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CFA Level I · CFA Level I Exam · The Behavioral Biases of Individuals

A portfolio manager attributes all of her past successful stock picks to her own skill and all of her poor results to bad luck. She also trades very frequently. Which of the following is the most likely consequence of her overconfidence?

Excessive trading that lowers net returns is the most likely consequence. Overconfident investors overrate their skill and information, so they trade too often and incur higher costs and taxes. They also tend to under-diversify, and refusing to sell losers reflects loss aversion instead.

  1. AExcessive trading that lowers net returns through higher costsCorrect
  2. BHolding an overly diversified portfolio of many securities
  3. CRefusing to sell positions that have declined in value

Explanation

Overconfident investors overestimate their ability and the precision of their information, which leads to excessive trading and higher transaction costs that reduce net returns. Overconfidence tends to produce under-diversification, not over-diversification. Holding losers reflects loss aversion rather than overconfidence.

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