Beyond Fundamentals: How Investor Overconfidence Shapes Firm Valuation in India
DOI:
https://doi.org/10.47941/ijf.3041Keywords:
Asset Pricing, Overconfidence Bias, Behavioural Finance, Firm Valuation, Panel Data Models, Generalized Method of Moments, Emerging MarketsAbstract
Purpose: This study investigates the impact of investor overconfidence on firm valuation within India’s dynamic and rapidly evolving equity market. Anchored in behavioural finance theory, which posits that cognitive biases and limits to arbitrage generate persistent mispricing, the analysis explores how overconfident trading behaviour contributes to valuation distortions. Overconfident investors tend to trade excessively and react asymmetrically to gains versus losses, leading to systematic deviations from firms’ intrinsic values.
Methodology: Utilizing a balanced panel of 1,367 continuously listed non-financial firms over the period April 2000 to March 2023, the study employs firm-fixed effects regressions and dynamic panel estimations using the Arellano-Bond Generalized Method of Moments (GMM). This methodological approach addresses potential issues of unobserved heterogeneity and endogeneity. To enhance empirical robustness, multiple proxies for investor overconfidence are implemented, including abnormal trading volume, turnover ratios, and changes in share issuance.
Findings: The results reveal a statistically significant positive association between investor overconfidence and firm valuation. This indicates that behavioural biases among investors contribute to sustained pricing inefficiencies, with overconfidence playing a key role in driving firm valuations above their intrinsic worth. The findings underscore the persistence of behavioural anomalies in price formation, especially within the context of an emerging market like India.
Unique Contribution to Theory, Policy, and Practice: Theoretically, this study enriches the behavioural finance literature by providing robust evidence that overconfidence-induced trading behaviour influences firm valuation, supporting the view that psychological factors can lead to systematic mispricing. From a policy perspective, the findings highlight the need for regulatory frameworks that mitigate sentiment-driven inefficiencies in capital markets.
Downloads
References
Adebambo, B., & Yan, G. (2018). Investor overconfidence and equity issuance. Journal of Behavioral Finance, 19(1), 85-98. https://doi.org/10.1080/15427560.2017.1344671
Adebambo, B., & Yan, X. (2018). Investor sentiment and share repurchases. Journal of Financial and Quantitative Analysis, 53(5), 2225–2256. https://doi.org/10.1017/S0022109018000533
Adebambo, B., & Yan, X. S. (2018). Investor overconfidence and firm valuation. Journal of Financial Markets, 38, 53-74.
Arellano, M., & Bond, S. (1991). Some tests of specification for panel data: Monte Carlo evidence and an application to employment equations. Review of Economic Studies, 58(2), 277-297. https://doi.org/10.2307/2297968
Arellano, M., & Bover, O. (1995). Another look at the instrumental variable estimation of error-components models. Journal of Econometrics, 68(1), 29-51. https://doi.org/10.1016/0304-4076(94)01642-D
Baker, M., & Wurgler, J. (2002). Market timing and capital structure. The Journal of Finance, 57(1), 1-32. https://doi.org/10.1111/1540-6261.00414
Baker, M., & Wurgler, J. (2006). Investor sentiment and the cross-section of stock returns. The Journal of Finance, 61(4), 1645-1680. https://doi.org/10.1111/j.1540-6261.2006.00885.x
Baker, M., & Wurgler, J. (2007). Investor sentiment in the stock market. Journal of Economic Perspectives, 21(2), 129-152. https://doi.org/10.1257/jep.21.2.129
Baker, M., & Wurgler, J. (2012). Behavioral corporate finance: An updated survey. In G. M. Constantinides, M. Harris, & R. M. Stulz (Eds.), Handbook of the Economics of Finance (Vol. 2, pp. 357-424). Elsevier.
Baker, M., Wurgler, J., & Yuan, Y. (2012). Global, local, and contagious investor sentiment. Journal of Financial Economics, 104(2), 272-287.
Baltagi, B. H. (2004). Econometric Analysis of Panel Data (3rd ed.). Wiley.
