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Overconfidence and Market Efficiency with Heterogeneous Agents

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  • Diego Garcia
  • Francesco Sangiorgi
  • Branko Urosevic

Abstract

We study financial markets in which both rational and overconfident agents coexist and make endogenous information acquisition decisions. We demonstrate the following irrele- vance result: when a positive fraction of rational agents (endogenously) decides to become informed in equilibrium, prices are set as if all investors were rational, and as a conse- quence the overconfidence bias does not affect informational efficiency, price volatility, ra- tional traders expected profits or their welfare. Intuitively, as overconfidence goes up, so does price informativeness, which makes rational agents cut their information acquisition activities, effectively undoing the standard effect of more aggressive trading by the overcon- fident. The main intuition of the paper, if not the irrelevance result, is shown to be robust to different model specifications.

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Bibliographic Info

Paper provided by Collegio Carlo Alberto in its series Carlo Alberto Notebooks with number 11.

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Length: 30 pages
Date of creation: 2005
Date of revision:
Publication status: Forthcoming in Economic Theory
Handle: RePEc:cca:wpaper:11

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Keywords: partially revealing equilibria; overconfidence; rational expectations; information acquisition; price informativeness.;

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References

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Citations

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Cited by:
  1. M. Middeldorp & S. Rosenkranz, 2008. "Information acquisition in an experimental asset market," Working Papers 08-25, Utrecht School of Economics.
  2. Juan Dubra & Jean-Pierre Benoit, 2011. "Apparent Overconfidence," Documentos de Trabajo/Working Papers 1106, Facultad de Ciencias Empresariales y Economia. Universidad de Montevideo..
  3. Benoît, Jean-Pierre & Dubra, Juan, 2008. "Overconfidence?," MPRA Paper 8879, University Library of Munich, Germany.
  4. Benoît, Jean-Pierre & Dubra, Juan & Moore, Don, 2009. "Does the Better-Than-Average Effect Show That People Are Overconfident?: An Experiment," MPRA Paper 13168, University Library of Munich, Germany.
  5. Zhou, Deqing, 2013. "Irrational confidence, imperfect and long-lived information," International Review of Economics & Finance, Elsevier, vol. 27(C), pages 383-405.
  6. Benoît, Jean-Pierre & Dubra, Juan & Moore, Don, 2009. "Does the Better-Than-Average Effect Show That People Are Overconfident?: Two Experiments," MPRA Paper 44956, University Library of Munich, Germany, revised 11 Mar 2013.
  7. Luca Rigotti & Matthew Ryan & Rhema Vaithianathan, 2011. "Optimism and firm formation," Economic Theory, Springer, vol. 46(1), pages 1-38, January.
  8. Rietveld, C.A. & Groenen, P.J.F. & Koellinger, Ph.D. & van der Loos, M.J.H.M. & Thurik, A.R., 2013. "Living Forever: Entrepreneurial Overconfidence at Older Ages," ERIM Report Series Research in Management ERS-2013-012-STR, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus Uni.
  9. Bertrand BLANCHETON (GREThA UMR CNRS 5113) & Yves JEGOUREL (LAREFI), 2009. "Sovereign wealth funds: toward a new state capitalism? (In French)," Cahiers du GREThA 2009-04, Groupe de Recherche en Economie Théorique et Appliquée.

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