0.064 –0.059 –0.052 –0.049 –0.036 –0.033
(–0.69) (–0.63) (–0.93) (–0.84) (–1.18) (–1.10) (–0.81) (–0.74)
Dependents 0.003 0.006 –0.002 0.005 0.019 0.018 0.008 0.010
(0.19) (0.44) (–0.09) (0.21) (1.17) (1.09) (0.44) (0.58)
Income –0.017 –0.020 –0.022 –0.027 –0.021 –0.022 –0.005 –0.007
(–1.47) (–1.73)∗ (–1.10) (–1.35) (–1.72)∗ (–1.77)∗ (–0.32) (–0.44)
Wealth –0.030 –0.031 –0.045 –0.048 –0.035 –0.036 –0.016 –0.016
(–3.49)∗∗∗ (–3.51)∗∗∗ (–3.36)∗∗∗ (–3.43)∗∗∗ (–3.62)∗∗∗ (–3.63)∗∗∗ (–1.97)∗∗ (–1.98)∗∗
Financial literacy –0.059 –0.057 –0.121 –0.120 –0.062 –0.059 –0.052 –0.050
(–2.21)∗∗ (–2.09)∗∗ (–2.26)∗∗ (–2.13)∗∗ (–2.23)∗∗ (–2.04)∗∗ (–1.02) (–0.93)
Constant –0.621 –0.627 2.504 2.512 –0.406 –0.438 1.194 1.172
(–4.79)∗∗∗ (–4.61)∗∗∗ (10.06)∗∗∗ (9.33)∗∗∗ (–2.81)∗∗∗ (–2.92)∗∗∗ (6.02)∗∗∗ (5.68)∗∗∗
R2 0.386 0.388 0.151 0.130 0.246 0.241 0.036 0.041
Observations 1911 1815 1913 1817 1883 1793 1913 1817
Time fixed effects yes yes yes yes yes yes yes yes

Notes: The table shows panel regressions of risk taking variables on overconfidence measures and controls (including
time fixed effects). All columns report GLS-models with random effects (standard errors are clustered by participant).
Dependent variables are logarithm of portfolio volatility (1y-horizon), relative volatility, logarithm of average com-
ponent volatility (ACV), and portfolio beta. Market return expectations are elicited in %, market risk expectations
on a seven-point-scale, both for a three months horizon (corresponds to one survey round). Overconfidence measures,
risk tolerance, and control variables are as defined in table 3. Coefficients are significant at *10%-level, **5%-level,
or ***1%-level.

41
 Table 6: Investment success and overconfidence

portf. return > portf. return <

market return market return difference
Portfolio return expectations 0.070 0.060 0.010∗∗∗/∗∗
∆ Portfolio return exp. 0.013 0.004 0.009∗∗/−
Overprecision (market) 0.181 0.101 0.080∗∗∗/∗∗∗
∆ Overprecision (market) 0.014 -0.014 0.28∗∗/∗∗
Overprecision (portfolio) 0.263 0.192 0.071∗∗∗/∗∗∗
∆ Overprecision (portf.) 0.020 -0.002 0.022∗∗/−
Overplacement (outperf.) 0.031 0.027 0.004∗/−
∆ Overplacement (outperf.) 0.005 0.000 0.005−/−
Overplacement (sharpe) 0.347 0.256 0.091−/∗
∆ Overplacement (sharpe) 0.086 0.037 0.049−/−
Overestimation -0.009 0.017 -0.027∗∗∗/∗∗∗
∆ Overestimation -0.012 -0.063 0.051−/∗∗∗

Notes: The table displays expectations, overconfidence measures and changes in these variables for two groups of
investors: those who outperformed and those who underperformed the market in the previous round. Portfolio return
expectations are three-months return estimates for own portfolios, overconfidence variables as defined in table 2.
Differences between the group are significant at *10%-level, **5%-level, or ***1%-level by a Wilcoxon rank-sum test
/ standard t-test.