Banerjee, R., & De, S. (2019). Capital structure and firm performance: Evidence from Indian manufacturing firms. International Journal of Financial Studies, 7(3), 50. https://doi.org/10.3390/ijfs7030050
Barber, B. M., & Odean, T. (2000). Trading is hazardous to your wealth: The common stock investment performance of individual investors. The Journal of Finance, 55(2), 773-806. https://doi.org/10.1111/0022-1082.00226
Barber, B. M., & Odean, T. (2001). Boys will be boys: Gender, overconfidence, and common stock investment. Quarterly Journal of Economics, 116(1), 261-292. https://doi.org/10.1162/003355301556400
Barber, B. M., & Odean, T. (2002). Trading is hazardous to your wealth: The common stock investment performance of individual investors. The Journal of Finance, 57(2), 773-806. https://doi.org/10.1111/1540-6261.00442
Barber, B. M., & Odean, T. (2016). The overconfident trading behavior of individual versus institutional investors. International Review of Economics & Finance, 41, 1–12. https://doi.org/10.1016/j.iref.2015.10.001
Barberis, N., & Thaler, R. (2003). A survey of behavioral finance. In G. M. Constantinides, M. Harris, & R. M. Stulz (Eds.), Handbook of the Economics of Finance (Vol. 1, pp. 1053-1128). Elsevier.
Barberis, N., & Thaler, R. H. (2003). A survey of behavioral finance. Handbook of the Economics of Finance, 1, 1053-1128.
Barberis, N., Huang, M., & Santos, T. (2001). Prospect theory and asset prices. Quarterly Journal of Economics, 116(1), 1-53.
Barberis, N., Shleifer, A., & Vishny, R. (1998). A model of investor sentiment. Journal of Financial Economics, 49(3), 307–343. https://doi.org/10.1016/S0304-405X(98)00027-0
Barberis, N., Shleifer, A., & Wurgler, J. (2005). Comovement. Journal of Financial Economics, 75(2), 283–317. https://doi.org/10.1016/j.jfineco.2004.08.006
Bar-Yosef, S., & Venezia, I. (2006). The effect of investors’ sentiment on prices and on the decision to trade: Experimental evidence. Journal of Economic Behavior & Organization, 61(3), 453–471. https://doi.org/10.1016/j.jebo.2004.03.016
Bekaert, G., & Harvey, C. R. (2003). Emerging markets finance. Journal of Empirical Finance, 10(1-2), 3-55. https://doi.org/10.1016/S0927-5398(02)00054-3
Bernard, V. L., & Thomas, J. K. (1989). Post-earnings-announcement drift: Delayed price response or risk premium? Journal of Accounting Research, 27(Supplement), 1–36. https://doi.org/10.2307/2491062
Blundell, R., & Bond, S. (1998). Initial conditions and moment restrictions in dynamic panel data models. Journal of Econometrics, 87(1), 115-143. https://doi.org/10.1016/S0304-4076(98)00009-8
Blundell, R., & Bond, S. (2000). GMM estimation with persistent panel data: An application to production functions. Econometric Reviews, 19(3), 321-340. https://doi.org/10.1080/07474930008800475
Booth, L., Aivazian, V., Demirguc-Kunt, A., & Maksimovic, V. (2001). Capital structures in developing countries. Journal of Finance, 56(1), 87–130. https://doi.org/10.1111/0022-1082.00320
Bremer, M., & Kato, K. (1996). Trading volume for winners and losers on the Tokyo Stock Exchange. The Journal of Financial and Quantitative Analysis, 31(1), 127-142.
Brown, G. W., & Cliff, M. T. (2005). Investor sentiment and asset valuation. The Journal of Business, 78(2), 405–440. https://doi.org/10.1086/427633
Chandra, A. (2008). Decision making in the stock market: Incorporating psychology with finance. ICFAI Journal of Behavioral Finance, 5(4), 43–51.
