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Overconfidence and forecast accuracy

Overconfidence and forecast accuracy This paper aims to investigate how overconfidence bias affects financial market participants’ forecast accuracy based on the hard–easy effect concept of overconfidence research.Design/methodology/approachThe authors adopt an experimental method for behavioural finance studies. In the experiment, the authors measure and capture participants’ forecast accuracy as well as their individual confidence level. In particular, participants make incentive-compatible forecasts, that is, the elicited forecast determines the participants’ financial rewards in real monetary gain/loss.FindingsThe results show that the hard–easy effect causes optimistic forecasts for hard-to-predict stocks, indicating that overconfident investors tend to make over-optimistic and less accurate price forecasts when making judgements on hard tasks. Consistent with the literature, the authors find evidence of a negative relationship between forecast accuracy and confidence level. The results also indicate that the overall relationship between overconfidence and forecast accuracy is driven by the price forecasts made for hard-to-predict stocks.Originality/valueAs per the authors’ knowledge, this paper is one of the first studies that provides empirical evidence directly showing the hard–easy effect in the relation between overconfidence and forecast ability in an experimental setting. This study uses an experimental design that specifically measures the hard–easy effect in a stock market scenario using professional financial information and real monetary incentives, which have not been used in any previous studies of the hard–easy effect. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Studies in Economics and Finance Emerald Publishing

Overconfidence and forecast accuracy

Studies in Economics and Finance , Volume 38 (3): 18 – Jul 27, 2021

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References (42)

Publisher
Emerald Publishing
Copyright
© Emerald Publishing Limited
ISSN
1086-7376
eISSN
1086-7376
DOI
10.1108/sef-12-2017-0345
Publisher site
See Article on Publisher Site

Abstract

This paper aims to investigate how overconfidence bias affects financial market participants’ forecast accuracy based on the hard–easy effect concept of overconfidence research.Design/methodology/approachThe authors adopt an experimental method for behavioural finance studies. In the experiment, the authors measure and capture participants’ forecast accuracy as well as their individual confidence level. In particular, participants make incentive-compatible forecasts, that is, the elicited forecast determines the participants’ financial rewards in real monetary gain/loss.FindingsThe results show that the hard–easy effect causes optimistic forecasts for hard-to-predict stocks, indicating that overconfident investors tend to make over-optimistic and less accurate price forecasts when making judgements on hard tasks. Consistent with the literature, the authors find evidence of a negative relationship between forecast accuracy and confidence level. The results also indicate that the overall relationship between overconfidence and forecast accuracy is driven by the price forecasts made for hard-to-predict stocks.Originality/valueAs per the authors’ knowledge, this paper is one of the first studies that provides empirical evidence directly showing the hard–easy effect in the relation between overconfidence and forecast ability in an experimental setting. This study uses an experimental design that specifically measures the hard–easy effect in a stock market scenario using professional financial information and real monetary incentives, which have not been used in any previous studies of the hard–easy effect.

Journal

Studies in Economics and FinanceEmerald Publishing

Published: Jul 27, 2021

Keywords: Experimental finance; Overconfidence; Hard-easy effect; Stock price forecast accuracy

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