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Borsa _Istanbul Review

_
Borsa Istanbul Review 23-1 (2023) 93–112
http://www.elsevier.com/journals/borsa-istanbul-review/2214-8450

Full Length Article

Investor psychology in the stock market: An empirical study of the impact

of overconfidence on firm valuation
Ruqayya Aljifri
King Abdulaziz University, Department of Economics, Jeddah, Saudi Arabia
Received 17 March 2022; revised 20 September 2022; accepted 20 September 2022
Available online 29 September 2022

Abstract

Behavioral theories suggest that overconfident investors overestimate the quality of their information and underestimate risk. They have a high
demand for risky assets and require a lower risk premium, causing asset prices to rise and leading to overvaluation. We investigate how over-
confidence affects firm valuation in Saudi Arabia's emerging stock market. We used 4004 firm-quarter observations. To ensure that our results are
robust to unobserved firm-specific heterogeneity and endogeneity issues, we used the fixed-effects panel data model and the dynamic panel data
model. The findings show that overconfidence positively and significantly affects firm valuation. Results remain robust when using various
overconfidence proxies and when replacing the different econometric models. This study has important implications for academics, investors, and
regulators. Hopefully, it will make investors more aware of the impact of their psychology on asset pricing; thus, increasing the rationality of their
stock market decision making for improved market efficiency.
Copyright © 2022 Borsa İstanbul Anonim Şirketi. Published by Elsevier B.V. This is an open access article under the CC BY license (http://
creativecommons.org/licenses/by/4.0/).

JEL classification: C12; C23; D81; G11; G41

Keywords: Behavioral biases; Overconfidence; Firm valuation; Investor psychology; Emerging stock market

1. Introduction
The behavior of stock markets may deviate from the as-
sumptions of standard theories, and such theories have failed to
provide plausible explanations for stock market anomalies such
as mispricing and overvaluation. Stock prices and market
valuation are affected not only by fundamental company fac-
tors (Fama & French, 2015, 2021) and macroeconomic fun-
damentals (Burmeister, Roll, & Ross, 1994) but also by
investor psychology, such as overconfidence bias (Adebambo
& Yan, 2018). Investor psychology and how investors pro-
cess available information affect their decision-making process
and, therefore, stock prices and market valuation. Over-
confidence is a key factor in understanding the decision-
making process in financial markets (Daniel & Hirshleifer,
2015). Overconfidence bias significantly affects investors'
E-mail address: raljifri@kau.edu.sa.
Peer review under responsibility of Borsa İstanbul Anonim Şirketi.
decision-making process (Bakar & Yi, 2016; Barber & Odean,
2001; Daniel & Hirshleifer, 2015; Hirshleifer & Luo, 2001;
Lambert, Bessière, & N'Goala, 2012; Statman, Thorley, &
Vorkink, 2006; Tekçe & Yılmaz, 2015).
Behavioral theories predict that the overconfidence bias of
investors may lead to overpricing and overvaluation
(Adebambo & Yan, 2018). Theories posit that overconfident
investors overestimate the quality and precision of their in-
formation while underestimating risk; as a result, they have an
irrationally high demand for risky assets and require a lower
risk premium, inflating asset prices and eventually leading to
firm overvaluation. In other words, overconfidence among in-
vestors leads to stock overpricing because overconfident in-
vestors overestimate the quality of their knowledge while
underestimating the risk in the stock (Trejos, van Deemen,
Rodríguez, & Gómez, 2019). This simply means that they
deem their assessment and judgment of a situation to be su-
perior to what the situation truly is (Pompian, 2011). As a

