Article

Overconfidence and Disposition Global Business Review

19(5) 1303–1321
Effect in Indian Equity Market: © 2017 IMI
SAGE Publications
An Empirical Evidence sagepub.in/home.nav
DOI: 10.1177/0972150917726660
http://journals.sagepub.com/home/gbr

Jaya M. Prosad1
Sujata Kapoor2
Jhumur Sengupta3
Saurav Roychoudhary4

Abstract
The article investigates the presence of the disposition effect and overconfidence in the Indian equity
market during 2006–2013 and provides some robust empirical evidence. It applies bivariate and trivari-
ate vector autoregression (VAR) models and associated impulse response functions on the Indian
equity market from NIFTY 50 index and individual security returns. The study arrives at three key
findings. First, the presence of the biases, overconfidence and the disposition effect is detected in Indian
equity market for our sample period. Second, the impact of these two biases can be distinctly segre-
gated for 20 companies among the companies in the index. Lastly, the overconfidence bias is found to
be predominant of the two. The study endorses the fact that like other developing markets, the Indian
markets are not so efficient with respect to overconfidence and the disposition effect. This article is
one of the few to provide empirical evidence for the behavioural issues (i.e., overconfidence and the
disposition effect) at a market level that is otherwise studied at the individual investor level.

Keywords
Overconfidence, disposition effect, vector autoregression, impulse response function, Indian equity
market

Introduction
Investor behaviour has long been subjected to the speculation of financial experts, and substantial efforts
have been made in this area to understand its meaning and impact on markets. Academic research reveals

1
Assistant Professor, Delhi Metropolitan Education, Guru Gobind Singh Indraprastha University, India.
2
Assistant Professor, Jaypee Business School, Jaypee Institute of Information Technology, India.
3
Assistant Professor, Dinabandhu Andrews College, Calcutta University, India.
4
Associate Professor of Finance and Economics, Department of Business, 227 Troutman Hall Capital University, 1 College &
Main, Columbus, Ohio, USA.

Corresponding author:
Jaya M. Prosad, C-101, Jeevan Ashray Appartments, Sec-62, Plot No. C 58/8, Noida, UP 201307, India.
E-mail: jayamamta1988@gmail.com
1304 Global Business Review 19(5)

the role of behavioural biases in changing the course of financial markets. These biases can become
potent inducers of market anomalies such as boom (bust) and overreaction (underreaction). We focus
particularly on the impact of two such biases, that is, the disposition effect and overconfidence.
The disposition effect stems from the investors’ dislike of selling their shares at a loss and was
initially documented by Shefrin and Statman (1985). This bias is found to be more prevalent amongst
household and retail investors (Kaustia, 2010). It is also reported to play a significant role in market
underreaction that can lead to price momentum (Kaustia, 2010). Kaustia (2010) also found that system-
atic disposition behaviour by many investors can affect the trading volume and create a gap between
market prices and fundamental values. Further, studies indicate that this bias can be dissipated with the
increase in investor sophistication (Feng & Seasholes, 2005). However, its contradiction has been
reported by Locke and Mann (2000), Coval and Shumway (2005) and Shapira and Venezia (2001) by
presenting the evidence of disposition effect in professional traders. These studies clearly suggest that
disposition effect is one of the potent biases which needs critical analysis and investigation by the market
experts as well as individual investors. Therefore, it is advisable to understand the underlying behaviour
of the disposition effect and when it has the highest tendency to prevail in the stock market.
The second bias is overconfidence. It is said to be one of the most prevalent biases amongst investors
(Glaser & Weber, 2010; Yeh & Yang, 2011). Scott et al. (2003) reported that investor overconfidence
could bias the security prices in over five countries like France, Germany, Japan, UK and the US. In general
terms, overconfidence arises when the perception of one’s knowledge exceeds its reality (Deaves,
Luders, & Schroder, 2005). Yeh and Yang (2011) reported that this bias can lead to an increase market
volatility, trading volume and price distortion. This bias is seen in both bull and bear phase of the market
(Jlassi, Naoui, & Mansour, 2014). They corroborate this finding using the data of 27 countries and also
emphasize on the fact that this bias ‘triggered and prolonged’ the global financial crises of 2007–2009.
Researchers have linked this bias in explaining stock market bubbles (Glaser, N¨oth, & Weber, 2004;
Moore & Healy, 2008). The most prominent feature of overconfidence is expressed in the form of high
trading volume. Moreover, Odean (1998a, 1999) suggested that individual investors influenced with
overconfidence trade more aggressively. The evidence of overconfidence in financial markets is so over-
whelming that De Bondt and Thaler (1995) treat this bias as ‘the single most embarrassing fact’ to under-
stand the standard financial paradigm.
The aforementioned account reveals that both these biases are extremely potent in creating stock
market disruption. Further, it is also seen that both these biases exhibit a common behaviour, that is, their
tendency to influence trading volume. Therefore, the trend and patterns of trading volume can become a
significant indicator in identifying the presence of both these biases. This finding has been corroborated
by studies in several countries such as the USA (Odean, 1998b), China (Shumway & Wu, 2006), Finland
(Grinblatt & Keloharju, 2001) and France (Siwar, 2011). However, few studies investigate these biases
in conjunction with developed countries and even fewer in emerging nations.
In this premise, we investigate the presence of the ‘disposition effect’ and ‘overconfidence’ in the
Indian stock market with the help of trading volume. We aim that such an empirical analysis will assist
in investigating whether these biases prevailed in the Indian equity market and the implications for
global money managers. We further identify the specific stocks for which Indian investors exhibit dispo-
sition effect as well as overconfidence. The advantage of such a study using historical data is that the
findings can be applied to the entire market. Moreover, it can help the practitioners to identify the biased
trends in the market beforehand and develop their investing strategies accordingly.
The remaining article is structured in the following manner. The next section reviews the literature;
the ‘Research Objectives and Rationale’ section presents the research objectives and rationale of the
study; the ‘Data and Methodology’ section provides the details of the data set as well as the methodology
Prosad et al. 1305