42
 Table 7: Dynamics of overconfidence

Panel A Overprecision (market) Overprecision (portfolio) Overplacement (outperf.) Overplacement (sharpe) Overest. ∆ Overest.
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)
Investment success 0.236 0.072 0.389 0.291 0.001 –0.021 0.417 0.069 0.048 0.659
(8.46)∗∗∗ (2.27)∗∗ (7.95)∗∗∗ (5.67)∗∗∗ (0.06) (–1.34) (1.62) (0.22) (1.58) (14.44)∗∗∗
∆ Market return 0.527 0.346 0.448 0.211 –0.063 –0.058 –1.571 –2.266 –0.193 –0.072
(10.73)∗∗∗ (6.83)∗∗∗ (5.37)∗∗∗ (2.40)∗∗ (–2.56)∗∗ (–2.14)∗∗ (–3.45)∗∗∗ (–4.35)∗∗∗ (–3.79)∗∗∗ (–0.91)
∆ Market volatility 0.350 0.333 0.248 0.194 –0.021 –0.014 –0.476 –0.766 –0.092 –0.216
(22.48)∗∗∗ (20.53)∗∗∗ (9.24)∗∗∗ (6.86)∗∗∗ (–2.67)∗∗∗ (–1.54) (–3.28)∗∗∗ (–4.50)∗∗∗ (–5.63)∗∗∗ (–8.30)∗∗∗
Overconfidence (lag) 0.421 0.330 –0.112 –0.223 —
(14.74)∗∗∗ (8.04)∗∗∗ (–3.47)∗∗∗ (–5.92)∗∗∗ —
Constant 0.114 0.067 0.196 0.131 0.031 0.037 0.338 0.495 0.005 –0.061
(29.14)∗∗∗ (13.15)∗∗∗ (28.88)∗∗∗ (12.79)∗∗∗ (15.55)∗∗∗ (15.83)∗∗∗ (9.32)∗∗∗ (11.37)∗∗∗ (1.29) (–9.63)∗∗∗
R2 0.476 0.667 0.116 0.406 0.002 0.044 0.013 0.000 0.014 0.335
Observations 1510 1063 1532 1107 1608 1192 1425 959 1610 1194
Individual fixed effects yes yes yes yes yes yes yes yes yes yes

Panel B Overprecision (market) Overprecision (portfolio) Overplacement (outperf.) Overplacement (sharpe) Overestimation
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10)

43
Perceived success 0.049 0.041 0.128 –0.028 0.031 0.038 0.611 0.780 0.035 0.052
(1.42) (1.10) (2.06)∗∗ (–0.40) (1.78)∗ (1.88)∗ (1.97)∗∗ (1.99)∗∗ (0.96) (1.15)
∆ Market return 0.576 0.344 0.541 0.244 –0.062 –0.067 –1.465 –2.249 –0.174 –0.231
(11.48)∗∗∗ (6.78)∗∗∗ (6.37)∗∗∗ (2.71)∗∗∗ (–2.54)∗∗ (–2.50)∗∗ (–3.24)∗∗∗ (–4.37)∗∗∗ (–3.46)∗∗∗ (–4.01)∗∗∗
∆ Market volatility 0.373 0.337 0.289 0.221 –0.023 –0.017 –0.435 –0.765 –0.086 –0.082
(23.70)∗∗∗ (21.17)∗∗∗ (10.70)∗∗∗ (7.80)∗∗∗ (–2.88)∗∗∗ (–1.90)∗ (–3.06)∗∗∗ (–4.58)∗∗∗ (–5.33)∗∗∗ (–4.39)∗∗∗
Overconfidence (lag) 0.445 0.410 –0.118 –0.214 –0.112
(16.48)∗∗∗ (10.09)∗∗∗ (–3.69)∗∗∗ (–5.68)∗∗∗ (–3.31)∗∗∗
Constant 0.124 0.068 0.213 0.129 0.032 0.037 0.368 0.508 0.007 0.008
(32.09)∗∗∗ (13.23)∗∗∗ (31.75)∗∗∗ (12.13)∗∗∗ (16.17)∗∗∗ (16.60)∗∗∗ (10.59)∗∗∗ (12.55)∗∗∗ (1.66)∗ (1.73)∗
R2 0.461 0.666 0.094 0.447 0.003 0.024 0.006 0.000 0.015 0.000
Observations 1514 1065 1526 1102 1621 1199 1436 964 1603 1189
Individual fixed effects yes yes yes yes yes yes yes yes yes yes

Notes: The table shows panel fixed effects regressions of overconfidence on investment success variables and controls. In Panel A, investment success is the
difference between (actual) past portfolio return and (actual) past market return in %-points. ∆ market return is change in the return of the FTSE all-share
index between the previous and the current survey round. ∆ market volatility is the change in one-year volatility of the FTSE for the same time period. Lagged
overconfidence is the level of overconfidence in the previous period of the type which corresponds to the dependent variable. In Panel B, perceived success is the
difference between perceived past portfolio return and perceived past market return in %-points. The other variables remain the same. Coefficients are significant
at *10%-level, **5%-level, or ***1%-level.
 Table 8: Selection into the survey

