Answer: holds a poorly diversified portfolio

## Explanation Overconfidence bias refers to investors' tendency to overestimate their own abilities, knowledge, and predictive accuracy. This bias typically leads to several consequences: 1. **Poor diversification**: Overconfident investors believe they can pick winning stocks and time the market, so they tend to hold concentrated portfolios rather than well-diversified ones. 2. **Excessive trading**: Overconfident investors trade more frequently than is optimal, incurring higher transaction costs. 3. **Underestimation of risks**: They tend to underestimate risks rather than overestimate them. 4. **Overestimation of returns**: They typically overestimate expected returns rather than underestimate them. Let's analyze each option: **A. Overestimates downside risks** - This is incorrect. Overconfident investors typically UNDERESTIMATE risks, believing they have superior ability to manage or avoid them. **B. Underestimates expected returns** - This is incorrect. Overconfident investors typically OVERESTIMATE expected returns, believing their stock picks will outperform the market. **C. Holds a poorly diversified portfolio** - This is CORRECT. Overconfident investors believe they can identify superior investments, leading them to concentrate their portfolios in a few stocks they think will outperform, rather than diversifying properly. **Behavioral Finance Context**: Overconfidence bias is one of the most well-documented behavioral biases in finance. Research shows that overconfident investors: - Trade 45% more than average - Earn returns 3.5% lower than the market - Are more likely to hold undiversified portfolios This question tests understanding of how specific behavioral biases manifest in investor behavior, which is crucial for the CFA curriculum's behavioral finance section.

Author: LeetQuiz .