Investor overconfidence in the South African exchange traded fund market

Abstract

Exchange Traded Funds (ETFs) have proven to be extremely popular amongst both retail and institutional investors. The increasing interest in this asset class may incite overconfidence in its' investor base, which could lead to undesirable market effects such as security mispricing, excess trading volumes, and exacerbated market volatility. This study aims to examine the South African ETF market for presence of investor overconfidence. To achieve this objective, Vector Autoregression (VAR) models and their associated impulse response functions are employed to examine the relationship between the current trading activity and the historical market return. Consistent with the overconfidence hypothesis, a positive and significant relationship between current market turnover and lagged market returns is found for both ETFs with domestic benchmarks and ETFs with international benchmarks. Further analysis of panel VAR models and their associated impulse response functions suggest that the overconfidence bias also influences the trading activities of individual ETFs. These findings have important implications for various market participants.

A Literature Review on the Influence of Availability Bias and Overconfidence Bias on Investor Decisions

“…This theory emphasizes how cognitive biases and psychological factors influence an individual's financial decisions, including investment choices. Investors and investment management firms can enhance their prospects for generating higher returns and reduce their risk exposure by understanding the behavioral biases influencing investor trading decisions (Kunjal & Peerbhai, 2021). Psychological evidence indicates that humans are susceptible to biases and heuristics that affect decision-making.…”

Presidential election uncertainty and investor overconfidence bias in sub-Saharan African stock markets

“…Kunjal and Peerbhai (2021) also investigate investor overconfidence bias among investors of exchange traded funds in the Johannesburg Stock Exchange. The results of their study indicate the presence of overconfidence bias.…”

“…In sub-Saharan Africa (SSA), a scan through the literature reveals two main studies on this subject matter namely those of Kunjal and Peerbhai (2021) and Kuranchie-Pong and Forson (2022). Kunjal and Peerbhai (2021) investigate the prevalence of overconfidence bias in exchange traded funds as an asset class in the Johannesburg Stock Exchange. However, exchange traded funds as an asset class is not representative of the average asset class traded in stock exchanges of the sub-Saharan African subregion.…”

“…Unfortunately, these studies are both single country studies, none of which can be said to be representative of the sub-Saharan African region. The Johannesburg Stock Exchange though large is not representative of the subregional markets in terms of the study conducted by Kunjal and Peerbhai (2021), because the focus was on exchange traded funds which are not common across the markets in the subregion. Furthermore, the study on the Ghana Stock exchange only examines overconfidence bias in terms of the Covid-19 pandemic.…”

Herding behavior by socially responsible investors during the COVID-19 pandemic

“…Gleason et al (2004) do not find evidence of intraday herding behavior by investors in sector ETFs; neither does Rompotis (2018), who examines herding behavior in 100 equity ETFs during the 2012-2016 time period. More recently, Kunjal and Peerbhai (2021) analyze ETFs trading during COVID-19 on the Johannesburg Stock Exchange in South Africa, and again find no evidence of herding. On the other hand, Chen et al (2011) document herding behavior by institutional investors in ETFs in US markets, between 1993 and 2007.…”