Chen, G., Kim, K. A., Nofsinger, J. R., & Rui, O. M. (2007). Trading performance, disposition effect, overconfidence, representativeness bias, and experience of emerging market investors. Journal of Behavioral Decision Making, 20(4), 425–451. https://doi.org/10.1002/bdm.561
Chen, Q., Li, D., & Yu, J. (2020). Beta anomalies and investor sentiment. Journal of Financial and Quantitative Analysis, 55(2), 423–451. https://doi.org/10.1017/S002210901800098X
Chiah, M., & Zhong, A. (2019). The investment premium: A robust return predictor? International Review of Financial Analysis, 61, 222–237. https://doi.org/10.1016/j.irfa.2018.10.011
Chiah, M., & Zhong, A. (2019). The investment premium: A robust return predictor? International Review of Financial Analysis, 61, 222–237. https://doi.org/10.1016/j.irfa.2018.10.011
Chiah, M., & Zhong, A. (2019). Trading volume and investor overconfidence: Evidence from Australia. International Review of Financial Analysis, 61, 78-93.
Chiu, C.-J., Ho, A. Y.-F., & Tsai, L.-F. (2022). Effects of financial constraints and managerial overconfidence on investment-cash flow sensitivity. International Review of Economics & Finance, 76, 135–150. https://doi.org/10.1016/j.iref.2021.06.005
Chiu, C.-W., Chung, H., & Hsu, T.-C. (2022). Investor overconfidence and stock price crash risk: Evidence from global markets. International Review of Economics & Finance, 80, 159–178. https://doi.org/10.1016/j.iref.2022.01.013
Chopra, N., Lakonishok, J., & Ritter, J. R. (1992). Measuring abnormal performance: Do stocks overreact? Journal of Financial Economics, 31(2), 235-268. https://doi.org/10.1016/0304-405X(92)90005-J
Chuang, W. I., & Lee, B. S. (2006). An empirical evaluation of the overconfidence hypothesis. Journal of Banking & Finance, 30(9), 2489-2515. https://doi.org/10.1016/j.jbankfin.2005.08.013
Chung, K. H., & Pruitt, S. W. (1994). A simple approximation of Tobin's q. Financial Management, 23(3), 70-74. https://doi.org/10.2307/3665623
Daniel, K., Hirshleifer, D., & Subrahmanyam, A. (1998). Investor psychology and security market under- and overreactions. Journal of Finance, 53(6), 1839-1885. https://doi.org/10.1111/0022-1082.00077
De Long, J. B., Shleifer, A., Summers, L. H., & Waldmann, R. J. (1990). Noise trader risk in financial markets. Journal of Political Economy, 98(4), 703-738.
Deaves, R., Lüders, E., & Luo, G. Y. (2009). An experimental test of the impact of overconfidence and gender on trading activity. Review of Finance, 13(3), 555–575. https://doi.org/10.1093/rof/rfn023
Dittmar, A. K., Mahrt-Smith, J., & Smith, H. (2007). Corporate governance and the value of cash holdings. Journal of Financial Economics, 83(3), 599–634. https://doi.org/10.1016/j.jfineco.2005.12.006
El Ghoul, S., Guedhami, O., & Kim, Y. (2017). Country-level institutions, firm value, and the role of corporate social responsibility initiatives. Journal of International Business Studies, 48(3), 360–385. https://doi.org/10.1057/s41267-016-0045-7
Fama, E. F. (1970). Efficient capital markets: A review of theory and empirical work. Journal of Finance, 25(2), 383-417. https://doi.org/10.2307/2325486
Fama, E. F., & French, K. R. (1992). The cross-section of expected stock returns. Journal of Finance, 47(2), 427–465. https://doi.org/10.1111/j.1540-6261.1992.tb04398.x
Feng, L., & Wu, S. (2018). Social networks and firm performance: Evidence from China. Journal of Corporate Finance, 49, 296-319.