used; and the next section presents the main findings and results. The final section discusses conclusion
and managerial implications of the study.

Related Literature

Disposition Effect
Many investors have the tendency to sell the stocks that have appreciated in value rather quickly while
holding on to their losing stocks. Finance research has documented a massive bias for selling winners
rather than losers. Shefrin and Statman (1985) coined this as the disposition effect which is built on the
implications of prospect theory and loss aversion (Kahneman & Tversky, 1979) and the emotions of
pride and regret. Individual investors prefer to lock in their gains by selling ‘winners’ that are stocks that
have appreciated since they were purchased, and hang on to their losers. This behaviour is not rational as
selling winners results in tax costs but holding on to losers implies foregoing tax benefits. Also, the
recent winners tend to do better than recent losers in the short run, so individuals end up selling the
wrong stocks (Kahneman, 2011). The investor has set up an account for each stock s/he bought, and s/he
wants to close every account as a profit.
Weber and Camerer (1998) in an experimental setting found that the original purchase price serves as
a reference point, or anchor, and the desire to avoid losses relative to this point leads to holding on to
loser stocks for too long. Odean (1998b) analysed 163,000 trades over 10,000 brokerage accounts of
individual investors in the USA, spanning a seven-year period to identify all instances in which an inves-
tor sold some of his holdings in one stock and almost simultaneously bought another stock. To determine
whether these stock picking skills were well founded, Odean (1998b) compared the returns on the stock
that the investor had sold and the stock that was bought in its place and found that the stocks that were
sold actually outperformed the shares that investors purchased, by an average of 3.2 per cent per year,
during the time period. Ranguelova (2002) used the trading data of 78,000 clients in the USA of a
discount brokerage firm and detected that the presence of the disposition effect is more pronounced on
large-cap firms.
Kaustia (2004) provided a hard evidence of the disposition effect linked with trading volume in the
initial public offering (IPO). The investors of these stocks have same purchase price, that is, the offer
price of the IPO. The author tracked the trading volume of the IPOs. He found that the trading volume
of stocks trading below their offer price surged significantly as soon as their price exceeded their initial
offer price. This phenomenon reconciles with the early sale of winning stocks in the disposition effect.
Disposition effect has been captured in many other countries across the world, for instance, in Finland
(Seru, Shumway, & Stoffman, 2010), Israel (Shapira & Venezia, 2001), China (Feng & Seasholes, 2005;
Shumway & Wu, 2006) and Japan (Misumi, Shumway, & Takahashi, 2007). The impact of this bias has
been mostly studied using market indicators like trading volume. For example, Lakonishok and Smidt
(1986) analysed the aggregate market volume data and found a positive correlation between current
volume and past price movements, which indicate the influence of the disposition effect. Ferris, Haugen
and Makhija (1988) calculated ‘expected normal volume’ and then compared it with actual volume
relative to the expected price changes. They found that price declines result in negative relative volume
and vice versa. Kumar (2009) used multiple measures of valuation uncertainty and behavioural bias
proxies to find that individual investors exhibit stronger disposition effect when stocks are harder to
value and when market-level uncertainty is higher.
1306 Global Business Review 19(5)

