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Overconfident investors and probability misjudgments

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Author Info

  • Kliger, Doron
  • Levy, Ori

Abstract

This paper explores systematic distortions of subjective probabilities by overconfident investors. In agreement with many non-expected utility theories, our devised setup acknowledges nonlinear weighting of physical probabilities by both rational and overconfident investors. Overconfidence - assumed to be higher after a history of gains and lower after a history of losses - changes these probability transformations. Using US asset price data, overconfident investors are found to be more optimistic than rational investors about future prospects.

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File URL: http://www.sciencedirect.com/science/article/B6W5H-4X3N427-1/2/5b3bbece85625d2b543f1e58adbe292d
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Bibliographic Info

Article provided by Elsevier in its journal Journal of Behavioral and Experimental Economics (formerly The Journal of Socio-Economics).

Volume (Year): 39 (2010)
Issue (Month): 1 (January)
Pages: 24-29

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Handle: RePEc:eee:soceco:v:39:y:2010:i:1:p:24-29

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Web page: http://www.elsevier.com/locate/inca/620175

Related research

Keywords: Market data Overconfidence Probability weighting functions;

References

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  1. Christensen, B. J. & Prabhala, N. R., 1998. "The relation between implied and realized volatility," Journal of Financial Economics, Elsevier, vol. 50(2), pages 125-150, November.
  2. Gervais, Simon & Odean, Terrance, 2001. "Learning to be Overconfident," Review of Financial Studies, Society for Financial Studies, vol. 14(1), pages 1-27.
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  7. Jackwerth, Jens Carsten, 2000. "Recovering Risk Aversion from Option Prices and Realized Returns," Review of Financial Studies, Society for Financial Studies, vol. 13(2), pages 433-51.
  8. Tversky, Amos & Kahneman, Daniel, 1992. " Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
  9. Mark Rubinstein., 1994. "Implied Binomial Trees," Research Program in Finance Working Papers RPF-232, University of California at Berkeley.
  10. Jackwerth, Jens Carsten & Rubinstein, Mark, 1996. " Recovering Probability Distributions from Option Prices," Journal of Finance, American Finance Association, vol. 51(5), pages 1611-32, December.
  11. Rubinstein, Mark, 1994. " Implied Binomial Trees," Journal of Finance, American Finance Association, vol. 49(3), pages 771-818, July.
  12. Brad M. Barber & Terrance Odean, 2001. "Boys Will Be Boys: Gender, Overconfidence, And Common Stock Investment," The Quarterly Journal of Economics, MIT Press, vol. 116(1), pages 261-292, February.
  13. Terrance Odean, 1998. "Volume, Volatility, Price and Profit When All Traders Are Above Average," Finance 9803001, EconWPA.
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Cited by:
  1. Michailova, Julija & Katter, Joana K. Q., 2013. "Thoughts on quantifying overconfidence in economic experiments," MPRA Paper 53112, University Library of Munich, Germany, revised Jan 2014.

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