Flannery, M. J., & Rangan, K. P. (2006). Partial adjustment toward target capital structures. Journal of Financial Economics, 79(3), 469–506. https://doi.org/10.1016/j.jfineco.2005.03.004
Frank, M. Z., & Goyal, V. K. (2009). Capital structure decisions: Which factors are reliably important? Financial Management, 38(1), 1–37. https://doi.org/10.1111/j.1755-053X.2009.01026.x
Gervais, S., & Odean, T. (2001). Learning to be overconfident. The Review of Financial Studies, 14(1), 1–27. https://doi.org/10.1093/rfs/14.1.1
Ghosh, S. (2008). Leverage, managerial monitoring and firm valuation: A simultaneous equation approach. Research in Economics, 62(2), 84–98. https://doi.org/10.1016/j.rie.2008.02.002
Gilchrist, S., Himmelberg, C. P., & Huberman, G. (2005). Do stock price bubbles influence corporate investment? Journal of Monetary Economics, 52(4), 805-827. https://doi.org/10.1016/j.jmoneco.2005.01.007
Glaser, M., & Weber, M. (2007). Overconfidence and trading volume. The Geneva Risk and Insurance Review, 32, 1–36. https://doi.org/10.1007/s10713-007-0003-3
Glaser, M., & Weber, M. (2011). True overconfidence in interval estimates: Evidence based on a new measure of miscalibration. Journal of Behavioral Decision Making, 24(3), 271–293. https://doi.org/10.1002/bdm.696
Glaser, M., Langer, T., & Weber, M. (2013). True overconfidence in interval estimates: Evidence based on a new measure of miscalibration. Journal of Behavioral Decision Making, 26(5), 405-417. https://doi.org/10.1002/bdm.1773
Gomes, J. F. (2001). Financing investment. American Economic Review, 91(5), 1263–1285. https://doi.org/10.1257/aer.91.5.1263
Gompers, P. A., Ishii, J. L., & Metrick, A. (2003). Corporate governance and equity prices. Quarterly Journal of Economics, 118(1), 107–155. https://doi.org/10.1162/00335530360535162
Graham, J. R., & Leary, M. T. (2011). A review of empirical capital structure research and directions for the future. Annual Review of Financial Economics, 3(1), 309–345. https://doi.org/10.1146/annurev-financial-102710-144821
Greene, W. H. (2012). Econometric analysis (7th ed.). Pearson Education.
Griffin, D., Nardari, F., & Stulz, R. M. (2007). Do investors trade more when stocks have performed well? Evidence from 46 countries. The Review of Financial Studies, 20(3), 905-951. https://doi.org/10.1093/rfs/hhl030
Han, B., Hirshleifer, D., & Walden, J. (2020). Social transmission bias and investor behavior. Journal of Financial Economics, 137(2), 371–398. https://doi.org/10.1016/j.jfineco.2020.03.003
Hassan, M. K. (2018). The role of firm characteristics and institutional factors in the capital structure of emerging market firms. Emerging Markets Review, 36, 89–103. https://doi.org/10.1016/j.ememar.2018.04.001
Hausman, J. A. (1978). Specification tests in econometrics. Econometrica, 46(6), 1251-1271. https://doi.org/10.2307/1913827
Hilary, G., & Hsu, C. (2011). Endogenous overconfidence in managerial forecasts. Journal of Accounting and Economics, 51(3), 300-313. https://doi.org/10.1016/j.jacceco.2011.01.002
Hirshleifer, D. (2001). Investor psychology and asset pricing. Journal of Finance, 56(4), 1533-1597. https://doi.org/10.1111/0022-1082.00379
Hong, H., & Stein, J. C. (2007). Disagreement and the stock market. Journal of Economic Perspectives, 21(2), 109-128.
Huang, Y., Jiang, F., Liu, Z., & Zhang, M. (2015). Investor sentiment, market reaction, and economic linkages: Evidence from Chinese stock market. Pacific-Basin Finance Journal, 32, 34–55. https://doi.org/10.1016/j.pacfin.2014.10.003
Huddart, S., Lang, M., & Yetman, M. (2009). Volume and price patterns around a stock's 52-week highs and lows: Theory and evidence. The Accounting Review, 84(4), 1385-1409.
Jegadeesh, N., & Titman, S. (1993). Returns to buying winners and selling losers: Implications for stock market efficiency. Journal of Finance, 48(1), 65-91. https://doi.org/10.1111/j.1540-6261.1993.tb04702.x
Kahneman, D., & Tversky, A. (1974). Judgment under uncertainty: Heuristics and biases. Science, 185(4157), 1124-1131.
Kahneman, D., & Tversky, A. (1979). Prospect theory: An analysis of decision under risk. Econometrica, 47(2), 263-291. https://doi.org/10.2307/1914185
Kansal, P., & Singh, S. (2018). Determinants of overconfidence bias in Indian stock market. Qualitative Research in Financial Markets, 10(4), 381-394.