Overconfidence
Terrence Odean (1998a) introduced the overconfidence bias in a theoretical model that was successfully
tested in an empirical study (Odean, 1999). He suggested that overconfidence increases expected trading
volume and decreases expected utility of overconfident traders. Examining data on 66,465 US house-
holds with accounts at a large discount broker during 1991 to 1996, Odean and his co-author Brad Barber
found that success in past trades makes the investor overconfident of their stock picking skills that leads
to excessive trading activity and poor performance (Barber & Odean, 2000, 2001). The most active
traders had the poorest performance, while the least active investors earned the highest returns. Even
experts are not immune to the overconfidence bias. It is a well-known fact that in the USA, two out of
three mutual fund managers underperform the overall market in any given year (Kahneman, 2011).
Overconfidence effect has been widely reported. Success in past trades makes investors overconfi-
dent which gets converted into higher risk taking, the behaviour of the investors which leads to an
increase in their trading activity and high trading volume (Shiller, 2005). In another instance, Daniel
et al. (1998) report that investors’ overconfidence could result in price reversals. Biais, Hilton, Mazurier
and Pouget (2002) pointed that overconfident investors have a probability of suffering from winner’s
curse which results in poor trading performance. Overconfidence has also been linked with sensation
seeking tendency which leads to excessive trading behaviour (Grinblatt & Keloharju, 2009).
Cheng (2007) found that overconfidence leads to poor trading performance in both stocks (electronic
trading) and futures (open outcry) markets. The level of overconfidence and its impact was much greater
for the open outcry market than the electronic trading platform. Griffin, Nardari and Stulz (2007) linked
current trading activity with past returns using vector autoregressions (VAR) across 46 countries. They
detected that a positive relationship exists between trading volume and past returns. Further, this positive
relationship is much stronger in developing countries as compared to countries where financial markets
are more developed. The reason given by authors for such a finding is that the developing countries are
more prone to economic and market inefficiencies such as high level of corruption, short sale restriction
and high market volatility.
Subash (2012) conducted investor surveys in different states of India for detecting the presence of the
overconfidence bias. He found that the investors of the state of Kerala in the southern part of India are
more prone to overconfidence in their ability to outperform the market. Incidentally, Kerala also has the
highest literacy rate in India. A research for similar purpose has been done by Chawla (2014) by conduct-
ing a primary survey which signifies the implications of behavioural biases in India.

Testing for Disposition and Overconfidence Effect

Initial work on these two biases was confined to proprietary data on the trading activity of individual
investors and actively managed funds or in an experimental setting. In the Indian context, De, Gondhi
and Sarkar (2011) used a large database of orders and trades of Indian investors over a period of
18 months to study the effects of the disposition effect and overconfidence in an integrated framework.
They compared the effect of these two biases on individual and institutional investors and found that
individual investors are more prone to this disposition bias.
Later academic work on the disposition effect and overconfidence used data on the overall market and
individual securities and provided the evidence that both these biases influence the trading volume, and
they have an adverse impact on portfolio performance. Nevertheless, the overwhelming majority of
existing finance literature deals with these biases separately, focusing on either the disposition effect or
Prosad et al. 1307

overconfidence. However, both these biases are intrinsically related, and their connecting link being
trading volume. Glaser and Weber (2007, 2010) pointed that majority of the overconfidence models
propose high trading volume in the presence of overconfident investors. More specifically, the individual
investors trade more aggressively when they are overconfident (Benos, 1998; Caball´e & S´akovics,
2003; Gervais and Odean, 2001; Odean, 1998a). This is because as the investors start making profits on
their investments, they may become overconfident. This, in turn, leads to high trading behaviour in the
overall market. In the case of the disposition effect, this behaviour has a more localized effect, particu-
larly for winning stocks. Lakonishok and Smidt (1986), Ferris et al. (1988), Kaustia (2004) and Statman,
Thorley and Vorkink (2006) found that the trading volume of winning stocks is significantly higher than
losing ones. By combining the evidence of overconfidence and disposition effect, it can be inferred that
overconfidence affects the trading volume of the market as a whole while disposition effect affects the
trading volume of specific stocks. Making use of this asymmetry in the mechanism that links security
returns to trading activity, it is possible to measure the two biases empirically.
Statman et al. (2006) tested the proposition that overconfidence in investors’ leads to increase in
trading volume using formal overconfidence models using monthly data on NYSE/AMEX stocks. They
control for turnover trend and contemporaneous volume–volatility relationships but still find evidence of
individual security turnover being positively related to lagged market returns and lagged security returns.
They differentiate between overconfidence and the disposition effect, where the former bias is studied at
the market level and the latter at the individual stock level. If investors overestimate their ability to
increase wealth by active trading, they are likely to maintain this belief about stocks in general rather
than the specific securities they currently trade. Their results are consistent with the disposition effect
trading in conjunction with the trading volume prediction of investor overconfidence. They found that
overconfidence and the disposition effect are more pronounced in small-cap stocks and in initial periods
where individual investors hold a greater proportion of shares. Our article employs a methodology
similar to Statman et al. (2006).
The disposition effect and overconfidence are two significant irrationalities prevailing in the investors
of several nations across the world. Moreover, it is observed that financial experts and sophisticated
investors also fall prey to these biases along with naive individual investors. While a little bias may be
harmless, but if present in large extent and over a period of time, their results can be damaging for the
financial performance of investors’ portfolios. This ultimately hampers the growth of the overall market
as well. Thus, gaining knowledge about the presence and impact of these biases becomes pertinent.
Researchers relate both these biases to the trading activity of the investors. They empirically detected the
two biases by linking overconfidence with an overall increase in market trading volume while the dispo-
sition effect with an increase in the trading volume of the individual stock. This knowledge aids us in
framing our research objectives that are discussed below.

