Investor overconfidence in the South African exchange traded fund market.

Abstract

In recent years, Exchange Traded Funds (ETFs) have transformed the investment management landscape. Despite the soaring popularity of ETFs, ETF traders may not always be rational. Mispricing of securities, excess trading volume, and excess return volatility present in financial markets can be attributed to the influence of the overconfidence bias. Several existing studies have explored the overconfidence bias in stocks markets, however, studies on investor overconfidence in ETF markets remain scanty. Therefore, the objective of this study is to investigate the presence of investor overconfidence in the South African ETF market. Vector Autoregressive (VAR) models are employed to examine the lead-lag relationship between market turnover and market return for the market of South African ETFs tracking domestic benchmarks and for the market of South African ETFs tracking international benchmarks from the inception of the first ETF till August 2019. Consistent with the overconfidence hypothesis, a positive and significant relationship between current market turnover and lagged market returns is found for both markets, even after controlling or market volatility and cross-sectional return dispersion. This relationship holds for both market and individual ETF turnover indicating that the overconfidence bias also influences the trading activities of individual ETFs in both markets. Additionally, using Exponential Generalised Autoregressive Conditional Heteroskedasticity (EGARCH) models, this study reports that overconfident trading exhibits a significant positive effect on the volatility of market return over the full sample periods. Notably, the sub-period analysis reveals that, there is a significant positive relationship between overconfident trading and market return volatility before and during the 2008 global financial crisis only in the market of ETFs tracking domestic benchmarks. However, for the post-crisis subsample, the positive effect of overconfident trading on market volatility is only significant for the market of ETFs tracking international benchmarks. These findings have important implications for ETF investors and traders who trade in the South African ETF market; investment management companies that guide investment decisions; as well as policymakers and regulators who are responsible for promoting the efficiency of the South African ETF market.