https://doi.org/10.1016/j.bir.2022.09.010
2214-8450/Copyright © 2022 Borsa İstanbul Anonim Şirketi. Published by Elsevier B.V. This is an open access article under the CC BY license (http://
creativecommons.org/licenses/by/4.0/).
R. Aljifri
result, the required risk premium is lower, and the price paid
for the security is higher (Adebambo & Yan, 2018). Over-
confident investors overvalue their own knowledge and skills
(Trejos et al., 2019) and act on their beliefs. Because they
overestimate their skills and abilities in interpreting available
information, they may interpret the same signals differently
than rational investors. They may cause overpricing and
overvaluation because they may trade excessively and buy
more shares of a particular company simply because they
believe the stock they are buying will outperform the one they
are selling. Excess demand is caused by overconfidence bias,
which may result in mispricing (Adebambo & Yan, 2018;
Brown & Cliff, 2005; Trejos et al., 2019).
A valuation is an opinion of market investors and is affected
by their psychology and the way in which they process in-
formation. According to Brown and Cliff (2005), investor
psychology drove the rapid rise and fall of technology stock
prices and valuations. They mentioned the need for stock
valuation models to measure deviations from theoretical prices
Hong, Scheinkman, and Xiong (2006) confirmed that hetero-
geneous beliefs due to overconfidence cause asset prices to
exceed their fundamental value, which may lead to over-
pricing. Investor psychology is crucial in determining stock
prices and may be a source of mispricing (Baker & Wurgler,
2007, 2013). The proposition that changes in overconfidence
affect stock prices is mentioned in studies by Gervais and
Odean (2001) and Scheinkman and Xiong (2003). Our
assumption is that firm valuation is directly influenced by
overconfidence bias; therefore, firms with overconfident in-
vestors are overvalued.
We note that psychological biases affect investor behavior
and, therefore, their investment choices. Focusing on the Saudi
stock market context, Fig. 1 illustrates the evolution of the
Saudi stock market index, TASI, over 11 years. The TASI
index is the major index tracking the performance of all listed
Fig. 1. Evolution of the TASI market index over the 11-year period (2009–2019).
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companies in the Saudi stock market. Fig. 1 shows that the
TASI series seems to have increased rapidly overall. According
to behavioral finance, this rapid increase can be explained by
investors’ psychology, which is consistent with the Saudi-
related literature that found investors in the Saudi stock mar-
ket are characterized by overconfidence bias, which has a
significant effect on their investment decisions (Alquraan,
Alqisie, & Al Shorafa, 2016; Matoussi & Mostafa, 2016).
Overconfidence may cause undesirable effects on stock
markets, such as mispricing, excessive trading volumes, and
increased market volatility (Kunjal & Peerbhai, 2021). This
study demonstrates the significance of overconfidence. It
demonstrates how overconfidence bias can lead to stock mar-
ket mispricing and overvaluation. The study raised the concern
that stock market investors may overestimate their own
knowledge and interpret available information in ways that
lead to overpricing and overvaluation. However, asset price
increases are associated with bubbles such as the Mississippi
bubble (1719–1720) and the South Sea bubble (1720)
(Brunnermeier, 2016).
There has been much research on overconfidence (Barber &
Odean, 2000, 2002; Gervais, Heaton, & Odean, 2007; Grinblatt
& Keloharju, 2009; Odean, 1998). However, previous literature
has focused on examining the effect of investors’ biases on their
decision-making process, market anomalies and trading volume
(Barber & Odean, 2000, 2001; Grinblatt & Keloharju, 2009;
Odean, 1998; Statman et al., 2006). To the best of our knowl-
edge, there have been two studies on its influence on firm and
stock market valuation (Adebambo & Yan, 2018; Bouteska &
Regaieg, 2018), both of which focused solely on the US stock
market. Moreover, Adebambo and Yan (2018) and Bouteska
and Regaieg (2018) applied cross-sectional and fixed effect
models, respectively, failing to provide an alternative estimation
approach such as a dynamic panel model to control for dynamic
endogeneity and to check the robustness of their findings.
R. Aljifri
In Saudi Arabia, no literature examines the impact of
investor bias on the behavior of a stock. Only a few studies
have examined the impact of investor bias on their decision-
making process, with the goal of identifying which biases
affect investor decision making (Alnajjar, 2013; Alquraan
et al., 2016; Alsedrah & Ahmed, 2017; Matoussi & Mostafa,
2016). However, this literature does not examine the influ-
ence of investor biases on the behavior of stock markets, such
as mispricing and market valuation. Unlike previous studies in
the Saudi context, which have focused solely on the impact of
investor bias on investors’ decision-making process, this study
examines the impact of investor bias on the behavior of the
stock market and particularly examines the impact of investor
overconfidence on asset prices and stock market valuation.
Behavioral finance studies not only the impact of psychological
biases on investor behavior but also the subsequent effect on
the behavior of stock markets (Sewell, 2010).
Given investors’ emotional behavior in the stock market,
this paper explores the relationship between investor psychol-
ogy and stock market behavior. Particularly, we analyze the
influence of investor overconfidence on stock prices and firm
valuation. We employ two econometrics models of fixed effect
and dynamic system generalized method of moments (GMM)
estimations to ensure our results are robust for both unobserved
firm-specific heterogeneity and endogeneity issues. Moreover,
we experimented with many alternative proxies for investor
overconfidence to ensure that our results are not sensitive to the
proxy variable. In this study, we present six alternative ways to
measure investor overconfidence, introducing new proxies of
investor overconfidence (three alternative proxies to measure
excessive trading) that are based on prior literature and are not
simply picking up previously documented results, as shown in
Section 6. Our results are robust when using all six over-
confidence proxy variables and replacing the different econo-
metric models, which confirms our findings. This study
considered the aggregate investor behavior of companies listed
on the Saudi stock market. Chuang and Lee (2006); Gervais
and Odean (2001) argued that investor behavior should be
observable in aggregate level data. This is supported by Fama
(2021a), who stated that for a financial theory to be valid, it
should explain market behavior rather than that of a specific
group of investors.
We are making three contributions. First, the Saudi stock
market is a developing market in a collectivist society that is a
member of both the Middle East and North Africa (MENA)
and the Gulf Cooperation Council (GCC) stock markets. As a
result, this study adds to our understanding of the impact of
overconfidence on mispricing and firm valuation in emerging
markets with collectivist societies like Turkey, China, India,
and Taiwan, as well as the MENA and GCC stock markets,
where data are not easily available. To the best of our
knowledge, two studies, Adebambo and Yan (2018) and
Bouteska and Regaieg (2018), have examined the impact of
investor overconfidence on firm valuation; however, they were
solely focused on the US stock market. Second, Adebambo and
Yan (2018) and Bouteska and Regaieg (2018) applied cross-
sectional and fixed effect models, respectively. In contrast to
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these studies, the current study used two econometric models; a
fixed effect model and a dynamic panel data model (system
GMM) to ensure that our findings are robust to unobserved
firm-specific heterogeneity and endogeneity issues. As a result,
this study contributes to the development of empirical models
for the relationship between investor overconfidence and firm
valuation. Third, a challenge any empirical study faces when
examining the impact of investor overconfidence is finding
good proxies of overconfidence. This study adds to the body of
knowledge by introducing new proxies of investor over-
confidence (three alternative proxies to measure excessive
trading) that are correlated with overconfidence bias and are
based on prior research, as shown in Section 6. We also pro-
vide evidence that our proxies of investor overconfidence do
not simply pick up the previously documented results.
The methodology considered here consists of developing
panel data models, using 4004 firm-quarter observations
covering 11 years, from 2009 to 2019. We applied this study's
fixed-effects panel data model for the main analysis. We
employed a panel regression model to analyze our secondary
data because the data collected exhibited cross-sectional and
time-series dimensions. The panel data model has the advan-
tage of providing cross-sectional and time-series dimensions,
allowing the researcher to control for unobserved heterogene-
ity. We used a panel fixed-effects model to examine the impact
of overconfidence bias on the valuation of Saudi companies
listed on the stock exchange. Generally, pooled panel data
analysis ignores the heterogeneity that might exist among
companies (Gujarati & Porter, 2003), and it does not distin-
guish between the various companies included in our study.
Based on the F-statistic (homogeneity test) and the Hausman
test results (χ 2 test), As discussed in detail in the methodology
section, we concluded that the fixed-effects model is the most
appropriate and consistent model for our sample. Therefore, we
used the fixed-effects model for panel data regression to
examine our null hypothesis. In addition, as an alternative
analysis to test the robustness of our results, we used dynamic
systems GMM estimation to control for endogeneity issues.
Dynamic endogeneity occurs when the past values of the
dependent variable influence the future values of the indepen-
dent variable, which can lead to incorrect inferences and biased
estimates. Despite controlling for unobserved firm-specific
heterogeneity, the fixed effect ignores the correlation between
the lagged dependent variable and the error term, which may
result in biased coefficient estimates. For instance, all else
being equal, the firm valuation in a previous year may affect
investor overconfidence in subsequent years. To ensure our
results are robust to endogeneity issues such as dynamic
endogeneity, we use the dynamic system GMM estimation as
an alternative estimation approach to ensure our results are
robust to endogeneity issues.
The findings have implications for academic researchers,
market investors, and market regulators, as well as implications
for investment expenditures, capital allocation, and market
efficiency. Our findings may also help explain mispricing and
overvaluation in emerging markets with collectivist societies
and in the MENA and the GCC stock markets, because Saudi
R. Aljifri
Arabia's stock market is an emerging market with a collectivist
society that is a member of both MENA and GCC stock
markets. The findings also support behavioral theories that
predict that investor psychology affects asset pricing and,
therefore, the market valuation, suggesting that the role of
investor behavior should be considered in asset pricing models.
Furthermore, the current study should help stock market
investors become more aware of the impact of their own psy-
chological factors, specifically overconfidence bias, on asset
pricing and market valuation, thereby increasing the rationality
of their stock market decision making for improved market
efficiency. Further interventions may be needed to raise in-
vestors' awareness of their behavioral biases, helping them
make better use of information sources when making invest-
ment decisions. Furthermore, our results show that this
cognitive bias can cause firm value in the Saudi stock market to
deviate from normal toward overvaluation. However, price
bubbles arise when asset prices exceed the asset's fundamental
value. Bubbles were associated with asset price increases
(Brunnermeier, 2016). Famous examples include the Dutch
tulip mania (1634–1637), the Mississippi bubble (1719–1720)
and the South Sea bubble (1720). Therefore, market regulators
should be aware of the influence that investor behavior can
have on market bubbles and economic activity.
Market valuation is also a key concept in finance, which has
significant implications for market efficiency, capital alloca-
tion, and investment expenditures. According to studies by
Khanna and Sonti (2004), Zaigham, Wang, and Ali (2019), and
Blanchard, Rhee, and Summers (1993), an increase in market
valuation results in an increase in a company's capital expen-
diture activity. As a result, investment expenditures are reduced
when a company's market value declines (Asker, Farre-Mensa,
& Ljungqvist, 2015; Del Brio, De Miguel, & Pindado, 2003;
Dessaint, Foucault, Frésard, & Matray, 2019; Kouser, Saba, &
Anjum, 2016). Significant evidence of linkages between mar-
ket valuation, capital market efficiency and capital allocation
can be found in Baker (2009). The current study investigates
the impacts of behavioral bias, namely, the overconfidence of
investors in the valuation of the Saudi stock market companies.
Our model's main prediction is that investor overconfidence
bias leads to overvaluation. Consistent with our prediction, we
discovered that investor overconfidence has a positive and
significant impact on company valuations in the Saudi stock
market. Our results show that overconfidence bias causes the
Saudi stock market valuation to deviate from normal toward
overvaluation. Two main robustness and sensitivity analyses
were performed in this study. First, we used six different
overconfidence proxies to ensure that our results were not
affected by the variable proxy. All proxies yield statistically
significant results. Our findings remained unchanged when we
used the alternative overconfidence measures. The results agree
with our main proxy variable of overconfidence. Second, we
conducted dynamic system GMM regression analyses as an
alternative estimation approach to ensure our results were
robust to endogeneity problems. Results show that over-
confidence is significant across all models at 1% and 5% levels.
The dynamic systems GMM model yielded larger coefficients
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with lower p-values of less than 5% for overconfidence proxies
compared to the fixed effect approach, implying a stronger
relationship and higher significance levels. The dynamic sys-
tems GMM results are consistent with the main results reported
for the analysis of the fixed-effects estimation. Overall,
robustness checks confirm our results and suggest that our
main findings are robust. In both the main and alternative
regression analyses, the significant positive relationship be-
tween the valuation of listed companies in the Saudi stock
market and all overconfidence proxy variables supports our
hypothesis.
The rest of this paper is structured as follows. Section 2
outlines the theoretical background and reviews the related
literature. Section 3 contains the research design, and Section 4
explains the methodology. Section 5 reports the empirical
findings and discussion; Section 6 contains the robustness and
sensitivity analysis, and Section 7 concludes this paper.
2. Theoretical background and related literature
Unintentionally, people use shortcuts and heuristics to deal
with some decisions, avoiding the complexity of estimating
probabilities with each decision, which may save time and
effort while resulting in good decisions. However, they may
also lead to systematic biases causing serious losses, particu-
larly in the case of financial decisions (Goodwin & Wright,
2014). Contrary to what standard financial theories suggest,
investors' psychology influence their decision-making process
to a great extent, and therefore, investors are not fully rational.
These psychological factors may lead to biases such as over-
confidence, and therefore must be taken into consideration
while making investment decisions (Chandra, 2008). Funda-
mental data do not explain the stock market crisis, remarkable
price decrease (Shiller, 1987), and high price volatility in 1987
(Siegel, 1992); these events are mainly caused by investors'
biases. Behavioral finance has introduced investors’ behavior
as a factor that may influence stock returns, performance and
valuation (Adebambo & Yan, 2018; Bollerslev, Gibson, &
Zhou, 2011; Bouteska & Regaieg, 2018) as well as market
anomalies (Stracca, 2004).
There has been a growing need in the relatively recent field
of behavioral finance, which enables us to explain the empir-
ically observed financial phenomena and anomalies that cannot
be explained by traditional theories (Barberis & Thaler, 2005,
pp. 1–76) and proposes alternative theories that consider the
effect of investors' psychology on their decisions and stock
markets. The field of behavioral finance is a combination of
standard finance, psychology, and sociology, attempting to
explain anomalies (Ricciardi & Simon, 2000). Behavioral
finance can be defined as the area that explores the influence of
investors’ psychology on their financial decision-making pro-
cess (Shefrin, 2002), and consequently, financial markets.
The reasons for conducting this research in the Saudi stock
market are as follows. First and foremost, the Saudi stock
market is by far the largest, most liquid, and most actively
traded in the GCC countries and the Arab world as a whole
(Abdalla & Suliman, 2012; Mensi, 2019; Rahman,
R. Aljifri
Chowdhury, & Sadique, 2015). Second, this type of research
has been done on the US stock market (Adebambo & Yan,
2018; Bouteska & Regaieg, 2018); however, the Saudi stock
market, an emerging stock market in a collectivist society that
is a member of both the MENA and the GCC stock markets, is
considered in this study. Therefore, we use this research to
expand our understanding of the impact of overconfidence on
firm valuation in emerging markets with collectivist societies
such as Turkey, China, India, and Taiwan, as well as the
MENA and the GCC stock markets, where data are not easily
available.
Third, investors in the Saudi stock market are characterized
by overconfidence, which has a significant effect on their in-
vestment decisions (Alquraan et al., 2016; Matoussi &
Mostafa, 2016). Alsabban and Alarfaj (2020) investigated
overconfidence bias in the Saudi stock market and found evi-
dence that investors exhibit overconfidence bias. The majority
of traders in the Saudi stock market are individuals, inexperi-
enced males aged 30–39 years (Alsedrah & Ahmed, 2017).