Research Objectives and Rationale

The present research article aims to investigate how disposition effect and overconfidence influence
trading volumes in Indian equity market. It further detects which bias has the greater impact on the
Indian equity market with respect to trading volumes.
Such a study can be helpful in providing an insight into the prevailing behavioural biases in the Indian
stock market. It will also delve deeper as to whether these biases are significant in creating inefficiencies
in the Indian markets.
1308 Global Business Review 19(5)

Data and Methodology

Data Source
For empirical findings, we use a large sample of Nifty 50 stocks. The Nifty 50 is a leading index of large
companies on the National Stock Exchange (NSE), which is the largest and the most liquid stock
exchange in India. Nifty 50 is well diversified and has representation from 22 sectors of the Indian
economy. Our sample consists of daily total returns and transaction volume for each constituent stock
and total returns of the index. This is collected for a period of 7 years, starting from 1st April 2006 to
31st March 2013. All data is from Centre for Monitoring Indian Economy (CMIE) Prowess database.
We track the trading activity of stock market during this period, and it can be seen that Nifty 50 has
touched great highs as well as lows (Figure 1). The market has seen the boom as well as recessionary
phase (characterized by low trading volume in 2009) followed by recovery in succeeding years.
The significant volatility of stock market trading volume in this period makes for an interesting analy-
sis of behavioural aspects, especially those biases that are linked with trading volume, that is, overcon-
fidence and the disposition effect, thus making it appropriate for our study.

Methodology
Following Statman et al. (2006), the market-wide VAR model is
k k
LogTt = a + | b j LogTt - j + | c j Rm t - j + vVol t + f 1t
j=1 j=1
k k (1)
Rm t = al + | blj LogTt - j + | clj Rm t - j + ol Vol t + f 2t,
j=1 j=1

Figure 1. Monthly Trading Volume of Indian Equity Market for the Period 2006–2013
Source: Prepared by the authors.
Prosad et al. 1309

where the two endogenous variables are LogT (log value of the trading volume of the market index) and
Rm (daily return on the market index). Following Karpoff (1987), we also include contemporaneous
daily volatility,1 Vol, as our single exogenous variable. Karpoff (1987) detected that volume is positively
related to the magnitude of volatility as well as volatility per se. Further, this relationship has been
confirmed in the Indian stock market by Mahajan and Singh (2009).
Overconfidence theories do not specify a precise time frame for the relationship between trading
volume and returns (Statman et al., 2006). Hence, we allow the data to determine the number of daily
lags to include. We set the number of lags, k, to be 10, based on Akaike Information Criteria (AIC),
where the lag selection relies on maximizing the log likelihood function but also includes a penalty for
increasing the number of estimated parameters. We also include contemporaneous daily volatility
(calculated using daily high and low values of the Nifty index) in our VAR model.
Security-wide VAR to Segregate the Impact of the Disposition Effect and Overconfidence on Trading Volume
The existing literature suggests that the positive portfolio returns make the investors overconfident,
which leads to an increase in trading volume for the overall market (Siwar, 2011; Statman et al., 2006).
However, for a disposition biased investor, an increase in return of a particular stock will influence him/
her to trade that stock, thereby increasing the transaction volume for that stock while not directly affect-
ing the trading volume of other stocks. This asymmetry in the mechanism makes it possible for the
researchers to measure the effect of these biases.
We measure this asymmetry by the VAR. The VAR establishes an endogeneity between individual
security transaction volume and lagged returns of both the market as well as individual stocks. The
endogenous variables for this study are log values of individual security transaction volume, lagged
values of market return and lagged values of individual security return. The exogenous variable and the
control variable is the idiosyncratic volatility of individual securities (a measure of firm-specific risk).
The VAR model for firm i can be represented as:
k k k
LogTi, t = a + | b j LogTi, t - j + | c j Rm t - j + | m j Ri t - j + oIvol i, t + f 1t
j=1 j=1 j=1
k k k
Rm t = al + | blj LogTi, t - j + | clj Rm t - j + | mlj Ri t - j + ol Ivol i, t + f 2t (3)
j=1 j=1 j=1
k k k
Ri t = a m + | bmj LogTi, t - j + | cmj Rm t - j + | mmj Ri t - j + om Ivol i, t + f 3t,
j=1 j=1 j=1

where the three endogenous variables are LogTi, which is the log value of a number of shares traded for
security i, Rm is the cumulative value of 5–10 days lag of daily market return (rm,t), Ri = cumulative value
of 5–10 days lag of daily return security i(ri,t). The contemporaneous exogenous idiosyncratic volatility2
of firm i is Ivoli. The number of lags, k, equals to 4, based on AIC.
The cumulative-lagged return values of the market index and individual security have been used
instead of daily return values as endogenous variables since existing empirical work, and our initial tests
using time series regression model confirm that lagged values of 5–10 days are most significant in
explaining overconfidence and the disposition effect.
The empirical results show the presence of positive and significant coefficients of delayed market
return (Rmt), and delayed stock return (Rit) indicates the separate impact of overconfidence and the
disposition effect. One-tailed t-statistic and F-statistic have been used to check the significance.
1310 Global Business Review 19(5)

Impulse Response Function

Individual VAR coefficients do not capture the full effect of an exogenous variable observation. Impulse
response functions (IRFs) use the available VAR coefficients to trace the impact of a shock from residuals
that is ± one standard deviation from zero. For example, changes in market return residual, f2t, in Equation
(1) will immediately change the current value of market return, Rm, but also affect future values of LogT
and Rm, since lagged values of LogT appear in both equations through the coefficients bj and blj, respec-
tively. To test whether the Indian equity market exhibits overconfidence bias, we shock the market return
residual, f2t, by one sample standard deviation and track how the trading volume responds over time to the
f2t shock using the estimated coefficients from the dynamic structure of VAR. The IRF is applied for
seven periods after which we find that the impact of these biases on trading volume gets diluted.

