BOYS WILL BE BOYS: GENDER, OVERCONFIDENCE, AND COMMON STOCK INVESTMENT [*].(Statistical Data Included)

Theoretical models predict that overconfident investors trade excessively. We test this prediction by partitioning investors on gender. Psychological research demonstrates that, in areas such as finance, men are more overconfident than women. Thus, theory predicts that men will trade more excessively than women. Using account data for over 35,000 households from a large discount brokerage, we analyze the common stock investments of men and women from February 1991 through January 1997. We document that men trade 45 percent more than women. Trading reduces men's net returns by 2.65 percentage points a year as opposed to 1.72 percentage points for women.

It's not what a man don't know that makes him a fool, but what he does know that ain't so.

Josh Billings, nineteenth century American humorist

It is difficult to reconcile the volume of trading observed in equity markets with the trading needs of rational investors. Rational investors make periodic contributions and withdrawals from their investment portfolios, rebalance their portfolios, and trade to minimize their taxes. Those possessed of superior information may trade speculatively, although rational speculative traders will generally not choose to trade with each other. It is unlikely that rational trading needs account for a turnover rate of 76 percent on the New York Stock Exchange in 1998. [1]

We believe there is a simple and powerful explanation for high levels of trading on financial markets: overconfidence. Human beings are overconfident about their abilities, their knowledge, and their future prospects. Odean [1998] shows that overconfident investors--who believe that the precision of their knowledge about the value of a security is greater than it actually is--trade more than rational investors and that doing so lowers their expected utilities. Greater overconfidence leads to greater trading and to lower expected utility.

A direct test of whether overconfidence contributes to excessive market trading is to separate investors into those more and those less prone to overconfidence. One can then test whether more overconfidence leads to more trading and to lower returns. Such a test is the primary contribution of this paper.

Psychologists find that in areas such as finance men are more overconfident than women. This difference in overconfidence yields two predictions: men will trade more than women, and the performance of men will be hurt more by excessive trading than the performance of women. To test these hypotheses, we partition a data set of position and trading records for over 35,000 households at a large discount brokerage firm into accounts opened by men and accounts opened by women. Consistent with the predictions of the overconfidence models, we find that the average turnover rate of common stocks for men is nearly one and a half times that for women. While both men and women reduce their net returns through trading, men do so by 0.94 percentage points more a year than do women.

The differences in turnover and return performance are even more pronounced between single men and single women. Single men trade 67 percent more than single women thereby reducing their returns by 1.44 percentage points per year more than do single women.

The remainder of this paper is organized as follows. We motivate our test of overconfidence in Section I. We discuss our data and empirical methods in Section II. Our main results are presented in Section III. We discuss competing explanations for our results in Section TV and make concluding remarks in Section V.

I. A TEST OF OVERCONFIDENCE

I.A. Overconfidence and Trading on Financial Markets

Studies of the calibration of subjective probabilities find that people tend to overestimate the precision of their knowledge [Alpert and Raiffa 1982; Fischhoff Slovic, and Lichtenstein 1977]; see Lichtenstein, Fischhoff and Phillips [1982] for a review of the calibration literature. Such overconfidence has been observed in many professional fields. Clinical psychologists [Oskamp 1965], physicians and nurses [Christensen-Szalanski and Bushyhead 1981; Baumann, Deber, and Thompson 1991], investment bankers [Stael von Holstein 1972], engineers [Kidd 1970], entrepreneurs [Cooper, Woo, and Dunkelberg 1988], lawyers [Wagenaar and Keren 1986], negotiators [Neale and Bazerman 1990], and managers [Russo and Schoemaker 1992] have all been observed to exhibit overconfidence in their judgments. (For further discussion see Lichtenstein, Fischhoff, and Phillips [1982] and Yates [1990].)

Overconfidence is greatest for difficult tasks, for forecasts with low predictability, and for undertakings lacking fast, clear feedback [Fischhoff, Slovic, and Lichtenstein 1977; Lichtenstein, Fischhorn and Phillips 1982; Yates 1990; Griffin and Tversky 1992]. Selecting common stocks that will outperform the market is a difficult task. Predictability is low; feedback is noisy. Thus, stock selection is the type of task for which people are most overconfident.

Odean [1998] develops models in which overconfident investors overestimate the precision of their knowledge about the value of a financial security. [2] They overestimate the probability that their personal assessments of the security's value are more accurate than the assessments of others. Thus, overconfident investors believe more strongly in their own valuations, and concern themselves less about the beliefs of others. This intensifies differences of opinion. And differences of opinion cause trading [Varian 1989; Harris and Raviv 1993]. Rational investors only trade and only purchase information when doing so increases their expected utility (e.g., Grossman and Stiglitz [1980]). Overconfident investors, on the other hand, lower their expected utility by trading too much; they hold unrealistic beliefs about how high their returns will be and how precisely these can be estimated; and they expend too many resources (e.g., time and money) on investment information [Odean 1998]. Overconfident investors also h old riskier portfolios than do rational investors with the same degree of risk aversion [Odean 1998].

Barber and Odean [2000] and Odean [1999] test whether investors decrease their expected utility by trading too much. Using the same data analyzed in this paper, Barber and Odean show that after accounting for trading costs, individual investors underperform relevant benchmarks. Those who trade the most realize, by far, the worst performance. This is what the models of overconfident investors predict. With a different data set, Odean [1999] finds that the securities individual investors buy subsequently underperform those they sell. When he controls for liquidity demands, tax-loss selling, rebalancing, and changes in risk aversion, investors' timing of trades is even worse. This result suggests that not only are investors too willing to act on too little information, but they are too willing to act when they are wrong.

