Market-wide overconfidence and stock returns

Abstract

In this paper, a novel measurement of overconfidence over the market is developed based on the size of ambiguity (the confidence of investors in information). The proposed measure of market-wide overconfidence is consistent with the predictions motivated by prior literature. It has a significant negative association with the next-month market excess return. Associations between the overconfidence measure and riskier portfolio returns behave stronger and last longer, implying a risk-taking proclivity of overconfident investors.