Results
The tests for stationarity of returns series and transaction volume is done by using augmented Dickey–
Fuller (ADF) tests, which reveal that both the series are stationary at the level. The stationarity results
are followed by individual results of market-wide VAR, security-wide VAR and IRFs. We discuss each
of these results in detail.

Result for Market-wide VAR (Refer Table A1)

Market trading volume is autocorrelated with highly significant coefficients for the first five lags though
the coefficients register declines after the first period. The results reveal that log transaction volume of
Nifty 50 index is positively related to all the lags of market return with the second lag of market return
being significant. This relationship prevails even after controlling for volume–volatility relationship.
This finding indicates the presence of overconfidence in the Indian equity market. Volatility also has a
highly positive contemporaneous relation with market trading volume with a coefficient of 2.52.

Results for Security-wide VAR (Refer Table A2)

The lags with significant positive and/or negative coefficients for security return and market return are
reported. The interpretation for same is based on following parameters.

1. Positive and significant values of security return lags (Ri) indicate the disposition effect.
2. Positive and significant values of market return lags (Rm) indicate overconfidence.
3. Positive and significant values of both (Ri) and (Rm) lags indicate both disposition effect and
overconfidence.
4. Significant positive value (Ri) lags but a significant negative value of (Rm) lags indicate the
presence of the disposition effect but inconclusive overconfidence bias.
5. Positive and significant value of (Rm) lags but significant negative value of (Ri) lags indicate the
presence of overconfidence bias, but the disposition effect is inconclusive.
6. Negative and significant values of both (Ri) and (Rm) lags indicate both disposition effect and
overconfidence bias are inconclusive.
7. Simultaneous presence of significant positive and negative lag for either (Ri) or (Rm) indicates
inconclusive bias.
Prosad et al. 1311

Based on these parameters, the results reveal that the disposition effect and overconfidence can be
detected in 20 firms with an extent of certainty (refer Table A2). More precisely, overconfidence bias is
present with 12 firms, the disposition effect is present with 5 firms and 3 firms are affected by both
biases. This makes overconfidence bias to be predominant amongst the two.
Results for Impulse Response Function

Market Impulse Response Function (Refer Figure A1 and Table A3)

Figure A1, Panel A presents the response of market trading volume (LogT) and market return (Rm) to one
standard deviation shock in their respective residuals. The results reveal that there is a positive impact of
LogT-shock on LogT, and it persists for all the seven periods. The impact is highest for the first period
(31 per cent), declines in the second and third period and thereafter remains stable ranging between 6 per
cent and 7 per cent. Further, the graph depicts the positive dependence of LogT to Rm shock which
persists for all seven periods. This dependence is clearly illustrated in Table A4 which shows that the
Rm shock leads to a positive and significant 2 per cent increase in LogT for the third period. This finding
verifies that market returns impact the investors’ confidence and subsequent trading activity.
Security Impulse Response Function (Refer Table A4)
It investigates the response of all the three endogenous variables, namely security trading volume (LogTi),
security returns (Ri) and market return (Rm), to the shock in their respective residuals. In the present
context, the response of LogTi to Ri and Rm shock is being discussed, as it brings more clarity to the
overconfidence and the disposition effect theory.
The empirical evidence for the overconfidence hypothesis can be verified for 12 firms as the trading
activity is positively related to past market returns. This can be observed from the response of LogTi for
market return shock, which is positive and significant. Whereas the disposition effect theory can be
validated for only three firms wherein the response of LogTi to Ri shock is positive. The periods for
which these results are significant are also identified.
The results of both market and security impulse response are in alignment with the findings of VAR
and suggest that overconfidence is predominant of the two biases.

Cross-country Analysis of Overconfidence and the Disposition Effect

We provide a comparative analysis of the results of similar tests conducted in other countries. These
studies investigate the relationship between the past returns and current trading volume to determine the
presence of overconfidence and the disposition bias. The findings are summarized Table 1.
It can be seen that previous evidence of these two biases was found in the USA, France and Estonia.
However, in countries like Pakistan and Tunisia, the prevalence of overconfidence was found but the
disposition effect was not confirmed. In a more elaborate study conducted by Griffin et al. (2007), it was
suggested that countries with weaker economic policies, inefficient markets, corruption and high volatility
are found to be more prone to the impact of behavioural biases. Emerging economies such as Pakistan,
Tunisia and Estonia may fall under these criteria. Along with this, several developed countries such
as, especially, the USA and Eurozone countries like France have faced grievous economic and financial
turmoil in the form of global financial crises (2007–2009) and sovereign debt crises (2008–2009). These
two crises have created uncertainty in the stock markets making investors prone to such behavioural
mistakes.
1312 Global Business Review 19(5)

Table 1. Comparative Analysis Overconfidence and the Disposition Effect in Different Countries

