Testing of overconfidence bias and disposition effect in Indian stock market

Abstract

This study explored how behavioural biases, specifically overconfidence and thedisposition effect, manifest in the Indian stock market across different marketenvironments: comparatively predictable (White Swan), uncertain (Grey Swan), andunpredictable(Black Swan, such as the COVID-19 pandemic). Covering the periodfrom April 2014 to March 2022, the research aimed to quantify these biases acrossvarious market phases and stock capitalizations (large, mid, and small-cap), examineinvestor overreaction to private information, and compare perceived versus actualtrading behaviours.A mixed-methods approach combined secondary market data from the Nifty 500Index with primary survey data from Indian equity investors. Econometric techniqueslike VAR and SVAR models were applied to trading volume and stock returns to detectbehavioural patterns, while statistical analyses of survey data captured perceivedbiases. These analyses were segmented by market phase and stock capitalization toprovide detailed insights.The findings showed that overconfidence bias was evident during stable and uncertainphases, but surprisingly absent during the Black Swan period, suggesting investorsbecame more risk-aware during extreme crises. Conversely, the disposition effect(selling winners too soon, holding losers too long) was consistently present across allmarket phases, intensifying under uncertain conditions and particularly affectingsmall-cap stocks. Small-cap stocks generally exhibited stronger behavioural intensityand trading sensitivity compared to mid-cap and large-cap stocks, which displayedmore restrained reactions. The study also identified that investors tend to overreact toprivate information signals, and while they acknowledge biases, they oftenunderestimate their true influence on their trading decisions.In essence, the research highlights that investor biases are not static traits butdynamically adapt to market conditions. These insights offer valuable implications forinvestors, financial advisors, and regulators, emphasizing the need for behaviouralawareness to craft better investment strategies, improve risk communication, andenhance market efficiency across varying market regimes. Future research may extendanalysis to post-pandemic market conditions and incorporate institutional investorbehaviour to further strengthen behavioural insights