Overconfidence and (Over)Trading: The Effect of Feedback on Trading Behavior

Abstract

Overconfidence is linked to higher levels of trading and lower profits in financial markets. This paper explores overconfidence and trading in a laboratory setting to determine whether overconfidence in the accuracy of one's information is a driver of this situation. In a laboratory experiment, I design an environment such that being overconfident in one's own accuracy of information creates incentives to overtrade. Across treatments, I exogenously vary the type of feedback participants receive, such that some groups receive no feedback and other groups receive varying feedback about the accuracy of information, limiting the likelihood that they remain overconfident. The results show that the accuracy of information mediates the overconfidence effects on trading, and indicate that overconfidence leads to higher trading volume and weakly damages profits.