Author Year Country Methodology Finding

Statman, Thorley 2006 USA Vector autoregression and Empirical evidence
and Vorknik impulse response function supports the presence of
overconfidence and the
disposition effect.
Duan and Shou 2008 China Vector autoregression and Overconfidence and the
impulse response function disposition effect prevailed in
Chinese stock market.
Siwar 2011 France VAR analysis, T-GARCH, Evidence of overconfidence
time series regressions was found. However, the
presence of the disposition
effect was limited to some
securities only.
Čekauskas and 2011 Estonia Proportion of realized Disposition effect and
Liatukas gains and losses; vector overconfidence prevailed
autoregression and impulse in Estonian stock market.
response function However, the level of
overconfidence was lower
than the USA.
Sheikh and Riaz 2013 Pakistan Vector autoregression and Overconfidence was
impulse response function confirmed in Karachi stock
exchange.
Zaine 2013 Tunisia Vector autoregression and Strong evidence of
impulse response function overconfidence was found,
but the disposition effect was
not present.
Source: Prepared by the authors.

Conclusion and Implications

In essence, the final conclusion one can reach from these results is that overconfidence and the disposi-
tion effect prevail in Indian equity market. The overall results of VAR demonstrate that there is a positive
joint impact of both the biases on transaction volume even after controlling for volatility. The results of
market-wide VAR indicate the presence of overconfidence which is in line with the previous literature
(Statman et al., 2006). Further, security-wide VAR results depict the presence and impact of both over-
confidence and the disposition effect. It is seen that the effect of these two biases can be clearly segre-
gated for 20 out of 45 companies. Specifically, overconfidence bias is present with 12 companies, the
disposition effect is present with 5 companies and 3 companies are affected by both biases. Thus, we can
conclude that overconfidence is predominant of the two biases. On further investigation, we find that
these biases affect almost all the sectors irrespective of their type or characteristic, which indicates that
prevalence of these biases is not specific to any particular industry. The stocks fall under a variety of
sectors, including, banking, manufacturing, infrastructure, pharmacy, information technology and tele-
communications. These findings are verified with the help of IRF. The findings herein are in confirma-
tion with the results of Statman et al. (2006) that transaction volume at market level increases when
investors are overconfident, while it escalates at stock level due to the disposition effect.
It is also likely that the nature of the stocks contributes to the presence of behavioural biases. We take
the case of public sector units (PSUs) listed at Nifty 50. The central and state PSUs play an integral role
Prosad et al. 1313

Figure 2. Growth of CPSEs in India

Source: Public Enterprises Survey (2012), Department of Public Enterprises.

in the growth and development of our economy. They are, in a great way, responsible, for achieving the
goals of industrialization, self-reliance, price stability and competing at par with the global economy.
There has been a continuous growth in PSUs. Pre-liberalization, there were only 5 PSUs in India which
has increased to 260 as on March 2012. Moreover, 5 out of 7 Indian firms in Fortune 500 list are PSUs,
namely IOCL, BPCL, HPCL, ONGC and SBI (Mrug & Dave, 2015). The increased investments in PSUs
reflect investors’ confidence in state- and centre-run units. Figure 2 shows the increase in investments in
central public sector enterprises (CPSEs or PSUs) for the period 2008–2012.
This confidence (or overconfidence) of investors in state- and centre-run units is understandable as
PSUs are considered to be more stable investments than private enterprises which appeal to the risk-
averse nature of Indian investors. However, the analysts’ reports of the year 2013 show that the financial
performance of PSUs has deteriorated since 2011 and government had to sell the shares of these compa-
nies at a discount to raise funds. The losers include ONGC, SAIL, NTPC and SBI (Kaushik, 2013). Even
so, the investors’ confidence could not be shaken for these PSUs as shown from our results (ONGC,
PNB, BPCL and SAIL) and confirmed by survey reports of Department of Public Enterprises, showing
an increase in investments, especially in the year 2011–2012 (Figure 2). More specifically, ONGC and
PNB present an example of investors’ overconfidence, while BPCL and SAIL present the case of both
disposition effect and overconfidence.
In a similar manner, the present study also throws light on private enterprises which have been influ-
enced by overconfidence and the disposition effect.

Implications of the Study

The findings of this article have relevant implications for individual investors and global investment
managers. The overall Indian stock market is affected, if investors suffer from these biases. It has been
1314 Global Business Review 19(5)

