Overconfidence, financial literacy, and panic selling: Evidence from Japan

Area of Science:

• Behavioral Finance
• Market Psychology
• Financial Economics

Background:

• Panic selling, characterized by rapid security sales due to fear, significantly impacts market stability during crises.
• Limited understanding exists regarding the precise factors driving panic selling behavior among investors.
• The overreaction hypothesis and financial literacy are key theoretical frameworks for analyzing investor sentiment and decision-making.

Purpose of the Study:

• To investigate the influence of investor sentiment, specifically overconfidence, on panic selling behavior.
• To examine the moderating role of financial literacy in the relationship between overconfidence and panic selling.
• To identify factors contributing to panic selling, even when financial knowledge is present.

Main Methods:

• Analysis of individual investor-level data from a Japanese survey (Rakuten Securities Company and Hiroshima University, Nov-Dec 2023).
• Application of probit regression models to assess relationships between variables.
• Control for demographic, socioeconomic, and psychological factors in the analysis.

Main Results:

• Overconfident investors demonstrate a higher likelihood of engaging in panic selling during market downturns.
• Financial literacy was found to reduce the tendency for panic selling, though overconfidence remained a significant predictor.
• The relationship between overconfidence and panic selling was consistent across different levels of divestment (partial to full).

Conclusions:

• Overconfidence is a critical factor driving panic selling, even among financially literate individuals.
• Policymakers should manage the flow of negative information during crises to curb panic selling.
• Investors should enhance financial knowledge and seek credible information to avoid succumbing to panic selling.