Kumar, A., & Lee, C. M. C. (2006). Retail investor sentiment and return comovements. Journal of Finance, 61(5), 2451–2486. https://doi.org/10.1111/j.1540-6261.2006.01063.x
Kumar, S., & Goyal, N. (2016). Evidence on rationality and behavioural biases in investment decision making. Qualitative Research in Financial Markets, 8(4), 270-287. https://doi.org/10.1108/QRFM-05-2016-0015
Kumar, S., & Prince, M. (2022). Investor overconfidence and asset pricing anomalies: Evidence from an emerging market. Journal of Behavioral and Experimental Finance, 33, 100668. https://doi.org/10.1016/j.jbef.2021.100668
Kumari, J., & Mahakud, J. (2015). Investor sentiment and stock market volatility: Evidence from India. Journal of Financial Economic Policy, 7(2), 171-192.
La Porta, R., Lopez‐de‐Silanes, F., Shleifer, A., & Vishny, R. W. (2002). Investor protection and corporate valuation. The Journal of Finance, 57(3), 1147–1170. https://doi.org/10.1111/1540-6261.00457
Lai, M. M., Low, K. Y., & Lai, M. L. (2013). Are Malaysian investors rational? A behavioral finance perspective. International Journal of Business and Society, 14(3), 435-450.
Langer, E. J. (1975). The illusion of control. Journal of Personality and Social Psychology, 32(2), 311- 328.
Li, Y., Zhang, H., & Zhou, X. (2013). Sentiment momentum and stock return: Chinese evidence. Pacific-Basin Finance Journal, 25, 146-157.
Liu, X., & Magnan, M. (2011). Corporate governance and earnings management: A comparative study of U.S. and Canadian firms. Journal of International Accounting Research, 10(2), 61-89.
Liu, Y., & Magnan, M. (2011). Self-regulation, financial reporting, and accountability: Evidence from Canadian firms’ adoption of IFRS. Journal of International Accounting Research, 10(1), 61–78. https://doi.org/10.2308/jiar-10053
Malmendier, U., & Tate, G. (2005). CEO overconfidence and corporate investment. The Journal of Finance, 60(6), 2661-2700. https://doi.org/10.1111/j.1540-6261.2005.00813.x
Meier, A. (2018). Investor sentiment and aggregate stock returns: A non-linear perspective. Journal of Behavioral and Experimental Finance, 18, 65-74.
Merton, R. C. (1987). A simple model of capital market equilibrium with incomplete information. The Journal of Finance, 42(3), 483-510. https://doi.org/10.1111/j.1540-6261.1987.tb04565.x
Miller, D. T., & Ross, M. (1975). Self-serving biases in the attribution of causality: Fact or fiction? Psychological Bulletin, 82(2), 213-225.
Mitra, A., & Bhaduri, S. N. (2015). Investor sentiment and stock market volatility: Evidence from India. Journal of Behavioral and Experimental Finance, 8, 45–56. https://doi.org/10.1016/j.jbef.2015.10.001
Modigliani, F., & Miller, M. H. (1958). The cost of capital, corporation finance and the theory of investment. American Economic Review, 48(3), 261–297. https://www.jstor.org/stable/1809766
Morck, R., Yeung, B., & Yu, W. (2000). The information content of stock markets: Why do emerging markets have synchronous stock price movements? Journal of Financial Economics, 58(1-2), 215-260. https://doi.org/10.1016/S0304-405X(00)00071-4
Mushinada, V. N. C., & Veluri, V. S. S. (2018). Elucidating investors' rationality and behavioural biases in Indian stock market. Review of Behavioral Finance, 11(2), 201-219.
Muth, J. F. (1961). Rational expectations and the theory of price movements. Econometrica, 29(3), 315-335. https://doi.org/10.2307/1909635
Nair, P. S., & Shiva, A. (2024). Specifying and validating overconfidence bias among retail investors: A formative index. Managerial Finance, 50(5), 1017-1036.