According to Menkhoff, Schmeling, and Schmidt (2013), in-
dividual investors are more overconfident than institutional
investors. According to surveys and experimental studies, men
are more overconfident than women (Barber & Odean, 2001;
Lundeberg, Fox, & Punćcohaŕ, 1994; Prince, 1993; Prosad,
Kapoor, & Sengupta, 2015). These findings are supported by
Tekçe and Yılmaz (2015), who found that overconfidence is
higher among males and young investors than among females
and older investors. Additionally, overconfidence behavior in
emerging markets such as Saudi Arabia has received consid-
erable critical attention, as empirical studies have proven that
market anomalies tend to be more dominant in emerging
markets (Abdeldayem & Mahmoud, 2013; Chen, Kim,
Nofsinger, & Rui, 2007; Metwally & Darwish, 2015). In-
vestors in emerging markets with collectivist characteristics,
such as Turkey, China, India, and Taiwan, are prone to
behavioral biases compared to their counterparts in developed
and individualistic societies, such as the USA (Tekçe &
Yılmaz, 2015). Therefore, we may expect the effect of over-
confidence bias on the emerging stock market of Saudi Arabia
with a collectivist society to be significant and strong. There-
fore, research on this issue in the Saudi stock market is
worthwhile. However, to our knowledge, no studies have
investigated the effect of biases from which Saudi investors
suffer on the behavior of the stock market.
This section contains a review of overconfidence bias, in
addition to the Saudi-related literature, related studies, and the
research hypothesis. Overconfidence bias is based on a large
body of psychological experiments and survey research.
2.1. Overconfidence bias
The overconfidence concept is driven by psychological
experiments and surveys, and it is the most frequently
mentioned bias in behavioral finance (Ho, 2011). Most in-
dividuals rank themselves better than average and better than
others rank them (Taylor & Brown, 1988). They frequently
overestimate their own performance as better than it is, as well
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as better than that of their peers (Pikulina, Renneboog, &
Tobler, 2017). Specifically, stock market investors' exhibit
overconfidence when they make financial decisions (Baker &
Nofsinger, 2002). More than half of investors see their stock
selection skills as better than other investors’ (Statman et al.,
2006). Chuang and Lee (2006) provided extensive evidence
of the presence of overconfidence in financial markets.
Overconfident investors tend to give more privilege to their
own information than information that is publicly available to
all other investors as well as their abilities and skills in inter-
preting the available information, and consequently will trade
excessively (Barber & Odean, 2000; Korniotis & Kumar,
2008). They believe that if they follow their own ideas and
rules, they will be more successful, which satisfies them even if
it is not justified. In line with these findings, Daniel,
Hirshleifer, and Subrahmanyam (2005) found that investors
overreact to private information signals while underreacting to
publicly available information signals. Overconfident investors
overestimate the precision of their private information in
comparison to publicly available data. According to Trejos
et al. (2019), overconfident investors tend to believe that
their abilities and the accuracy of their own information are
better than average. They also added that overconfident in-
vestors tend to have a high trading volume.
Overconfident investors are not necessarily incompetent or
ignorant; rather, they assume that their judgments’ accuracy is
higher than what it truly is (Pompian, 2011). Benos (1998)
examined an extreme form of posterior overconfidence in
which some risk-neutral investors overestimate the accuracy of
their personal information and compete in market orders with
another group of informed traders who have rational expecta-
tions. He confirmed that a higher trading volume and a deeper
market result from overconfident investors in the stock market.
More importantly, he demonstrated that such traders may
outperform rational traders in terms of expected profits.
Overconfident investors may profit more than rational investors
because they take on more risk (Bradford, De Long, Summers,
& Waldmann, 1991) and may exploit mispricing caused by
noise trading (Hirshleifer & Luo, 2001). In line with these
findings, Kyle and Wang (1997) showed that overconfident
traders may strictly outperform rational traders because an
overconfident trader is more likely to generate higher expected
profit and utility than his rational opponent and higher than if
he were also a rational trader. They concluded that over-
confident investors could persist and survive eventually.
Overconfidence bias is the source of high levels of trading
on financial markets because overconfident investors tend to
have higher trading volumes than rational investors (Odean,
1998). In line with these results, Barber and Odean (1999)
concluded that overconfidence bias increases trading volume
because overconfident investors overvalue their knowledge and
abilities and, as a result, are too certain about their own
choices, ignoring other options. They also concluded that
investor psychology results in systematic overconfidence bia-
ses, which may influence asset prices. Jain, Jain, and Jain
(2015) found that stock market investors tend to be over-
confident and therefore trade too much, driving stock prices to
R. Aljifri
behave unexpectedly. In line with these findings, according to
Alrabadi, Al-Abdallah, and Aljarayesh (2018), overconfidence
bias explains the majority of the changes in stock prices on the
Amman stock exchange. Given the influence of the over-
confidence bias in investors' decisions and stock prices, it is
expected that this bias will ultimately affect stock market
valuation. Adebambo and Yan (2018) investigated the effects
of investor overconfidence on US stock market firm valuation
and discovered a strong positive relationship between investor
overconfidence and firm valuation; firms with more over-
confident investors are overvalued. Consistent with these
findings, Bouteska and Regaieg (2018) found that over-
confidence positively impacts Tobin's Q of companies in the
US stock market.
This part of the literature showed that overconfidence bias
influences the valuation of companies listed in the Saudi stock
market, which leads to our hypothesis.
H0: Overconfidence bias positively affects the valuation of
companies listed in the Saudi stock market.
In conclusion, this review includes pioneering and cutting-
edge research on this topic. The aforementioned studies' find-
ings show that the investors' overconfidence bias has been the
focus of financial literature studies (Barber & Odean, 2000,
2001; Grinblatt & Keloharju, 2009; Heger & Papageorge,
2018; Odean, 1998; Statman et al., 2006; Trejos et al., 2019).
Previous studies have focused on examining the effects of in-
vestors' biases on their decision-making process, market
anomalies, and trading volume (Barber & Odean, 2000, 2001;
Grinblatt & Keloharju, 2009; Odean, 1998; Statman et al.,
2006). Overconfidence has been scrutinized by a great deal
of research Barber and Odean (2000, 2002); Gervais et al.
(2007); Gervais and Odean (2001); Grinblatt and Keloharju
(2009); Odean (1998), yet there have been few studies on its
influence on firm and stock market valuation Adebambo and
Yan (2018); Bouteska and Regaieg (2018). These studies,
however, have concentrated on the stock market in the United
States. None have been used in Saudi Arabia because previous
research has ignored the Saudi stock market in favor of
American data, which is more readily available. The few
studies examining the impact of investor overconfidence on
firm valuation have not used a dynamic panel model, so they
do not account for dynamic endogeneity. This study aims to fill
that gap by controlling for endogeneity issues and focusing on
the emerging Saudi stock market. Our study is the first to
investigate the impact of overconfidence on the valuation of
companies listed on Saudi Arabia's emerging stock market, and
it will explain the market rather than a specific group of in-
vestors, as Fama (2021b) suggested.
Moreover, the influence may differ depending on the country
or location of investigation; for example, Zia, Ilyas Sindhu, and
Haider Hashmi (2017) found that investors in the United States
are more overconfident than investors in South Asian countries.
Corredor, Ferrer, and Santamaria (2013) studied four European
nations with similar financial development and found that in-
vestors’ sentiments influence stock prices, and country-specific
characteristics influence sentiments. Therefore, it is necessary to
investigate how overconfidence bias influences stock markets in
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a country-specific context. The literature analysis reveals that
this topic requires further investigation.
2.2. Review of Saudi-related literature
Alnajjar (2013) investigated the investors' irrational attitude
while investing in the Saudi stock market, using a question-
naire approach collected from 119 respondents who invest in
Tadawul. He used correlational statistics to describe the rela-
tionship between the variables in his study. The findings
indicate that investors' decision-making processes in Tadawul
are influenced by their psychology. He tested the correlations
between the independent variables, namely information type,
information asymmetry and risk propensity on the risk
perception variable. The information - type variable includes
different kinds of information: interest rate, improper man-
agement and variation in stock market policies. Then, subse-
quently, he tested how risk perception is correlated with the
variables, namely, reinvestment intension, investment perfor-
mance, return expectations and investment performance. He
found that the information type is positively correlated with the
investors’ risk perception. This shows that different types of
information are significantly important for an investment de-
cision. Information asymmetry is also positively correlated
with risk perception, whereas the relationship between risk
propensity and risk perception was negatively formed in his
study. Moreover, he found that reinvestment intension invest-
ment performance, and investment satisfaction are negatively
correlated with risk perception. In comparison, there was a
positive correlation between risk perception and return expec-
tations. However, he focused only on risk perception: What
factors are correlated with risk perception, and, subsequently,
how is risk perception correlated with other variables of rein-
vestment intension investment performance, return expecta-
tions, and investment performance? Also, he only used the
correlational stats method to analyze his data.
Alquraan et al. (2016) examined the impact of behavioral
finance factors on the investment decisions of investors in the
Saudi stock market using a multiple linear regression test. They
distributed 140 questionnaires randomly. They found that
behavioral factors (overconfidence, loss aversion, and risk
perception) significantly affect the stock investment decisions
of individual investors in the Saudi stock market, whereas herd
has an insignificant effect. However, this study only looked at
Saudi investors in 2015. (Fama, 2021b) stated that for a
financial theory to be valid, it should explain the market rather
than a specific group of investors. We considered the aggregate
investor behavior of companies listed on the Saudi stock
market. In the same year, Matoussi and Mostafa (2016)
investigated the effect of psychological biases on Saudi in-
vestors’ decision making using a survey approach and
analyzing the data using descriptive statistics and correlation.
They found that Saudi investors tend to be overconfident
because they are affected by rumors and herding behavior that
hinder them from making rational decisions. However, they
used simple descriptive statistics and correlation approaches to
analyze their data.
R. Aljifri
Alsedrah and Ahmed (2017) attempted to determine the
behavioral factors that influence investors' speculative behavior.
The partial least square method results indicate that over-
confidence bias, among other biases, has a significant rela-
tionship with speculative behavior. In contrast, loss aversion
and regret aversion do not play a significant role in investors’
speculative behavior. Recently, Alsabban and Alarfaj (2020)
used monthly data from 2007 to 2018 to investigate the pres-
ence of overconfidence bias in the Saudi stock market and
applied the vector autoregression (VAR) model. They discov-
ered that Saudi stock market investors are overconfident. They,
on the other hand, used data at the market level, whereas we
used data at the firm level over time. Unlike stock market
trading volume, each company may have specific information in
each period that explains a large portion of the trading volume.
By reviewing the relevant Saudi literature, there are a few
points to be clarified, and we will identify the gap in the Saudi
studies as follows. First, regarding overconfidence bias results,
according to Statman et al. (2006), if historical stock returns are
able to explain the current trading volume, then it confirms the
presence of overconfidence bias. Alsabban and Alarfaj (2020)
found that historical stock returns are able to explain the cur-
rent trading volume in the Saudi stock market, and therefore,
they confirmed the existence of overconfidence bias in the
Saudi stock market. Moreover, overconfidence has a significant
positive effect on the investor decision (Alquraan et al., 2016),
and Saudi investors are characterized by overconfidence
(Matoussi & Mostafa, 2016).
Second, these studies used correlational stats, ordinary least
squares (OLS) and its extension multiple linear regression, the
partial least squares and VAR methods to analyze their data.
Traditional linear regression models can lead to biased esti-
mators due to unseen individual-specific heterogeneity. Panel
data regression, on the other hand, combines two dimensions
that provide more information and data variation than time-
series regression. Panel fixed-effects regression, among other
panel regression models, provides significant interpretations and
can be generalized due to the large sample size (Abdulsamad,
Yusoff, & Lasyoud, 2018). In this study, we use the fixed-
effects panel data model for the main analysis, as well as dy-
namic systems GMM estimation to control for endogeneity is-
sues as an alternative analysis to test the robustness of our
results. As a result, by controlling for unobserved heterogeneity
and endogeneity issues, this study adds to the empirical models
used in the relationship between investor overconfidence and
the valuation of listed firms in the Saudi stock market.
Third, few studies exist that have considered the effect of
investors' biases on their investment decision in the Saudi
Stock Exchange (SSE) Tadawul since its establishment. Hence,
the current study remedies the relative dearth of research on
this topic. Fourth, apart from Alsabban and Alarfaj (2020),
earlier studies conducted in the Saudi stock market context are
questionnaire-based studies and faced small sample problems,
for example, Alnajjar (2013), Alquraan et al. (2016), Matoussi
and Mostafa (2016), and Alsedrah and Ahmed (2017) distrib-
uted 119, 140, 180, and 130 questionnaires respectively. The
current study uses secondary data with 4004 quarterly
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observations, including 91 of the companies over 11 years. The
survey analysis might suffer from reliability and validity issues.
The survey results do not necessarily reflect the investors' real
thoughts. Additionally, the investors' attitudes will be affected
by the investing environment, especially if this environment is
difficult at the time of collection. For example, it is difficult to
ensure that coronavirus (COVID-19) does not affect the in-
vestors' attitudes when completing the survey. Therefore, the
current research results are more reliable than the conclusions
of an analysis based on a survey. Moreover, real trading data
accurately reflect the psychological bias tendencies of in-
vestors. Ho (2011), Bouteska and Regaieg (2018), Adebambo
and Yan (2018), and Bailey, Kumar, and Ng (2011) used
actual market trading data to substitute for investors’ psycho-
logical biases.
Fifth, Saudi-related literature has empirically proven that
investors exhibit irrational behavior in the Saudi stock market,
which confirms that investors do not always follow traditional
finance theories, and their irrational behavior must be consid-
ered when studying the Saudi stock market. However, none of
the studies reviewed above has considered the influence of
investor overconfidence on the Saudi stock market. Saudi-
related studies have focused solely on finding evidence for
the existence of behavioral biases for investors in the Saudi
stock market in an attempt to identify which biases influence
investors' decisions while also ignoring the consequent influ-
ence of these biases on the Saudi stock market. In contrast to
the previous studies reviewed above, this study is the first to
examine the impact of investor overconfidence on the valuation
of companies on the Saudi stock market. According to Sewell
(2010), behavioral finance studies the impact of psychological
biases on investors' behavior and its subsequent effect on the
stock market behavior. Our study, for the first time, examines
the impact of investor overconfidence on the valuation of
companies on the Saudi stock market. This point is particularly
important, given that psychological biases may play a signifi-
cant role in the Saudi stock market; for example, the main cause
of the Saudi stock market crash of 2006 was the result of in-
vestors’ behavior (Aljloud, 2016; Malik & Hammoudeh, 2007).
3. Research design
3.1. Data, sample, and variables measurement
The target population for the current study is all nonfinance
companies listed on the SSE from 2009 to 2019. Following the
literature, we excluded the financial and insurance firms from
the sample for various reasons. We excluded financial com-
panies from our sample due to the significant differences in
their accounting methods and practices, as well as the various
regulatory restrictions for these companies compared to their
nonfinance counterparts (Abed, Al-Attar, & Suwaidan, 2012;
Al-Najjar, 2011; Estrin, Hanousek, Kocenda, & Svejnar, 2009;
Jiraporn, Singh, & Lee, 2009), which can make capturing the
effect of investor biases on firm valuation more difficult.
Similar to previous works (Adebambo & Yan, 2018; Bouteska
& Regaieg, 2018), excluding financial firms contributes to a
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Borsa Istanbul Review 23-1 (2023) 93–112