participation trading diversification risk taking

dummy variable ln(turnover) ln(HHI) ln(volatility)
(1) (2) (3) (4)
Risk tolerance 0.008 –0.006 0.001
(1.38) (–0.55) (0.15)
Overprecision –0.058 0.198 0.123
(–0.80) (3.45)∗∗∗ (2.68)∗∗∗
Overplacement (outperf.) 0.344 0.198
(3.30)∗∗∗ (1.02)
Overplacement (sharpe) 0.010
(1.96)∗∗
Overestimation 0.054 0.269 0.043
(1.08) (3.13)∗∗∗ (0.83)
Gender 0.202 –0.040 0.002 0.101
(3.92)∗∗∗ (–0.88) (0.01) (1.90)∗
Age –0.000 –0.000 –0.012 –0.004
(–1.63) (–0.31) (–3.34)∗∗∗ (–3.08)∗∗∗
Couple 0.002 0.140 –0.032
(0.05) (1.27) (–0.78)
Dependents 0.020 0.038 0.007
(1.30) (1.03) (0.52)
Income 0.003 –0.059 –0.017
(0.27) (–1.65)∗ (–1.52)
Wealth 0.018 –0.028 –0.031
(2.08)∗∗ (–1.19) (–3.49)∗∗∗
Financial literacy 0.017 –0.036 –0.048
(0.81) (–0.54) (–1.74)∗
ln(portfolio value) 0.030
(1.70)∗
ln(# of trades) 0.098
(6.58)∗∗∗
ln(positions) –0.012
(–0.47)
Inverse Mills ratio –0.813 0.926 –0.281
(–5.58)∗∗∗ (2.30)∗∗ (–1.92)∗
Constant –2.583 1.901 –3.123 –0.115
(–14.75)∗∗∗ (5.27)∗∗∗ (–3.12)∗∗∗ (–0.30)
R2 0.013 0.143 0.084 0.386
Observations 19721 1347 1905 1778
Time fixed effects no yes yes yes

Notes: The table shows a first stage probit regression (column 1) of survey participation on age and gender, as well
as portfolio value, portfolio positions, and transactions (all logarithmized). Columns 2-4 reproduce results of tables
3, 4, and 5 including the inverse Mills ratio of the first stage. Coefficients are significant at *10%-level, **5%-level,
or ***1%-level.

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 Table 9: Panel attrition

participation trading diversification risk taking

dummy variable ln(turnover) ln(HHI) ln(volatility)
(1) (2) (3) (4)
Risk tolerance 0.009 –0.003 0.003
(0.99) (–0.23) (0.55)
Overprecision (market) 0.066 0.090
(0.71) (1.81)∗
Overprecision (portf.) 0.327
(5.44)∗∗∗
Overplacement (outperf.) 0.419 –0.009
(2.61)∗∗∗ (–0.02)
Overplacement (sharpe) 0.010
(1.67)∗
Overestimation 0.016 0.339 0.083
(0.18) (2.66)∗∗∗ (1.05)
Risk tolerance (lag) –0.016
(–0.63)
Overprecision (market) (lag) –0.126
(–0.34)
Overplacement (outperf.) (lag) –0.089
(–0.15)
Overplacement (sharpe) (lag) –0.034
(–0.97)
Overestimation (lag) –0.100
(–0.41)
Gender 0.142 0.028 –0.120 0.120
(0.60) (0.33) (–0.58) (1.16)
Age –0.003 –0.001 –0.010 –0.003
(–0.59) (–0.58) (–1.84)∗ (–1.62)
Couple –0.079 –0.020 0.187 –0.089
(–0.58) (–0.38) (1.26) (–1.43)
Dependents –0.014 0.007 –0.019 –0.003
(–0.30) (0.30) (–0.35) (–0.13)
Income –0.116 0.010 –0.049 0.000
(–2.96)∗∗∗ (0.50) (–0.91) (0.00)
Wealth 0.108 0.032 –0.033 –0.042
(3.54)∗∗∗ (2.31)∗∗ (–0.95) (–3.32)∗∗∗
Financial literacy –0.081 0.039 0.009 –0.010
(–0.97) (1.16) (0.10) (–0.26)
Inverse Mills ratio –0.040 –0.236 0.022
(–0.90) (–2.22)∗∗ (0.66)
Constant 0.269 –0.207 –1.365 –1.093
(0.52) (–1.15) (–2.60)∗∗∗ (–4.70)∗∗∗
R2 — 0.099 0.094 0.422
Observations 1694 703 996 925
Time fixed effects yes yes yes yes

Notes: The table shows a probit regression (column 1) of survey participation over time on demographic variables
and lagged survey variables. Columns 2-4 reproduce results of tables 3, 4, and 5 including the inverse Mills ratio of
the first stage. Coefficients are significant at *10%-level, **5%-level, or ***1%-level.

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 Figure 1: Return and risk expectations of investors
Average portfolio return expectations and market return expectations in % (left axis). Average risk perceptions for
own portfolio and stock market on a seven-point scale (right axis).

Figure 2: Overconfidence and investing behavior

Types of overconfidence and their identified pathways to several aspects of investing behavior.

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