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Investor Psychology and Security Market Under- and Overreactions

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  • Kent Daniel

    (Northwestern University and NBER,)

  • David Hirshleifer

    (University of Michigan, Ann Arbor,)

  • Avanidhar Subrahmanyam

    (University of California at Los Angeles)

Abstract

We propose a theory of securities market under- and overreactions based on two well-known psychological biases: investor overconfidence about the precision of private information; and biased self-attribution, which causes asymmetric shifts in investors' confidence as a function of their investment outcomes. We show that overconfidence implies negative long-lag autocorrelations, excess volatility, and, when managerial actions are correlated with stock mispricing, public-event-based return predictability. Biased self-attribution adds positive short-lag autocorrelations ("momentum"), short-run earnings "drift," but negative correlation between future returns and long-term past stock market and accounting performance. The theory also offers several untested implications and implications for corporate financial policy. Copyright The American Finance Association 1998.

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Bibliographic Info

Article provided by American Finance Association in its journal The Journal of Finance.

Volume (Year): 53 (1998)
Issue (Month): 6 (December)
Pages: 1839-1885

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Handle: RePEc:bla:jfinan:v:53:y:1998:i:6:p:1839-1885

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