better exploration and analysis of the research questions, and it
helps to avoid distorting the results. The following parameters
were used to select the study sample of companies: To begin,
the sample includes companies that were listed on the stock
market at the start of the sample period but excludes companies
that ceased operations or were listed on the exchange during
the study's sample period. Second, no changes occurred in the
included companies, such as mergers, during the study period.
Third, the company's annual reports and stock market data
must be available for all 11 years from 2009 to 2019. After
implicating the above criteria, the sample consisted of 91
nonfinancial firms listed on the Saudi stock market that
comprised 4004 firm-quarter observations, covering the period
2009–2019. For this paper, we consider the quarterly data
period (frequency). The choice of the quarterly frequency is
driven by the fact that, for calculating Tobin's Q ratio for firm
valuation and other firm-specific attributes (e.g., market capi-
talization, return on assets and leverage of all firms in our
sample, and the number of shares outstanding used to calculate
some overconfidence proxies), a few of these variables are
disclosed with the SSE on a quarterly basis. The data for this
study were provided by the SSE, which is a unique indepen-
dent financial data provider in Saudi Arabia.
This study used Tobin's Q ratio (Tobin′sQit) as a dependent
variable to measure the valuation of firms in the Saudi stock
market. We used Tobin's Q ratio (Tobin′sQit) as a measure of
firm valuation (Brainard & Tobin, 1968; Buchanan, Cao, &
Chen, 2018; Daines, 2001; Fang, NOE, & Tice, 2009;
Gompers, Ishii, & Metrick, 2003; Kumar & Singh, 2013;
Yermack, 1996). Moreover, previous literature has identified a
number of firm characteristics that are related to firm valuation,
such as market capitalization, ROA, and leverage: market
capitalization (MarketCapit) (Chen & Lee, 2017; Feng & Wu,
2018; Liu & Magnan, 2011; Yung & Jian, 2017), return on
assets (ROAit) (Al-Najjar & Anfimiadou, 2012; El Ghoul,
Guedhami, & Kim, 2017; Hassan, 2018; Jiao, 2010; Jo &
Harjoto, 2011; Liu & Magnan, 2011), and leverage (Lever-
ageit) (Al-Najjar & Anfimiadou, 2012; Chen & Lee, 2017; El
Ghoul et al., 2017; Feng & Wu, 2018; Hassan, 2018; Jiao,
2010; Yung & Jian, 2017). We tested H0 by including the
overconfidence variable proxy. Table 1 presents the source and
definition of our variables.
3.2. Measures of investor overconfidence
The fact that investor biases are not directly observable is a
challenge for any study of them. Because behavioral biases are
difficult to measure precisely and directly, it is difficult to
obtain a direct proxy for investor overconfidence (Baker &
Wurgler, 2013; Malmendier & Tate, 2005). Nevertheless, in
Section 6, we experiment with many alternative variable
proxies for investor overconfidence to ensure our results are not
sensitive to the variable proxy and to check the robustness of
our findings. In this study, we provide six alternative ways to
measure investor overconfidence, and we will show that, based
on prior literature, these variable proxies are correlated with
overconfidence bias. Investor overconfidence proxies are
defined as follows: the change in trading volume (Δtvit), three
alternative proxies to measure excessive trading (etit, etdit &
etmit), turnover rate (turnoverit), and the increase in the number
of shares outstanding (isoit). There are no uncontroversial
proxies for investor biases; however, the proxies used in this
study are motivated by the literature. Although few of these
researchers have directly explored the company and stock
market valuation on which we concentrate, it is crucial to
provide evidence that our proxies of investor overconfidence
are not simply picking up the previously documented results.
3.2.1. The change in trading volume (Δtvit)
Based on this proxy, the overconfidence of investors in the
stock market is measured by the change in trading volume for
each company included in the current study and for each
period. This proxy is motivated by a number of pioneer studies.
De Bondt and Thaler (1985) stated that investor overconfidence
is the key behavior in understanding the trading volume puzzle.
Odean (1998) developed a theoretical model of over-
confidence, suggesting that overconfident investors overvalue
their own personal assessment and knowledge of an asset's
value, therefore, increasing trading volume. Odean (1998,
1999) concluded that overconfidence bias is the source of high

