Investor Overconfidence and the Security Market Line: New Evidence from China

Han, Xing; Li, Kai; Li, Youwei

Abstract

This paper documents a highly downward-sloping security market line (SML) in China, which is more puzzling than the typical “flattened” SML in the US, and does not reconcile with existing theories of the low-beta anomaly. We show that investor overconfidence offers some promises in resolving the puzzle in China: In the time-series dimension, the slope of the SML becomes more “inverted” when investors get more overconfident. This dynamic overconfidence effect is intensified with biased self-attribution. As a general symptom of overconfidence in the cross section, high-beta stocks are also the mostly heavily traded. After accounting for trading volume, there is no longer the low-beta anomaly at both the firm and portfolio levels. Mutual fund evidence reinforces the view that institutional investors actively exploit the portfolio implications of a downward-sloping SML by shying away from high-beta stocks and betting on low-beta stocks for superior performance.

Citation

Han, X., Li, K., & Li, Y. (2020). Investor Overconfidence and the Security Market Line: New Evidence from China. Journal of Economic Dynamics and Control, 117, Article 103961. https://doi.org/10.1016/j.jedc.2020.103961

• Journal Article Type: Article
• Acceptance Date: Jun 17, 2020
• Online Publication Date: Jun 20, 2020
• Publication Date: 2020-08
• Deposit Date: Jun 22, 2020
• Publicly Available Date: Jun 21, 2022
• Journal: Journal of Economic Dynamics and Control
• Print ISSN: 0165-1889
• Publisher: Elsevier
• Peer Reviewed: Peer Reviewed
• Volume: 117
• Article Number: 103961
• DOI: https://doi.org/10.1016/j.jedc.2020.103961
• Keywords: Security market line; Beta anomaly; Betting against beta; Overconfidence; Mutual fund
• Public URL: https://hull-repository.worktribe.com/output/3525151
• Publisher URL: https://www.sciencedirect.com/science/article/pii/S0165188920301299?via%3Dihub