2019 China Finance Review International Conference (CFRIC)

2 / 2019-04-15 11:20:01

Investor Overconfidence and the Security Market Line: New Evidence from China

Security Market Line, Beta Anomaly, Betting Against Beta, Overconfidence, Mutual Fund

This paper documents a highly downward sloping security market line (SML) in China, which is more puzzling than the typical “flattened” SML in the US, and does not reconcile with existing theories of low-beta anomaly. We show that investor overconfidence offers some promises in resolving the puzzle in China: In the time-series dimension, the slope of the SML becomes more “inverted” when investors get more overconfident. As a general symptom of overconfidence in the cross section, high-beta stocks are also the mostly heavily traded. After accounting for trading volume, there is no longer the low-beta anomaly at both the firm and portfolio levels. Mutual fund evidence reinforces the view that institutional investors actively exploit the portfolio implications of a downward sloping SML by shying away from high-beta stocks and betting on low-beta stocks for superior performance.