Table 1
Description of variables.
Variables
Tobin's Q ratio (Tobin'sQ)
Market capitalization (MarketCap)
Return on assets (ROA)
Leverage Ratio (Leverage)
Investor overconfidence (Δtvit)
Definition Source
Ratio between a firm's stock market value and its Database of Saudi Stock Exchange
fixed capital replacement value, which is Company www.tadawul.com.sa
calculated by the source as the market value of
equity plus the book value of assets minus the
book value of equity divided by the book value
of assets.
Total market value of a firm's outstanding shares,
which is calculated by the source as the product
of share price and the number of shares
outstanding.
Net profit as a percentage of total assets (%).
Ratio between total debt and total assets.
Change in trading volume.

100
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levels of trading volume on financial markets because over-
confident investors tend to trade more actively and to take
greater risk than rational investors. Similar results were docu-
mented by Barber and Odean (1999), who found that over-
confidence bias increases trading volume because
overconfident investors overvalue their knowledge and abili-
ties; therefore, they are too sure about their own choices,
ignoring other choices. Chuang and Lee (2006) tested the
overconfidence hypothesis, which proposes that overconfident
investors trade more risky securities because they underesti-
mate risk, and discovered empirical evidence to support this
hypothesis. An experimental study was carried out by Deaves,
Lüders, and Luo (2009) provides solid evidence that higher
investor overconfidence leads to increased trading volume.
They confirmed that these findings hold true at both the indi-
vidual and market levels. Investors' overconfidence is linked to
stock trading changes (Strahilevitz, Odean, & Barber, 2011).
A substantial amount of research has confirmed that investor
overconfidence leads to increased trading volume in stock
markets, implying a positive relationship between trading
volume and overconfidence (Barber & Odean, 2002; Benos,
1998; Bradford et al., 1991; Chuang & Lee, 2006; Glaser &
Weber, 2007; Grinblatt & Keloharju, 2009; Hirshleifer &
Luo, 2001; Statman et al., 2006). Several studies have used
trading volume as a proxy for investor overconfidence
(Alsabban & Alarfaj, 2020; Asaad, 2020; Barber & Odean,
1999, 2000; Deaves et al., 2009; Statman et al., 2006; Trejos
et al., 2019). Therefore, trading volume seems to be a suit-
able proxy variable for investor overconfidence. This proxy is
calculated from the change in trading volume as either an in-
crease or a decrease in trading volume relative to its prior
period as follows:
tvit − tvit−1
Δtvit = (1)
tvit−1
Where Δtvit represents the change in trading volume for
company i at time t, tvit is the trading volume in the current
period and tvit−1 is the trading volume in the previous period.
Unlike stock market trading volume, each company might
possess certain information in each period, which would
explain a large amount of the trading volume.
3.2.2. Measures of excessive trading (etit, etdit & etmit)
To more precisely capture the expression of “excessive
trading” we calculated three alternative proxies based on
different thresholds. Based on these proxies, investor over-
confidence in the stock market is measured by an increase in
trading volume, which is calculated for each company and time
period. Kyle and Wang (1997) stated that overconfident in-
vestors trade more excessively because they believe their own
information is better than others. Barber and Odean (1999)
proposed that excessive trading is an investor's common
mistake. Many studies have highlighted that overconfident
investors will trade more excessively in stock markets and that
overconfidence is the key behavior to explain the observed
excessive trading volume (Benos, 1998; Chuang & Lee, 2006;
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De Bondt & Thaler, 1985; Odean, 1998; Zaiane, 2013). Similar
results were documented by Barber and Odean (2001, 2002),
who provided evidence that overconfident investors engage in
excessive stock market trading volumes.
The majority of the overconfidence models suggest a posi-
tive correlation between trading volume and investor over-
confidence (Glaser & Weber, 2007). More precisely, investors
with higher overconfidence tend to trade more excessively,
which will lead to higher trading volume (Gervais & Odean,
2001; Odean, 1998). Trinugroho and Sembel (2011) conduct-
ed experimental research to examine the excessive trading
hypothesis. They found that investors who have higher over-
confidence tend to practice the excessive trading strategy. They
confirm that highly overconfident investors have higher trading
volumes than less overconfident investors. According to Trejos
et al. (2019), overconfidence has been measured by excessive
trading. However, the manifestation of excessive trading is
hazy. As a result, we calculated three alternative proxies based
on various thresholds to capture the expression “excessive”
trading volume.
First, we calculated this proxy variable etit by including the
change in trading volume only if the change in trading volume
is more than 0; that is, overconfident investors. To capture the
increase in trading volume, we defined overconfident investors
using the 0 threshold. This variable is defined as follows:
Δtvit , if Δtvit > 0
etit = { (2)
ϕ, if Δtvit ≤ 0
Where etit is the increased trading volume that represents
“excessive trading,” and ϕ denotes a null value. Over-
confidence is defined as a change in trading volume that is
greater than the previous period; otherwise, it is a null value.
This proxy was calculated for each company and period; each
company may have certain information in a period, which
would explain a large portion of the increase in trading volume.
Second, we calculated this proxy variable etdit by including
the change in trading volume only if the change in trading
volume is more than the median μ1/2; that is, overconfident
investors. We defined overconfident investors based on the
median following Ho (2011). This variable is defined as
follows:
Δtvit , if Δtvit > μ1/2i
etdit = { (3)
ϕ, if Δtvit ≤ μ1/2i
where μ1/2i is the median of the trading volume change of a
company i.
Third, we calculated this proxy variable etmit by including
the change in trading volume only if the change in trading
volume is more than the mean μik; that is, overconfident in-
vestors. We defined overconfident investors based on the mean
level for Δtvit to capture any increase in trading volume above
an average increase. The mean μik is calculated as follows:
1 k
μik = ∑t Δtvit (4)
n
R. Aljifri
where μik is the mean for period k of company i, k is a fixed
window, and n is the number of observations in k. k is shifted
forward by n observations to create the next nonoverlapping
window. In this study, k is equal to one year, n is equal to four
quarters. This variable proxy is defined as follows:
Δtvit , if Δtvit > μik
etmit = { , ∀t ∈ k (5)
ϕ, if Δtvit ≤ μik
The linkage between overconfidence and the increase in
trading volume is plausible because overconfident investors
will trade excessively and increase trading volume.
3.2.3. Turnover rate (turnoverit)
Based on this proxy, investors’ overconfidence in the stock
market is measured by the turnover rate for each company
included in this study and for each period. Overconfident in-
vestors trade excessively and, therefore, increase the turnover
rate (Ho, 2011; Odean, 1998; Statman et al., 2006). According
to Barber and Odean (2001), higher turnover implies higher
overconfidence, suggesting that turnover rate and investor
overconfidence are positively correlated. The turnover rate is
used as the main proxy for overconfidence by a number of
studies Chuang and Lee (2006); Griffin, Nardari, and Stulz
(2007); Statman et al. (2006); Tekçe and Yılmaz (2015)
because the turnover findings are robust theoretically and
empirically.
Tekçe and Yılmaz (2015) used an annual turnover to mea-
sure overconfidence, which was calculated by multiplying the
average monthly turnover by twelve. However, in our study,
we used the quarterly turnover to measure overconfidence. For
each period and firm, the turnover rate is defined as the ratio of
the number of shares traded to the number of shares
outstanding. Each firm may have more information in each
period, explaining a large portion of the turnover rate. There-
fore, the turnover rate seems to be a suitable proxy for investor
overconfidence, and it is calculated as follows:
tvit
turnoverit = (6)
soit
where soit is the number of shares outstanding.
3.2.4. The increase in the number of shares outstanding
(isoit)
Based on this proxy, the overconfidence of investors in the
stock market is measured by the increase in the number of
outstanding shares, which is calculated for each company and
each period. This proxy is motivated by Bouteska and Regaieg
(2018), who used shares outstanding as a proxy for investor
overconfidence in the US stock market. This variable was
widely used as a proxy for managerial overconfidence
Malmendier and Tate (2005); Michailova (2010). Although the
justification for using proxy variables based on trading volume,
excessive trading, and turnover is obvious, the justification for
using the proxy variable of shares outstanding may be less
obvious. We assume, however, that including this proxy vari-
able will provide an additional alternative proxy for investor
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overconfidence that can be used as a robustness check.
Therefore, we provide two arguments to justify using this
proxy for investor overconfidence.
First, according to Gasteren (2016), overconfidence is
caused by culture, individual factors, and social factors. Indi-
vidual factors vary from person to person. However, over-
confidence is shared by the entire population due to both social
and cultural factors. This population component implies that all
individuals must share some degree of overconfidence in their
behavior. As a result, it is reasonable to assume that the cultural
and social causes of overconfidence for investors and CEOs are
the same; thus, CEO overconfidence measures are good proxies
for investor overconfidence from this perspective. This
assumption is supported by relevant studies of Bouteska and
Regaieg (2018); Gasteren (2016). Following Bouteska and
Regaieg (2018), we chose an increase in the number of
shares outstanding as a substitute variable for investor over-
confidence. We consider an investor to be overconfident if he
increased his holdings of firm shares during the period.
Second, firms with more overconfident investors issue more
equity and make more investments because corporate managers
exploit stock market mispricing in their financing and invest-
ment decisions (Adebambo & Yan, 2018; Baker & Wurgler,
2002; Gilchrist, Himmelberg, & Huberman, 2005; Polk &
Sapienza, 2008). Specifically, firms with more overconfident
investors issue a significantly higher number of shares than
those with less overconfident investors (Adebambo & Yan,
2018). This proxy is motivated by the literature findings sug-
gesting that firms with more overconfident investors will issue
more shares, increasing the number of outstanding shares.
According to these findings, the number of outstanding
shares is positively related to investor overconfidence.
Although the increase in shares outstanding is primarily used to
measure managerial overconfidence, we believe it can also be
used to measure investor overconfidence. As a result, the in-
crease in the number of shares outstanding was used as a
measure of investor overconfidence in this study, which was
calculated as follows:
Δsoit , if Δsoit > 0
isoit = { (7)
ϕ, if Δsoit ≤ 0
where isoit represents the increase in the number of shares
outstanding, and Δsoit is the change in the number of shares
outstanding. If the number of shares outstanding in this period
is more than that in the previous period, it is defined as
overconfident.
4. Methodology
We employed a panel regression model to analyze our
secondary data because the data collected exhibited cross-
sectional and time-series dimensions. The panel data model
has the advantage of providing cross-sectional and time-series
dimensions, allowing the researcher to control for unobserved
heterogeneity. Using Stata software, we ran a panel fixed-
effects model StataCorp (2019) to capture the effect of
R. Aljifri
overconfidence bias on the valuation of companies listed on
the SSE. In general, pooled panel data analysis ignores the
heterogeneity that might exist among companies (Gujarati &
Porter, 2003), and it does not distinguish between the
various companies included in our study. However, we
decided the most appropriate model was the fixed-effects
model based on the results of the F-statistic (homogeneity
test, Wald test: P(F-statistic) < 0.05) and the Hausman test (χ 2
test). Homogeneity test results provide (F-value = 62.25, p-
value = 0.0000) for our model, suggesting that the pooled
regression model (pooled OLS) is not appropriate for our data
because there is a high heterogeneity among the companies
included in our study. These results were expected as we are
working with different companies that are likely to have un-
observed differences.
We used the Hausman test to determine which of the
random and fixed-effects models provides a consistent and
unbiased estimator. A Hausman test can be used to determine
whether unobserved heterogeneity is related to the explanatory
variables. If the explanatory variables are correlated with the
individual effect, the fixed-effects model is the only approach
that provides consistent estimators. The Hausman test provides
a chi-square value with a corresponding p-value, which formed
the basis of accepting or rejecting the null as appropriate. The
null hypothesis of the Hausman test is that the random effect
estimator is preferred and consistent. Based on the Hausman
test results, χ 2 = 345.56, with a p-value of 0.0000 for our
model, which rejects the null hypothesis and indicates that the
random effects model is inconsistent and the fixed-effects
estimator is consistent and preferred. Based on homogeneity
and the Hausman tests, we conclude that the fixed-effects
model is the most appropriate and the only consistent model
for our sample. Therefore, for panel data regression, we used
the fixed-effects model to analyze our data.
R-squared is typically lower in cross-sectional data than in
time-series data due to the heterogeneity of cross-sections. The
cross-sectional dimension in our data is larger than the time-
series dimension. Therefore, in panel data analysis, we rely
more on the model's individual significance and overall sig-
nificance instead of R-squared. Also, the within R-squared
value is the main focus because a within-group fixed-effects
approach examines the deviations in means within a company.
Moreover, to address the issue of both heteroskedasticity and
serial correlation, we applied the “vce” (robust standard errors)
option. The model used to examine the effect of over-
confidence on the valuation of companies listed on the Saudi
stock market (H0) can be written as follows:
Tobin′ sQit = α0 + β1 MarketCapit + β2 ROAit + β3 Leverageit
+ β4 Overconfidenceit + 3 it
(8)
where α0 is the intercept term. β1, β2, β3, and β4 are the co-
efficient of market capitalization, ROA, leverage, and over-
confidence, respectively. 3 it is the error term, i is a company,
which sampled 91 companies listed at the SSE, and t represents
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time in quarters that covers the period 2009–2019. H0 predicts
that the coefficient of overconfidence variable (β4) is signifi-
cant, suggesting that investor overconfidence has an empirical
influence on the valuation of companies listed in the SSE. The
model controls a number of other variables found to affect firm
valuation in the literature.
5. Results and discussion
This section presents the results and discussion. We discuss
descriptive statistics and correlation analysis, and then we
present the results and discussion related to our hypothesis
(H0).
5.1. Descriptive statistics and correlations
This subsection describes the descriptive statistics and
pairwise correlation of the variables included in the current
study. Table 2 contains three panels: Panel A provides
descriptive statistics for all variables used in this study,
including means, medians, first quartile (Q1), third quartile
(Q3), and standard deviations. Panel B provides pairwise cor-
relations for variables in this study's main analysis, and Panel C
provides pairwise correlations for all six investor over-
confidence proxies used in this study. Over an 11-year period,
the study included 4004 quarterly observations from 91 com-
panies (2009–2019). Variables used in this study are Tobin's Q,
market capitalization (MarketCap), return on assets (ROA),
leverage, and investor overconfidence proxies (Δtv, et, etd,
etm, turnover, and iso).
The average Tobin's Q ratio was 2.34, which is consistent
with recent studies that reported an average Tobin's Q ratio of
approximately 2 (Adebambo & Yan, 2018; Villalonga &
Amit, 2006). The mean market capitalization of the com-
panies investigated was 7.88 million Saudi Riyal (SAR), with
a median of 7.54 million Saudi Riyal (SAR). The sample firms
had an average ROA of 3.37%, and the average leverage was
0.33. Finally, the main variable of overconfidence (Δtv) had a
mean of 0.39 with a median of −0.03 and a standard deviation
of 2.48.
In Table 2 Panel B, we examined the magnitude and di-
rection of linear associations between the variables used in the
current study: the dependent, explanatory, and independent
variables using pairwise correlation analysis. The results of a
correlation analysis indicate whether or not there is a rela-
tionship between the dependent variable and the independent
variables (Cohen, West, & Aiken, 2014). As shown in Panel B,
the main variable of overconfidence (Δtv) is positively corre-
lated with Tobin's Q, and this correlation is statistically sig-
nificant at the 1% level. These results provide initial evidence
that investor overconfidence is strongly and positively associ-
ated with market valuation expressed by Tobin's Q ratio. As
expected, the market valuation is positively and highly corre-
lated with market capitalization and ROA, while it is negatively
correlated with leverage. Finally, the correlation between the
independent variables is low, indicating that there is no mul-
ticollinearity problem.
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Table 2
Descriptive statistics and correlations.
Panel A: Descriptive statistics
Variable Mean Q1 Median Q3 Std
Tobin′sQ 2.3426 1.22 1.77 2.7 2.3034
MarketCap (SAR Mn) 7.8752 6.7024 7.5459 8.9260 1.5413
ROA (%) 3.3741 0.402 2.7808 6.2468 10.7951
Leverage 0.3285 0.1428 0.3139 0.4865 0.2118
Δtv 0.3923 −0.3799 −0.0337 0.4964 2.4802
et 1.2278 0.2044 0.5327 1.2366 3.3768
etd 1.1756 0.1753 0.4959 1.2031 3.32
etm 1.3755 0.2338 0.6419 1.3899 3.6421
turnover 1.2744 0.1807 0.5217 1.4433 2.0406
iso 0.1345 0.0029 0.0248 0.1436 0.3148
Panel B: Pairwise correlations
Tobin′sQ MarketCap ROA Leverge
MarketCap 0.0512***
ROA 0.0621*** 0.1846***
Leverge −0.1863*** 0.1773*** −0.0342
Δtv 0.1194*** −0.0451*** −0.0133 −0.0568**
Panel C: Correlation of investor overconfidence proxies
Δtv et etd etm turnover
et 1.0000***
etd 1.0000*** 1.0000***
etm 1.0000*** 1.0000*** 1.0000***
turnover 0.1727*** 0.1300*** 0.1344*** 0.1391***
iso 0.5000*** 0.5348*** 0.5352*** 0.5802*** 0.0626***
Abbreviations: Std, standard deviation; Q1, first quartile; Q3, third quartile; Mn, Million.
*** and ** denote statistical significance at the 1% and 5% levels, respectively.