observed that some biases like overconfidence are considered to be the most prevalent bias (Glaser &
Weber, 2010). However, just by the common knowledge that a particular bias prevails in the market will
not help the investors in making any practical strategies. In order to counter the bias, the investors need
to know the specific investments or specific stocks wherein they are making behavioural mistakes. Our
study aids the investors in achieving this objective. The present research establishes a relationship
between trading volume and returns and finds out the specific stocks that are more likely to get influ-
enced by the aforementioned biases. Markets that suffer from overconfidence bias tend to have extreme
reactions. Especially, the overconfidence in trying to time the market, trying to catch a falling knife can
create disastrous outcomes in stock market. For example, during the global financial crisis NIFTY 50 fell
60 per cent between January and November 2008. But systematic overconfidence can help in the recov-
ery too, with the NIFTY 50 doubling itself between March and December of 2009.
Disposition behaviour in certain stocks affects trading volume and drive a wedge between market
prices and fundamental values. Specific stocks that suffer disposition effect tend to underreact to nega-
tive information. When the global finance crisis (GFC) hit the market, the stocks which were prone to
disposition effect did not immediately adjust to the information. Investors overreact to private informa-
tion signals and underreact to public information signals. This is then followed by long-run correction.
By understanding this relationship and analysing the hidden trends in trading volume and returns,
investors can identify the specific stocks which are prone to these behavioural biases for which extra
caution is required. Such knowledge can help the investors in developing strategies and taking appropri-
ate measures. As Glaser and Weber (2010) suggested that this counter attack on behavioural biases or
‘debiasing’ can be made with the help of behavioural training and increasing financial literacy.

Acknowledgement
The authors are grateful to the anonymous referees of the journal for their extremely useful suggestions to improve
the quality of the article. Usual disclaimers apply.

Appendix
Table A1.

Lagged Market Trading Volume

Coefficient t-stat Coefficient t-stat
LOGTt–1 0.27*** (11.57) Rmt–1 0.00 (0.64)
LOGTt–2 0.11*** (4.50) Rmt–2 0.01*** (2.71)
LOGTt–3 0.08*** (3.33) Rmt–3 0.00 (0.61)
LOGTt–4 0.10*** (4.24) Rmt–4 0.00 (0.34)
LOGTt–5 0.09*** (3.73) Rmt–5 0.01 (1.32)
LOGTt–6 0.03 (1.13) Rmt–6 0.01 (1.14)
LOGTt–7 0.03 (1.08) Rmt–7 –0.001 (–0.24)
LOGTt–8 0.03 (1.19) Rmt–8 0.01* (1.91)
LOGTt–9 0.06** (2.28) Rmt–9 0.01 (1.06)
LOGTt–10 0.09*** (3.94) Rmt–10 0.00 (0.07)
Volt 2.52*** (5.29)
Adj R-sq 0.64 F-statistic 142.56
Prosad et al. 1315

Lagged Market Return

Coefficient t-stat Coefficient t-stat
LOGTt–1 0.19 (1.46) Rmt–1 0.02 (.96)
LOGTt–2 –0.13 (–0.92) Rmt–2 –0.03 (–1.38)
LOGTt–3 0.13 (0.95) Rmt–3 –0.04 (–1.75)
LOGTt–4 –0.05 (–0.32) Rmt–4 –0.03 (–1.18)
LOGTt–5 0.01 (0.12) Rmt–5 –0.03 (–1.37)
LOGTt–6 0.19 (1.37) Rmt–6 –0.06*** (–2.57)
LOGTt–7 –0.17 (1.16) Rmt–7 0.01 (0.32)
LOGTt–8 0.06 (0.43) Rmt–8 0.05** (2.10)
LOGTt–9 0.01 (0.09) Rmt–9 0.00 (.06)
LOGTt–10 –0.09 (–0.66) Rmt–10 0.00 (.01)
Volt –15.3*** (–5.71)
Adj R-sq 0.02 F-statistic 2.85
Source: Authors’ own findings.
Notes: The table reports coefficients and t-statistics from VAR equations of logged market volume (LOGT) and market return
(Rm) with 10 lags. Both VARs also include contemporaneous market volatility (Volt). *, ** and *** imply significance at
10%, 5% and 1% levels, respectively.

Table A2.

Positive and significant Negative and significant

Rit–j Rmt–j Rit–j Rmt–j Overconfidence Disposition
A C C Ltd. 7 8, 9 yes yes
Bharat Heavy Electricals Ltd. 3, 4, 5 Inconclusive no
Bharat Petroleum Corpn. Ltd. 1 2 yes yes
Bharti Airtel Ltd. 5 1 no Inconclusive
H C L Technologies Ltd. 9 no yes
Hero Motocorp Ltd. 8 4 Inconclusive yes
Hindalco Industries Ltd. 9 7, 9 yes Inconclusive
Hindustan Unilever Ltd. 8 no Inconclusive
Housing Development Finance 7, 8 yes no
Corpn. Ltd.
Infosys Ltd. 10 no Inconclusive
Infrastructure Development 6, 7, 8, 9, 10 7, 8, 9, 10 Inconclusive yes
Finance Co. Ltd.
Jaiprakash Associates Ltd. 8 yes no
Kotak Mahindra Bank Ltd. 1 1 Inconclusive yes
Larsen & Toubro Ltd. 10 no Inconclusive
Oil & Natural Gas 5 1 Inconclusive Inconclusive
Corpn. Ltd.
Punjab National Bank 2 yes no
Ranbaxy Laboratories Ltd. 5, 6 yes no
Reliance Capital Ltd. 2 2, 9 yes Inconclusive
Reliance Communications Ltd. 8, 9 no yes
Reliance Industries Ltd. 8 8 yes Inconclusive
Reliance Infrastructure Ltd. 8 8 yes Inconclusive

(Table A2 continued)
1316 Global Business Review 19(5)