These studies demonstrate that investors trade too much and to their detriment. The findings are inconsistent with rationality and not easily explained in the absence of overconfidence. Nevertheless, overconfidence is neither directly observed nor manipulated in these studies. A yet sharper test of the models that incorporate overconfidence is to partition investors into those more and those less prone to overconfidence. The models predict that the more overconfident investors will trade more and rea1ize lower average utilities. To test these predictions, we partition our data on gender.

I.B. Gender and Overconfidence

While both men and women exhibit overconfidence, men are generally more overconfident than women [Lundeberg, Fox, and Puncochar 1994]. [3] Gender differences in overconfidence are highly task dependent [Lundeberg, Fox, and Puncochar 1994]. Deaux and Farris [1977] write "Overall, men claim more ability than do women, but this difference emerges most strongly on...masculine task[s]." Several studies confirm that differences in confidence are greatest for tasks perceived to be in the masculine domain [Deaux and Emswiller 1974; Lenney 1977; Beyer and Bowden 1997]. Men are inclined to feel more competent than women do in financial matters [Prince 1993]. Indeed, casual observation reveals that men are disproportionately represented in the financial industry. We expect, therefore, that men will generally be more overconfident about their ability to make financial decisions than women.

Additionally, Lenney [1977] reports that gender differences in self-confidence depend on the lack of clear and unambiguous feedback. When feedback is "unequivocal and immediately available, women do not make lower ability estimates than men. However, when such feedback is absent or ambiguous, women seem to have lower opinions of their abilities and often do underestimate relative to men." Feedback in the stock market is ambiguous. All the more reason to expect men to be more confident than women about their ability to make common stock investments.

Gervais and Odean [1998] develop a model in which investor overconfidence results from self-serving attribution bias. Investors in this model infer their own abilities from their successes and failures. Due to their tendency to take too much credit for their successes, they become overconfident. Deaux and Farris [1977], Meehan and Overton [1986], and Beyer [1990] find that the self-serving attribution bias is greater for men than for women. And so men are likely to become more overconfident than women.

The previous study most like our own is Lewellen, Lease, and Schlarbaum's [1977] analysis of survey answers and brokerage records (from 1964 through 1970) of 972 individual investors. Lewellen, Lease, and Schlarbaum's report that men spend more time and money on security analysis, rely less on their brokers, make more transactions, believe that returns are more highly predictable, and anticipate higher possible returns than do women. In all these ways, men behave more like overconfident investors than do women.

Additional evidence that men are more overconfident investors than women comes from surveys conducted by the Gallup Organization for PaineWebber. Gallup conducted the survey fifteen times between June 1998 and January 2000. There were approximately 1000 respondents per survey. In addition to other questions, respondents were asked "What overall rate of return do you expect to get on your portfolio in the NEXT twelve months?" and "Thinking about the stock market more generally, what overall rate of return do you think the stock market will provide investors during the coming twelve months?" On average, both men and women expected their own portfolios to outperform the market. However, men expected to outperform by a greater margin (2.8 percent) than did women (2.1 percent). The difference in the average anticipated outperformance of men and women is statistically significant (t 3.3). [4]

In summary, we have a natural experiment to (almost) directly test theoretical models of investor overconfidence. A rational investor only trades if the expected gain exceeds the transactions costs. An overconfident investor overestimates the precision of his information and thereby the expected gains of trading. He may even trade when the true expected net gain is negative. Since men are more overconfident than women, this gives us two testable hypotheses:

H1: Men trade more than women.

H2: By trading more, men hurt their performance more than do women.

It is these two hypotheses that are the focus of our inquiry. [5]

II. DATA AND METHODS

II.A. Household Account and Demographic Data

Our main results focus on the common stock investments of 37,664 households for which we are able to identify the gender of the person who opened the household's first brokerage account. This sample is compiled from two data sets.

Our primary data set is information from a large discount brokerage firm on the investments of 78,000 households for the six years ending in December 1996. For this period, we have end-of-month position statements and trades that allow us to reasonably estimate monthly returns from February 1991 through January 1997. The data set includes all accounts opened by the 78,000 households at this discount brokerage firm. Sampled households were required to have an open account with the discount brokerage firm during 1991. Roughly half of the accounts in our analysis were opened prior to 1987, while half were opened between 1987 and 1991. On average, men opened their first account at this brokerage 4.7 years before the beginning of our sample period, while women opened theirs 4.3 years before. During the sample period, men's accounts held common stocks for 58 months on average and women's for 59 months. The median number of months men held common stocks is 70. For women it is 71.

In this research, we focus on the common stock investments of households. We exclude investments in mutual funds (both open and closed-end), American depository receipts (ADRs), warrants, and options. Of the 78,000 sampled households, 66,465 had positions in common stocks during at least one month; the remaining accounts either held cash or investments in other than individual common stocks. The average household had approximately two accounts, and roughly 60 percent of the market value in these accounts was held in common stocks. These households made over 3 million trades in all securities during our sample period; common stocks accounted for slightly more than 60 percent of all trades. The average household held four stocks worth $47,000 during our sample period, although each of these figures is positively skewed. [6] The median household held 2.6 stocks worth $16,000. In aggregate, these households held more than $4.5 billion in common stocks in December 1996.

Our secondary data set is demographic information compiled by Infobase Inc. (as of June 8, 1997) and …