Table 2 Panel C shows the correlations among over-
confidence proxies (Δtv, et, etd, etm, turnover, and iso). The
correlation of all variables is positive and highly significant at
the 1% level of significance, implying that the variables are
good proxies for measuring overconfidence. Hence, we did not
exclude any proxy from further regression analysis for over-
confidence robustness checks. The correlation of turnover with
other overconfidence proxies is the lowest; however, it is
highly significant at the 1% level. Since et, etd and etm are by
definition calculated based on Δtv, these variable proxies are
perfectly correlated. However, as mentioned earlier, we intro-
duced the variable proxies et, etd, and etm as different alter-
native measures that might capture the expression of
“excessive trading” more precisely.
5.2. Empirical results and discussion related to each
hypothesis
In this section, we examine our hypothesis H0. We present
the results, then discuss our results and compare them with the
findings of other studies. To identify the impact of over-
confidence bias on the valuation of companies listed on the
Saudi stock market, we use the panel fixed-effects model as
clarified in the methodology section.
Behavioral theory predicts that investor overconfidence will
have a significant and positive effect on the valuation of
companies listed on the Saudi stock market and, therefore,
104
stock market valuation. The purpose of this study is to deter-
mine whether investor overconfidence bias has an effect on the
valuation of companies listed on the Saudi stock market. The
regression analysis covers the entire 11 years period
(2009Q1–2019Q4) for the 91 companies listed on the Saudi
stock market. Table 3 reports the results of the main estimated
regression model used to test H0.
As shown in Table 3, the F-value (F = 16.25, p-
value = 0.0000) suggests that this model is overall jointly
significant at 1% level. (R-squared = 0.38) shows that 38% of
the variation in firm valuation (represented by the company's
Tobin's Q) within each firm is captured by our model regres-
sion. It suggests that explanatory variables do explain 38% of
changes in valuation within each company over time. Indi-
vidually, overconfidence and market capitalization are statisti-
cally significant at the 5% and 1% levels, respectively, in
explaining Tobin's Q. However, the other variables (leverage
and ROA) are statistically nonsignificant. We applied the “vce”
(robust) option to obtain robust standard errors for hetero-
skedasticity and serial correlation.
Consistent with our previous prediction, we found that
investor overconfidence (measured by the company's trading
volume change Δtv) positively and significantly affects the
valuation of companies in the Saudi stock market with a co-
efficient of 0.079 and p-value < 0.05. This value shows that
holding other variables in the model constant, an increase in
the investor overconfidence variable of one unit is associated
R. Aljifri
Table 3
Investor overconfidence and firm valuation.
H0: Overconfidence bias positively affects the valuation of companies listed in the Saudi stock market.
Tobin′sQit = α0 + β1MarketCapit + β2ROAit + β3Leverageit + β4Overconfidenceit +
Variable Coef
Intercept −13.6974***
MarketCap 1.9007***
ROA −0.0001
Leverage 0.5954
Overconfidence 0.0790**
F-value 16.25 ***
Abbreviations: Coef, coefficient; SE, standard errors; t, t-statistics.
***, **, and * denote statistical significance at the 1%, 5% and 10% levels, respectively.
with an increase in Tobin's Q ratio of 0.079 units. The positive
effect shows that investor overconfidence has a positive and
statistically significant effect on the valuation of Saudi com-
panies. Market capitalization is positively and statistically
significant at a 1% level. This means that if market capitali-
zation increases by 1%, then Tobin's Q ratio is expected to
increase by 0.019 units.
Our results show that overconfidence bias causes the Saudi
stock market valuation to deviate from normal toward over-
valuation. No similar study currently exists in the published
Saudi-related studies. Several studies have found that over-
confidence bias has a significant and positive impact on in-
vestors' decision making (Chin, 2012; Khawaja, Bhutto, &
Naz, 2013; Qadri & Shabbir, 2014), which is likely to affect
stock market valuation. Our findings are supported by Brown
and Cliff (2005), who provided evidence that sentiment posi-
tively affects asset valuation. The findings in this study are also
consistent with those of Adebambo and Yan (2018), who
investigated the effect of investor overconfidence on firm
valuation and found a strong positive relation between investor
overconfidence and the valuation of the US firms. Their find-
ings were also consistent with those of Bouteska and Regaieg
(2018), who found that the overconfidence variable positively
impacts Tobin's Q of US companies.
The results are consistent with our prior predictions that
investor overconfidence significantly affects firm valuation in
the Saudi stock market for the following reasons. First, the
Saudi-related literature suggests that Saudi investors are char-
acterized by overconfidence, which has a significant positive
effect on investors' decision-making process in the Saudi stock
market (Alquraan et al., 2016; Matoussi & Mostafa, 2016), and
is consequently expected to affect stock market valuation.
Moreover, Alsabban and Alarfaj (2020) investigated over-
confidence bias in the Saudi stock market and confirmed the
existence of overconfidence bias in the Saudi stock market.
Therefore, the Saudi-related literature supports the current
study's findings that investor overconfidence significantly af-
fects Saudi stock market valuation.
Second, most traders in the Saudi stock market are in-
dividuals, mostly inexperienced males between 30 and 39 years
old (Alsedrah & Ahmed, 2017). According to Menkhoff et al.
(2013), individual investors are more overconfident than
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3 it
SE t
2.3279 −5.88
0.2876 6.61
0.0006 −0.31
0.4889 1.22
0.0363 2.18
χ2 345.56***
institutional investors. According to survey and experimental
studies, men are more overconfident than are women (Barber &
Odean, 2001; Lundeberg et al., 1994; Prince, 1993; Prosad
et al., 2015). Overconfidence is higher among males and
young investors than among females and older investors
(Tekçe & Yılmaz, 2015). Therefore, the results of the current
study are consistent with the researchers’ prior expectations
that investor overconfidence has a significant effect on the
valuation of companies in the Saudi stock market.
6. Robustness and sensitivity analysis
For robustness and to ensure our results are not sensitive for
the variable proxy, we first experimented with a number of
alternative variable proxies for investor overconfidence. In
subsection 6.1, we re-examined the hypothesis H0 using five
alternative investor overconfidence proxies. Second, as pre-
sented in subsection 6.2, to ensure our results are robust to
endogeneity problems, we applied an alternative estimation of
the dynamic panel data model (system GMM) by Arellano and
Bond (1991); Arellano and Bover (1995); Blundell and Bond
(1998). Robustness checks confirmed our results and sug-
gested our main findings are robust.
6.1. Alternative overconfidence proxies
In this subsection, we re-examined our hypothesis using five
alternative variable proxies for investor overconfidence to
ensure our results are not sensitive for the variable proxy and to
check the robustness of our findings. In addition to the main
variable proxy (Δtv), we considered five alternative investor
overconfidence proxies (et, etd, etm, turnover, and iso). As
discussed in subsection 3.2, our proxies of investor over-
confidence were derived from and supported by prior literature,
and, therefore, they are not simply picking up previously
documented results. We also show that the proxies used in this
study are plausibly correlated with overconfidence bias.
We conducted five fixed-effects panel models for which
each alternative proxy was included in the regression analysis
one at a time to capture the effect of overconfidence on the
valuation of companies listed on the SSE, ensuring our results
were not sensitive for the variable proxy and checking the
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Borsa Istanbul Review 23-1 (2023) 93–112