(Table A2 continued)

Positive and significant Negative and significant

Rit–j Rmt–j Rit–j Rmt–j Overconfidence Disposition
Sesa Goa Ltd. 2, 3, 4 yes no
Siemens Ltd. 2 yes no
State Bank Of India 4 no Inconclusive
Steel Authority Of India Ltd. 8 2 yes yes
Sterlite Industries (India) Ltd. 2 7 yes Inconclusive
Sun Pharmaceutical Ind. Ltd. 6,8 7 Inconclusive Inconclusive
Tata Steel Ltd. 2 9 yes Inconclusive
Total 12 5
Both (Overconfidence and 3
Disposition effect)
Source: Authors’ own findings.
Notes: This table reports firms with significant coefficients for security return and market return lags. The numbers in each
column correspond to the lag values that were significant. Positive and significant values of security return lags Ri indi-
cate the disposition effect. Positive and significant values of market return lags Rm indicate overconfidence. Positive and
significant values of both Ri and Rm lags indicate both disposition effect and overconfidence. Significant positive value
of Ri lags but significant negative value of Rm lags indicate the presence of the disposition effect but inconclusive over-
confidence bias. Positive and significant values of Rm lags but significant negative value of Ri lags indicate the presence
of overconfidence bias, but the disposition effect is inconclusive. Negative and significant values of both Ri and Rm lags
indicate both biases are inconclusive. And lastly, the simultaneous presence of significant positive and negative lag for
either Ri or Rm indicates inconclusive bias.

Table A3.

Trading Volume (LogT) IRF: trading volume shock

1 2 3 4 5 6 7
LogT 0.31*** 0.09*** 0.06*** 0.06*** 0.07*** 0.07*** 0.06***
t-stat 58.78 11.83 7.97 7.33 8.58 9.2 7.75
Trading Volume (LogT) IRF: market return shock
1 2 3 4 5 6 7
Rm 0 0 0.02*** 0.01 0.01 0.01 0.02
t-stat 0.32 0.46 2.59 1.27 0.83 1.65 1.83
Source: Authors’ own findings.
Notes: This table reports the response of logged market trading volume (LogT) and market return (Rm) to a one standard
deviation shock in their respective residuals. *, ** and *** imply significance at 10%, 5% and 1% levels, respectively.
Prosad et al. 1317

Table A4.

Panel A: Security (LOGTi) Impulse Response Function: Market return shocks

1 2 3 4 5 6 7
Bharat Petroleum Corpn. Ltd. 0 –0.01 0.06*** 0.02 0.04** 0.01 0.02
I C I C I Bank Ltd. 0 0.01 –0.01 –0.01 0 0.03** –0.02
Maruti Suzuki India Ltd. 0 0.02 0.03** 0.02 0 0.01 0.01
Punjab National Bank 0 0.01 0.03*** 0.01 0.02 0.01 0
Ranbaxy Laboratories Ltd. 0 0.01 0.03 0.03 0.01 0.03** 0.04**
Reliance Capital Ltd. 0 0.02 0.03*** 0 0.02 0.02 0.03**
Sesa Goa Ltd. 0 0.01 0.03** 0 –0.02 –0.01 0.01
Siemens Ltd. 0 0.01 0.03** 0.03** 0.02 0.01 0.02
Sterlite Industries Ltd. 0 0.01 0.04*** 0.01 0.01 0.01 0.03**
Tata Motors Ltd. 0 0.20*** –0.08 –0.12 –0.02 0.04 0.04
Tata Power Co. Ltd. 0 0.01 0.03** 0.01 0.01 0 0
Tata Steel Ltd. 0 0.01 0.02** 0 0.01 0.01 0.02
Panel B: Security (LOGTi) Impulse Response Function: Security ‘i’ return shock
1 2 3 4 5 6 7
Bharat Petroleum Corpn. Ltd. 0 0.04*** 0.03 0.05*** 0.03 0.03** 0.03
Oil & Natural Gas Corpn. Ltd. 0 0.02 0.02** 0 0 –0.01 0
Steel Authority Of India Ltd. 0 0.02** 0.01 0.02 0 0.01 0.01
Source: Authors’ own findings.
Notes: Panel A reports impulse response function results on security trading volume (LOGTi) due to a one standard devia-
tion shock from the market return (Rm) residual. Panel B reports corresponding results due to shock from individual
security return (Ri) residual. For brevity only, firms which have significant coefficients are reported. *, ** and *** imply
significance at 10%, 5% and 1% levels, respectively.
1318 Global Business Review 19(5)

Figure A1. Response to Cholesky One S.D. Innovation ± 2 S.E.

Source: Authors’ own findings.

Notes
1. Volatility is estimated using daily high and low values of the index.
2. We follow Arena, Haggard and Yan (2008) to calculate idiosyncratic volatility for a security i by taking standard
deviations of the error terms in the extended capital asset pricing model (CAPM). ri.t = a i + b 1, i rm, t + b 2, i rm, t - 1 + f i.t,
where ri,t is the daily return of security i, rm,t is the Nifty 50 daily index return, rm,t-1 is the lagged value of the
market return and εit is the error term.

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