Nickell, S. (1981). Biases in dynamic models with fixed effects. Econometrica, 49(6), 1417–1426. https://doi.org/10.2307/1911408
Odean, T. (1998). Volume, volatility, price, and profit when all traders are above average. The Journal of Finance, 53(6), 1887-1934. https://doi.org/10.1111/0022-1082.00078
Odean, T. (1999). Do investors trade too much? The American Economic Review, 89(5), 1279-1298. https://doi.org/10.1257/aer.89.5.1279
Penman, S. H., & Zhang, X.-J. (2002). Accounting conservatism, the quality of earnings, and stock returns. The Accounting Review, 77(2), 237–264. https://doi.org/10.2308/accr.2002.77.2.237
Polk, C., & Sapienza, P. (2008). The stock market and corporate investment: A test of catering theory. The Review of Financial Studies, 21(3), 1151-1180. https://doi.org/10.1093/rfs/hhn030
Prosad, J. M., Kapoor, S., Sengupta, J., & Roychoudhary, S. (2018). Overconfidence and Disposition Effect in Indian Equity Market: An Empirical Evidence. Vision: The Journal of Business Perspective, 22(3), 225-235.
Rajan, R. G., & Zingales, L. (1995). What do we know about capital structure? Some evidence from international data. The Journal of Finance, 50(5), 1421–1460. https://doi.org/10.1111/j.1540-6261.1995.tb05184.x
Roodman, D. (2009). A note on the theme of too many instruments. Oxford Bulletin of Economics and Statistics, 71(1), 135-158. https://doi.org/10.1111/j.1468-0084.2008.00542.x
Ross, S. A. (1976). The arbitrage theory of capital asset pricing. Journal of Economic Theory, 13(3), 341-360. https://doi.org/10.1016/0022-0531(76)90046-6
Russo, J. E., & Shoemaker, P. J. H. (1992). Managing overconfidence. Sloan Management Review, 33(2), 7-17.
Safeeda, P. K., & Ganesh, L. (2024). Do overconfident investors affect firm valuation? Evidence from India. Emerging Markets Finance and Trade. Advance online publication. https://doi.org/10.1080/1540496X.2024.000000
Scheinkman, J. A., & Xiong, W. (2003). Overconfidence and speculative bubbles. Journal of Political Economy, 111(6), 1183-1219. https://doi.org/10.1086/378531
SEBI. (2023). Handbook of Statistics on Indian Securities Market. Securities and Exchange Board of India.
Shleifer, A., & Vishny, R. W. (1997). The limits of arbitrage. Journal of Finance, 52(1), 35-55. https://doi.org/10.1111/j.1540-6261.1997.tb03807.x
Siganos, A., Vagenas-Nanos, E., & Verwijmeren, P. (2017). Divergence of sentiment and stock market trading. Journal of Corporate Finance, 46, 490-514.
Simon, H. A. (1955). A behavioral model of rational choice. The Quarterly Journal of Economics, 69(1), 99-118. https://doi.org/10.2307/1884852
Statman, M., Fisher, K. L., & Anginer, D. (2006). Affect in a behavioral asset-pricing model. Financial Analysts Journal, 64(2), 20-29.
Statman, M., Thorley, S., & Vorkink, K. (2006). Investor overconfidence and trading volume. Review of Financial Studies, 19(4), 1531-1565. https://doi.org/10.1093/rfs/hhj032
Tekce, M., & Yilmaz, M. K. (2015). Investor overconfidence in the case of an emerging market. Applied Economics Letters, 22(10), 783-787. https://doi.org/10.1080/13504851.2014.979453
Von Neumann, J., & Morgenstern, O. (1944). Theory of games and economic behavior. Princeton University Press.
Wooldridge, J. M. (2010). Econometric analysis of cross section and panel data (2nd ed.). MIT Press.
Downloads
Published
How to Cite
Issue
Section
License
Copyright (c) 2025 Jyoti Kumari

This work is licensed under a Creative Commons Attribution 4.0 International License.
Authors retain copyright and grant the journal right of first publication with the work simultaneously licensed under a Creative Commons Attribution (CC-BY) 4.0 License that allows others to share the work with an acknowledgment of the work's authorship and initial publication in this journal.