robustness of our findings. We decided the most appropriate
model to use was a fixed-effects model based on the results of
the F-statistic (homogeneity test, Wald test: P(F-statistic) <
0.05) and Hausman test (χ 2 test). Homogeneity test results for
alternative overconfidence proxies et, etd, etm, turnover, and
iso, respectively, were F-value = 23.86, p-value = 0.0000; F-
value = 28.19, p-value = 0.0000; F-value = 19.53, p-
value = 0.0000; F-value = 56.11, p-value = 0.0000; and F-
value = 48.71, p-value = 0.0000. Results of the homogeneity
test suggested that a pooled regression model (pooled OLS) is
not appropriate for our data because there is a high heteroge-
neity among the companies included in our study. These results
were expected as we are working with different companies that
are likely to have unobserved differences.
We conducted the Hausman test to determine which model
would provide a consistent and unbiased estimator between
random and fixed-effects models. The null hypothesis of the
Hausman test is that the random effects estimator is preferred
and consistent. Hausman test results for alternative over-
confidence proxies et, etd, etm, turnover, and iso, respectively,
were χ 2 = 202.76, p-value = 0.0000; χ 2 = 235.29, p-
value = 0.0000; χ 2 = 166.84, p-value = 0.0000; χ 2 = 229.14,
p-value = 0.0000; and χ 2 = 316.90, p-value = 0.0000.
Therefore, we rejected the null hypothesis indicating that the
random effects model is inconsistent and the fixed-effects
estimator is consistent and preferred. Based on homogeneity
and Hausman tests, we concluded that fixed-effects models are
the most appropriate and the only consistent approach for our
sample. Therefore, we used fixed-effects panel data regression
to analyze all alternative overconfidence proxies models.
Table 4 displays regression results for overconfidence
robustness checks based on et, etd, etm, turnover, and iso,
controlled for a number of variables that prior research has
found to explain the valuation of companies. The table sum-
marizes results where the five alternative proxies were included
in the regression analysis one at a time. Values for our five
alternative proxy variables are statistically significant. The
significant and positive coefficients indicate that investor
overconfidence has a positive and statistically significant
impact on the valuation of companies listed in the Saudi stock
market. iso is significant at the 1% level, while etm is signifi-
cant at the 5% level and et, etd, and turnover are significant at
the 10% level. We applied the “vce” (robust standard errors)
option to address heteroskedasticity and serial correlation
issues.
To summarize our findings on the robustness of alternative
investor overconfidence proxies, results for all proxies are
statistically significant. Considering alternative proxies for
robustness, proxies for investor overconfidence generated
consistent results when used in our analysis. The findings of
our analysis did not change when we used the alternative
overconfidence measures. Results are in line with those of the
change in trading volume (Δtv). Having established robust
measures for investor overconfidence, we can confirm the
positive and significant relation between investor over-
confidence and the valuation of companies listed on the SSE.
6.2. Dynamic system generalized method of moments
(GMM) regression
With panel data, researchers commonly use a fixed-effects
estimator to address the concerns of omitted variables (Ding,
Fan, & Lin, 2018; Gooris & Peeters, 2016; Li, Ding, Hu, &
Wan, 2021). However, some researchers have noted that firm
and market valuation research results are plagued with endo-
geneity problems (Beiner, Drobetz, Schmid, & Zimmermann,
2006; Caixe & Krauter, 2014; Chi, 2005; Palia, 2001). Dy-
namic endogeneity is one type of endogeneity, and it occurs
when the past values of the dependent variables affect the in-
dependent variables, violating a strict exogeneity assumption in
fixed-effects estimators (Li et al., 2021; Nickell, 1981). Failing
to adjust for endogeneity has consequences such as generating

Table 4
Alternative overconfidence proxies and firm valuation.
Robustness
Tobin′sQit = α0 + β1MarketCapit + β2ROAit + β3Leverageit + β4Overconfidenceit + 3 it

Variable et etd etm turnover iso

Intercept −15.5108*** −14.2262*** −16.4574*** −12.8988*** −13.4767***
(3.2922) (2.469635) (3.6828) (2.3517) (2.4689)
MarketCap 2.1044*** 1.9268*** 2.2090*** 1.7954*** 1.9000***
(0.4113) (0.3018) (0.4606) (0.2887) (0.3101)
ROA −0.0206 −0.0130 −0.0237 0.0002 −0.0003
(0.0215) (0.0194) (0.0257) (0.0007) (0.0006)
Leverage 1.0374* 1.0909** 1.1881* 0.5379 0.5427
(0.5652) (0.5219) (0.6417) (0.4777) (0.5386)
Overconfidence 0.0987* 0.0979* 0.1020** 0.1647* 2.2399***
(0.0506) (0.0505) (0.0501) (0.0939) (0.6054)
F-value 12.77*** 15.56*** 13.37*** 12.91*** 16.24***
χ2 202.76*** 235.29*** 166.84*** 229.14*** 316.90***
R2 0.41 0.45 0.41 0.34 0.40
No. of observations 692 720 593 1479 1280
***, **, and * denote statistical significance at the 1%, 5%, and 10% levels, respectively. Robust standard errors in parenthesis. These results were generated using
et, etd, etm, turnover, and iso in the regression analysis one at a time.

106
R. Aljifri
biased estimates and drawing the wrong inferences that lead to
invalid conclusions. In this model, firm valuation (represented
by the firm's Tobin's Q) is dynamic, depending on its own
past realizations. Wilkins (2018) confirms that including the
additional lags yields more accurate coefficient estimates; re-
searchers should include lagged dependent variables as part of
a robust estimation strategy, and such strategies are frequently
used to eliminate autocorrelation in the residuals.
This subsection presents a test of our hypothesis in which
we applied a dynamic systems GMM estimation as an alter-
native analysis to examine the robustness of our results. We
employed the dynamic systems generalized method of mo-
ments (dynamic systems GMM) estimation (Arellano & Bond,
1991; Arellano & Bover, 1995; Blundell & Bond, 1998) to
control for the problems of endogeneity; hence, this study
provides unbiased estimates. Dynamic panel estimators are
designed for situations with few time periods and many in-
dividuals and are increasingly popular estimators (Roodman,
2009). We applied Stata software and, specifically, the xta-
bond2 package Roodman (2009) to conduct our empirical
analysis.
Many researchers argue that dynamic systems GMM pro-
vides efficient estimates because it exploits all the available
information in a sample (Arellano & Bond, 1991; Arellano &
Bover, 1995; Blundell & Bond, 1998). Blundell, Bond, and
Windmeijer (2001) theoretically and experimentally
confirmed that the use of the systems GMM estimator greatly
improves precision and reduces finite-sample bias. An essential
property of dynamic systems GMM is internal instruments
embedded in the present dataset and available to the re-
searchers (Schultz, Tan, & Walsh, 2010). Only a few studies
have examined the impact of investor overconfidence on firm
valuation, and those have not applied a dynamic panel model
and, therefore, failed to control for dynamic endogeneity.
These studies focused on the US stock market, ignoring
emerging stock markets. This study intends to fill this gap,
control for these endogeneity issues, and focus on the emerging
market of the Saudi stock market.
6.2.1. Dynamic system GMM results
This subsection presents and discusses the results from
dynamic systems GMM estimation. We will show how fixed-
effects estimator provide different regression results
compared to GMM estimator. An exogeneity assumption in the
dynamic systems GMM model suggests that historical firm
valuation and explanatory variables are exogenous concerning
error terms. This means the instruments must be exogenous for
the GMM model to be valid. To verify this assumption, two
fundamental tests should be conducted (Arellano & Bond,
1991; Blundell & Bond, 1998; Roodman, 2009). The first
test, the Hansen test for joint validity of all instruments, as-
certains whether or not the model is overidentified, in addition
to the difference-in-Hansen test for the exogeneity of IV and
GMM instrument subsets (Roodman, 2009; Schultz et al.,
2010). Accepting the null hypothesis, the Hansen test for
joint validity and the difference-in-Hansen test of exogeneity of
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instrument subsets indicate that all instruments are jointly valid
and instrument subsets are uncorrelated with error terms,
respectively. The Hansen test produces J-statistics and follows
a chi-square distribution.
Second, the dynamic systems GMM estimation uses lags as
instruments, and therefore the Arellano-Bond test for autocor-
relation, with a null hypothesis of no serial correlation, ascer-
tains whether the model includes sufficient lags to control for
possible autocorrelation (Roodman, 2009; Wintoki, Linck, &
Netter, 2012). The null hypothesis of no first-order serial cor-
relation in first differences (AR(1) test) can be rejected because,
by construction, disturbances in first differences AR(1) can be
correlated. However, the null hypothesis of no second-order
serial correlation in first differences (AR(2) test) should not
be rejected, indicating the validity of the historical firm valu-
ation (Roodman, 2009).
Two-step estimation is argued to be asymptotically more
efficient (Arellano & Bond, 1991; Blundell & Bond, 1998).
However, according to Windmeijer (2005), estimated asymp-
totic standard errors of the efficient two-step GMM estimator
can be severely downwardly biased in small samples. In this
study, we used the xtabond2 package that applies a finite-
sample correction to the two-step covariance matrix derived
by Windmeijer (2005), leading to more accurate inference. We
included time dummies, making no correlation across in-
dividuals in the idiosyncratic disturbances assumption more
likely to hold. We also applied a robust option to correct for
heteroscedastic and autocorrelation. We retested our hypothesis
H0 applying a dynamic systems GMM estimation as an alter-
native analysis to examine the robustness of our results. The
dynamic systems GMM used to re-examine the effect of
overconfidence on the valuation of companies listed on the
Saudi stock market is stated as follows:
ΔTobin′ sQit =α0 + L.ΔTobin′ sQδit
+ β1 ΔMarketCapit + β2 ΔROAit
(9)
+ β3 ΔLeverageit
+ β4 ΔOverconfidenceit + Δ3 it
Equation (9) shows the impact of lag valuation proxy changes
(L.ΔTobin′sQδit), market capitalization (ΔMarketCapit), ROA
(ΔROAit), leverage (ΔLeverageit), and overconfidence
(ΔOverconfidenceit) on changes in firm valuation
(ΔTobin′sQit). Where the L represents a lag operator of the
valuation proxy (Tobin′sQ). Δ denotes the difference.δ is the
lag time coefficient for differenced firm valuation proxy
(LΔTobin′sQ), across N observations. The system GMM im-
proves on the moment conditions using instruments with lag-
ged variations of Tobin's Q and the independent variables.
Thus, the system GMM produces efficient and consistent co-
efficients for the independent variables which are not affected
by dynamic endogeneity and unobserved heterogeneity.
Table 5 shows the regression results of the dynamic systems
GMM equation for overconfidence robustness checks based on
Δtv, et, etd, etm, turnover, and iso, which controls for a number
of variables that prior research has found to explain the
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Table 5
Dynamic system GMM results.
Robustness
ΔTobin′sQit = α0 + L.ΔTobin′sQδit + β1ΔMarketCapit + β2ΔROAit + β3ΔLeverageit + β4ΔOverconfidenceit + Δ3 it
Variable Δtv et etd etm turnover iso
Intercept −0.6849 −0.3891 −0.4254* −0.3692 −1.8668** −0.2574
(0.2457) (0.3499) (0.2340) (0.3295) (0.9362) (0.1687)
L.Tobin′sQ 0.7786*** 0.7523*** 0.7225*** 0.8115*** 0.6331*** 0.7802***
(0.0921) (0.0882) (0.0569) (0.0764) (0.1303) (0.0761)
MarketCap 0.0583* 0.0216 0.0225 0.0033 0.2834** 0.0491
(0.0340) (0.0234) (0.0137) (0.0165) (0.1232) (0.0303)
ROA 0.0008 0.0174 0.0234 0.0089 0.0003 0.0009
(0.0023) (0.0222) (0.0179) (0.0190) (0.0025) (0.0023)
Leverage −0.1562 −0.1491 −0.1268 −0.0529 −0.3987 −0.1780
(0.1922) (0.1606) (0.1082) (0.1243) (0.3134) (0.1624)
Overconfidence 0.1327*** 0.1087** 0.1219*** 0.1102** 0.8431** 3.7856***
(0.0297) (0.0459) (0.0381) (0.0467) (0.4229) (0.2033)
Year dummies Included Included Included Included Included Included
F-value 100.98*** 448.80*** 685.10*** 440.70*** 100.39*** 673.21***
AR(1) test (p-value) 0.037 0.274 0.118 0.078 0.234 0.024
AR(2) test (p-value) 0.296 0.478 0.227 0.433 0.987 0.207
Hansen test of overidentification (p-value) 0.125 0.426 0.773 0.879 0.547 0.230
Diff-in-Hansen tests of exogeneity (p-value) 0.248 0.497 0.754 0.868 0.523 0.206
No. of observations 1474 690 718 590 1474 1275
***, **, and * denote statistical significance at the 1%, 5%, and 10% levels, respectively. Robust standard errors are in parentheses (). Each column displays
regression results of a dynamic systems GMM equation where the six alternative proxies of overconfidence (Δtv, et, etd, etm, turnover, and iso) are included in the
regression analysis one at a time. The Arellano-Bond test statistic, AR(1) and AR(2), follow an asymptotic normal distribution, with null (H0): No autocorrelation in
the differenced errors. The residual values in first differences AR(1) can be correlated by construction; however, there should not be a serial correlation in the second
difference AR (2). The Hanson test of overidentification (J-Statistic) follows a chi-square distribution; with a null (H0) = the instruments as a group are exogenous
and specified correctly, which means that instruments in the dynamic system GMM are valid. Difference-in-Hansen tests of exogeneity have a null
(H0) = instruments in the systems GMM equation are exogenous.

