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Overconfidence, overreaction and personality

Robert Durand (Department of Finance and Banking, Curtin University, Perth, Australia)
Rick Newby (Department of Accounting and Finance, University of Western Australia, Perth, Australia)
Kevin Tant (Department of Accounting and Finance, Monash University, Melbourne, Australia)
Sirimon Trepongkaruna (Department of Accounting and Finance, University of Western Australia, Perth, Australia)

Review of Behavioral Finance

ISSN: 1940-5979

Article publication date: 25 November 2013

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Abstract

Purpose

The purpose of this paper is to systematically profile investors’ personality traits to examine if, and how, those traits are associated with phenomena observed in financial markets. In particular, the paper looks at overconfidence and overreaction in an experimental foreign exchange market.

Design/methodology/approach

The paper measures the personality of the subjects using the short form of the NEO-PIR instrument, the NEO-FFI developed by Costa and McRae (1992) which is based on Norman's (1963) “Big Five” personality constructs of negative emotion, extraversion, openness to experience, agreeableness and conscientiousness. The paper measures psychological gender using questions developed by Bem (1994). Preference for innovation and risk-taking propensity are measured using instruments developed by Jackson (1976). The paper then examines the behavior of the subject who traded interactively in “real time” in an interactive-simulated foreign exchange market where “price discovery” was instantaneous and pricing decisions were made instantaneously as items of news, determined by the researchers, were released.

Findings

The paper demonstrates that personality traits are associated with overconfidence and overreaction in financial markets. The paper presents meta-analysis which facilitates the development of a posteriori theories of how particular traits affect investment; there are important roles for risk-taking propensity, negative emotion, extraversion, masculinity, preference for innovation and conscientiousness.

Originality/value

A typical behavioral finance paper might find an empirical regularity in prices and, on the basis of such patterns, infer the underlying psychology motivating the behavior of investors. The approach differs from this caricature of the “typical” behavioral finance paper. The paper does not infer the underlying psychology of investors from patterns in prices. Rather, the paper learns about investors by systematically profiling their personality traits. The paper then demonstrates how those traits are associated with the prices generated by the investors the authors study. In focussing on the role of individual personality, the paper refocusses behavioral finance on the individuals who set prices.

Keywords

Acknowledgements

JEL classification – G02

Citation

Durand, R., Newby, R., Tant, K. and Trepongkaruna, S. (2013), "Overconfidence, overreaction and personality", Review of Behavioral Finance, Vol. 5 No. 2, pp. 104-133. https://doi.org/10.1108/RBF-07-2012-0011

Publisher

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Emerald Group Publishing Limited

Copyright © 2013, Emerald Group Publishing Limited

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