Overconfidence Of Manager And The Trading Strategy Based On Managers' Behaviour

In the behavioral corporate finance theory has emerged in a variety of analysis framework under different assumptions, for example, rational managers with irrational investors, or rational investors with irrational managers. However, company managers not only play the role of corporate helmsman in the market, but an investor as well. This means that the formation of cognitive bias in the management of the company may also affect their own investment decisions, especially overconfident managers. This paper is devoted to study whether managers in Chinese stock market have psychological overconfident biases. Whether and how the overconfidence will influence their individual investment decisions.Firstly, from the perspective of theoretical research, this paper discusses the various individual irrational behavior, respectively, the bias, the direct inference and framing effects. Overconfidence is an important form of bias. It is the bias due to the lack of understanding of their own ability and knowledge. The individuals overconfident about their abilities tends to over-judge the situation, individuals overconfident about their knowledge always feel that they understand a lot of things, but in fact, not so. Those who have bias of overconfidence will show over-optimistic attitude toward their ability and estimation.Domestic and foreign scholars have different methods to measure overconfidence. Measurement of Holding State; Content Analysis; Consumer Sentiment Index or Enterprise Prosperity Index method; the acquisition frequency method; Earnings Forecast Deviation method.In this paper, according to the actual situation of Chinese market, I used the earnings forecast deviation method as the measurement for overconfidence. In the validation, the paper finds that the index can show the irrational behavior of the overconfident managers in the process of enterprises' merger and acquisitions. Overconfident managers will overestimate the synergy of the mergers and acquisitions that they take and their ability to handle the M&A event. They do not have the ability to complete integration of several mergers and acquisitions in such a short time, and cannot create more return than relatively rational managers, even worse, destroy the value of the enterprise.In the domestic market, people tend to think that as the managers have more information of their own enterprises, they have more opportunities for arbitrage. Therefore, managers' increasing of their holdings of the company is a symbol of stock price undervalued. However, after using the measurements above to distinguish between overconfident managers and rational managers, the paper finds that overconfident managers' short-term excess return is not significantly different from the market. And in the long term investment return, overconfident managers is significantly lower than the relatively rational managers.The subsequent trading strategies is to overlook the increase in holdings by the overconfident managers, and track the rational managers. Buy the stock when the rational managers increase their holdings and hold it for 1 years. The backtracking finds that this strategy had more than 10% of excess returns, has certain anti-risk ability in the bear market, and can enlarge returns in the bull market. Although there are some difficulties in adopting the strategy, the trading strategy is a good one.