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Overconfidence and Correlated Information Structures

Author

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  • Junghum Park

    (Bank of Lithuania, Vilnius University)

Abstract

This paper analyzes a model of multiple overconfident traders submitting market orders where traders’ private information is subject to correlated errors, as well as its extension to endogenous information. We consider two standard types of overconfidence: overconfidence in own signals and underconfidence in others’ signals. The analyses on the effects of overconfidence on traders’ behavior and the equilibrium price suggest that these effects are richer than our typical understanding of overconfidence focusing on its positive effect on trading volume as follows: First, trading volume may increase or decrease with overconfidence depending on its type. Second, these different types of overconfidence may differ radically on the patterns of trading volume and price informativeness with respect to the number of traders. Third, overconfidence can cause equilibrium multiplicity in information acquisition.

Suggested Citation

  • Junghum Park, 2023. "Overconfidence and Correlated Information Structures," Bank of Lithuania Working Paper Series 116, Bank of Lithuania.
    • Handle: RePEc:lie:wpaper:116
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    More about this item

    Keywords

    Overconfidence; Disagreement; Strategic trading; Information aggregation; Efficient market hypothesis;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G4 - Financial Economics - - Behavioral Finance

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