valuation of a company. Each column displays regression re-
sults of the dynamic systems GMM equation where each of the
six alternative proxies of overconfidence was included in the
regression analysis one at a time. The F-values across all
equations indicate that the dynamic systems GMM results are
statistically significant at 1%. The Hansen tests and the
Arrelano–Bond are standard tests to be sure that estimates are
unbiased and consistent.
The first is the Hansen test of overidentification with the null
hypothesis of joint validity of all instruments. As reported in
the results across all equations, the Hansen–J test yielded a p-
value between 0.125 and 0.879 for the Δtv and etm proxies,
respectively, suggesting that our instruments are valid at all
conventional levels of significance. We also followed the
recommendation of Roodman (2009) about good practices in
applying the difference-in-Hansen test for the exogeneity of
instrument subsets. For all six models, p-values imply that
instrument subsets are exogenous and valid.
The second is the Arrelano–Bond test for second-order se-
rial correlation AR(2), with null hypothesis that there is no
serial correlation. The test results across the six dynamic sys-
tems GMM equations show that there is no serial correlation,
indicating dynamic systems GMM estimates are valid and
models contain sufficient lag instruments to control for auto-
correlation. According to prior research (e.g., Areneke and
Kimani (2019); Blundell and Bond (1998); Esho, Kirievsky,
Ward, and Zurbruegg (2004); Flannery and Hankins (2013))
in a GMM estimation, there can exist a significant first-order
serial correlation AR(1), but there should be no significant
serial correlation in the second order AR(2). Therefore, the
diagnostic tests support the estimation choices made.
Overconfidence is the main variable of interest and is sig-
nificant across all models at the 1% and 5% levels. The dy-
namic systems GMM model yielded larger coefficients with
lower p-values of less than 5% level for overconfidence proxies
compared to the fixed-effects approach, implying a stronger
relationship and higher significance levels. The dynamic sys-
tems GMM results are consistent with the main results reported
for the analysis of the fixed-effects estimation.
As previously stated, this study included two major robust-
ness and sensitivity analyses. First, we used five different over-
confidence proxies to ensure that our results were not affected by
the variable proxy. Second, we used dynamic systems GMM
regression analyses as an alternative estimation method to ensure
that our results were robust to endogeneity issues. Overall,
robustness checks confirm our results and suggest our main
findings are robust. The significant positive relationship between
the valuation of listed companies in the Saudi stock market and
all overconfidence proxy variables in both the main and alter-
native regression analyses support our hypothesis.
7. Conclusion
Empirical evidence suggests that investors in the stock
market are affected by overconfidence bias, and such a bias
has been neglected by traditional financial theory, which relies

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on the rationality assumption. Behavioral biases may affect
investor decisions and consequently affect stock markets. In
this paper, we examine the impact of investor overconfidence
on the valuation of companies listed on the SSE. Theories
predict that investor overconfidence leads to firm overvaluation
(Adebambo & Yan, 2018). Based on theories of behavioral
finance, overconfident investors expected to have an irratio-
nally high demand for risky assets because they tend to un-
derestimate risk and overestimate the quality and precision of
their own information, requiring a lower risk premium; this
results in a higher price for risky equities, eventually leading to
overvaluation.
We tested this prediction using a main variable proxy of
overconfidence (Δtv) and applying a fixed-effects panel model
as the main estimation. Additionally, to check the robustness of
our findings, we performed two robustness and sensitivity an-
alyses in this study. First, we used five alternative proxies to
measure investor overconfidence and to ensure our results were
not sensitive for the variable proxy. Second, we conducted the
dynamic systems GMM estimation as an alternative estimation
approach to ensure our results were robust to the problems of
endogeneity. Consistent with our prediction, we found that
investor overconfidence positively and significantly affects the
valuation of companies in the Saudi stock market. Robustness
checks confirm our results and suggest that our main findings
are robust. Regarding our findings on the robustness of alter-
native investor overconfidence proxies, all proxies were sta-
tistically significant and generated consistent results when used
in our analysis. Results are in line with those of the main
variable proxy of overconfidence (Δtv). The dynamic systems
GMM results are consistent with the results reported for the
main analysis of the fixed-effects estimation. Having estab-
lished robust measures for investor overconfidence using both
main and alternative regression analyses, we confirm the pos-
itive and significant relation between investor overconfidence
and the valuation of companies listed on the SSE.
Given the fact that the Saudi stock market is the largest in terms
of market capitalization and the most liquid in the Arab world
(Mensi, 2019), the literature analysis revealed that the emerging
stock market of Saudi Arabia requires further investigation. None
of the previous studies considered the influence of investor
overconfidence on the valuation of companies in the Saudi stock
market. The Saudi-related literature has focused on finding evi-
dence for the existence of behavioral biases for investors in the
Saudi stock market in an attempt to identify which biases influ-
ence investors’ decisions while also ignoring the consequent in-
fluence of these biases on the Saudi stock market. In contrast with
the earlier studies reviewed in this paper, this research is the first
to examine the impact of investor overconfidence on the valuation
of companies in the Saudi stock market.
The findings have implications for academic researchers,
market investors, and market regulators, as well as implications
for investment expenditures, capital allocation, and market effi-
ciency. Our findings may also help provide an explanation for
mispricing and overvaluation in emerging markets with collec-
tivist societies and on the MENA and the GCC stock markets
because Saudi Arabia's stock market is an emerging market with a
109
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Borsa Istanbul Review 23-1 (2023) 93–112
collectivist society that is a member of both MENA and GCC
stock markets. The findings also support behavioral theories that
predict that investor psychology affects asset pricing and, there-
fore, market valuation, suggesting that the role of investor
behavior should be considered in asset pricing models.
Furthermore, the current study should help stock market
investors become more aware of the impact of their own psy-
chological factors, specifically overconfidence bias, on asset
pricing and market valuation, thereby increasing the rationality
of their stock market decision making for improved market
efficiency. Further interventions may be needed to raise in-
vestors' awareness about their behavioral biases, helping them
make better use of information sources when making invest-
ment decisions. Furthermore, our results show that this
cognitive bias can cause firm valuation in the Saudi stock
market to deviate from normal toward overvaluation. However,
price bubbles arise when asset prices exceed the asset's
fundamental value (Werner, 2014). Bubbles are associated with
asset price increases (Brunnermeier, 2016). Famous examples
include the Dutch tulip mania (1634–1637), the Mississippi
bubble (1719–1720) and the South Sea bubble (1720). There-
fore, market regulators should be aware of the influence that
investor behavior can have on market bubbles and, conse-
quently, economic activity.
Additionally, market valuation is a key concept in finance,
which has significant implications for market efficiency, capital
allocation, and investment expenditures. According to studies
by Khanna and Sonti (2004), Zaigham et al. (2019), and
Blanchard et al. (1993), an increase in market valuation results
in an increase in a company's capital expenditure activity. As a
result, investment expenditures are reduced when a company's
market value declines (Asker et al., 2015; Del Brio et al., 2003;
Dessaint et al., 2019; Kouser et al., 2016). Significant evidence
of linkages between market valuation, capital market effi-
ciency, and capital allocation can be found in Baker (2009).
A possible limitation in this study includes data availability.
Due to the data availability and special conditions of Saudi
Arabia's security market, we could not use more proxies of
investor overconfidence. For example, we could not use ana-
lyst's earnings forecast deviation proxy because we could not
find data for profit (earning) level predicted by the manager or
the financial analyst. This proxy method refers to the com-
parison between the profit (earning) level predicted by the
manager or the financial analyst and the actual (earning) profit
level. This kind of cognitive deviation can be used to determine
if a manager or an investor is overconfident. The greater the
gap between the predicted situation and the actual situation, the
higher the degree of managerial overconfidence and investor
overconfidence (Lin, Hu, & Chen, 2005).
Investor biases may affect investor decisions and conse-
quently affect stock markets. Especially that an emerging
markets are more prone to behavioral biases, such as over-
confidence, generally to a higher extent, compared to the
developed markets (Chen et al., 2007; Tekçe, Yılmaz, &
Bildik, 2016). However, few studies have examined the in-
fluence of investor overconfidence on firm and stock market
valuation and mainly focus on the United States, ignoring
R. Aljifri
emerging stock markets. More research is needed to investigate
the impact of investor biases on their decisions in emerging
markets, particularly the impact of these biases on emerging
stock markets such as the Saudi stock market. We focused on
the Saudi stock market in this paper because it is an emerging
market with a collectivist culture. Future researchers could
propose a study comparing emerging stock markets with
collectivist societies versus developed stock markets with
individualistic societies. They could investigate how over-
confidence bias influences stock markets in a society-specific
context and, therefore, how society-specific characteristics
may affect such a relationship.
Declaration of competing interest:
None.
Acknowledgments
This research did not receive any specific grant from
funding agencies in the public, commercial, or not-for-profit
sectors.
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