Impact of overconfidence among finance managers on forecasted market returns: Evidence from India

• Published date: 01 May 2022
• Author: Hardeep Singh Mundi,Era Nagpal
• Date: 01 May 2022
• DOI: http://doi.org/10.1002/pa.2349

ACADEMIC PAPER

Impact of overconfidence among finance managers on

forecasted market returns: Evidence from India

Hardeep Singh Mundi

1

| Era Nagpal

2

1

DoGM, School of Business, University of

Petroleum and Energy Studies, Dehradun,

Uttrakhand, India

2

Chitkara Business School, Chitkara University,

Punjab, India

Correspondence

Hardeep Singh Mundi, DoGM, School of

Business, University of Petroleum and Energy

Studies, Knowledge Acres, Kandoli. Dehradun,

258007, Uttrakhand.

Email: hardeep.sm@hotmail.com,hardeep@

ddn.upes.ac.in

The current article studies the impact of overconfidence among finance managers on

forecasted market returns in India. Overconfidence among finance managers is mea-

sured using a standardised questionnaire and data is collected from February, 2017

to October, 2018. Snowball sampling is used as the sampling technique to collect

data from 200 finance managers. The secondary data for the study is collected from

the Centre for Monitoring Indian Economy (CMIE) Prowess. Overconfidence among

finance managers is modelled as per the methodology of Ben-David, et al. (2013).

After running a regression model to test whether overconfidence among finance

managers results in more accurate forecasts of market returns, it is found that over-

confident finance managers predict forecasted error with more accuracy and also

predict narrow confidence intervals. Fama and MacBeth regression results present

that finance managers are overconfident after their decisions of forecasted market

returns are accurate. Overconfidence among managers is not due to the skill of man-

agers but is present because overconfident managers are often miscalibrated. Key

words: Behavioural corporate finance, bias of overconfidence, decision-making, fore-

casted market returns.

KEYWORDS

Behavioural corporate finance, bias of overconfidence, decision-making, forecasted market

returns

1|INTRODUCTION

The traditional finance paradigm considers agents to be rational in

financial markets. Rationality includes two parts: (a) Agents update

their beliefs correctly as per Bayes's Law and (b) Choices of agents

are consistent with expected utility theory. After decades of

research, it has been established that the aggregate stock market

and individual trading behavior are challenging to comprehend in

the traditional finance paradigm. Puzzles in finance exist because

theanalysisofbehavioralbiasesisnotdone(Goel&Thakor,2008),

and the continuing research in behavioral corporate finance is pro-

viding alternative explanations for such puzzles.

Behavioral finance is a new paradigm to understand the aggregate

stock market, corporate decision making, and individual trading

behavior (Thaler, 1999). Behavioral finance emphasizes that agents

are not entirely rational. Financing decisions are affected by irrational

investor behavior (Thaler, 1999). A manager's fixed effects influence

the financial, investment, and organizational practices of the firm

(Bertrand and Schoar, 2003), and this influence is so strong that simi-

lar firms perform differently. The development of behavioral capital

asset pricing model, behavioral portfolio theory, adaptive market

hypothesis, and other similar models—is based on the foundations set

by Shefrin in the field of behavioral corporate finance.

Corporate policies are majorly designed based on the predictions

made by the financial managers of a firm. One of the vital responsibili-

ties of a financial manager is to estimate the unknowns

(e.g., cashflows, demand, and competition). These estimates are often

subject to biases stemming from the level of overconfidence or

miscalibration on the part of the managers. Much research and psy-

chological evidence suggests that people usually overestimate their

Received: 11 July 2020 Accepted: 2 August 2020

DOI: 10.1002/pa.2349

J Public Affairs. 2022;22:e2349. wileyonlinelibrary.com/journal/pa © 2020 John Wiley & Sons Ltd 1of11

https://doi.org/10.1002/pa.2349