Exploring Disposition Effect and Overconfidence in Pakistani Investors in KSE Listed Sectors

Abstract

Financial markets are analyzed by using different models in whichinvestors are “rational”. Many traditional theories of varying nature and applicationhave existed and been developed over the past several decades. Investors are thoughtof as rational individuals, who carefully take all economic decisions every time.But irregularities were noticed in the behavior of investors when economy of theworld was shaken by the Financial Crisis of 2008 that started off in the USA andresulted in global recession. The news of international financial crisis affectstheir investment strategies and help to estimate the shock absorbing abilities ofcapital market. This arise the need to study this phenomenon in capital market ofPakistan and check what heuristics are used by investors in decision making. Investorsuse heuristics in their financial decisions whenever they are faced with uncertainsituation. For this study we have collected data of ten years (2005-2014) of 229companies listed in all sectors of Karachi stock exchange. We used Logit regressionto find the relationship between disposition effect and overconfidence of investorsin Pakistani stock market. We have found that disposition effect is used by Pakistaniinvestors in their financial decision making and it helps them to generate returns.Overconfidence has negative but significant effect on investment returns for theinvestors. So theory of EMH and CAPM does not hold with all its assumptions in Pakistanicapital market.Keywords: Heuristics, Behavior, overconfidence, disposition effect,EMH, CAPM