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A Theory of Overconfidence, Self-Attribution, and Security Market Under- and Over-reactions

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Author Info
KENT D. DANIEL (Northwestern University - Kellogg School of Management)
David Hirshleifer (Fisher College of Business, Ohio State University, Department of Finance)
AVANIDHAR SUBRAHMANYAM (University of California, Los Angeles)

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Abstract

We propose a theory based on investor overconfidence and biased self- attribution to explain several of the securities returns patterns that seem anomalous from the perspective of efficient markets with rational investors. The theory is based on two premises derived from evidence in psychological studies. The first is that individuals are overconfident about their ability to evaluate securities, in the sense that they overestimate the precision of their private information signals. The second is that investors' confidence changes in a biased fashion as a function of their decision outcomes. The first premise implies overreaction to private information arrival and underreaction to public information arrival. This is consistent with (1) post-corporate event and post-earnings announcement stock price 'drift', (2) negative long- lag autocorrelations (long-run 'overreaction'), and (3) excess volatility of asset prices. Adding the second premise leads to (4) positive short-lag autocorrelations ('momentum'), and (5) short-run post-earnings announcement 'drift,' and negative correlation between future stock returns and long-term measures of past accounting performance. The model also offers several untested empirical implications and implications for corporate financial policy.

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Paper provided by EconWPA in its series Finance with number 0412006.

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Length: 45 pages
Date of creation: 04 Dec 2004
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Handle: RePEc:wpa:wuwpfi:0412006

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Keywords: Overconfidence; Market Efficiency; Investor Psychology; Asset Pricing;

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G - Financial Economics

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Markus Noeth & Martin Weber, 2000. "Information Aggregation with Random Ordering: Cascades and Overconfidence," Econometric Society World Congress 2000 Contributed Papers 1592, Econometric Society. [Downloadable!]
  2. Dong-Hyun Ahn & Jacob Boudoukh & Matthew Richardson & Robert Whitelaw, 1999. "Behavioralize This! International Evidence on Autocorrelation Patterns of Stock Index and Futures Returns," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-040, New York University, Leonard N. Stern School of Business-. [Downloadable!]
  3. Harrison Hong & Terence Lim & Jeremy C. Stein, 1998. "Bad News Travels Slowly: Size, Analyst Coverage and the Profitability of Momentum Strategies," NBER Working Papers 6553, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  6. Harrison Hong & Jeffrey D. Kubik & Jeremy C. Stein, 2003. "The Neighbor's Portfolio: Word-of-Mouth Effects in the Holdings and Trade of Money Managers," NBER Working Papers 9711, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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    Other versions:
  8. Antonio E. Bernardo & Ivo Welch, 2001. "On the Evolution of Overconfidence and Entrepreneurs," Cowles Foundation Discussion Papers 1307, Cowles Foundation, Yale University. [Downloadable!]
    Other versions:
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  17. William N. Goetzmann & Massimo Massa, 2000. "Daily Momentum and Contrarian Behavior of Index Fund Investors," NBER Working Papers 7567, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  18. Nicholas Barberis & Andrei Shleifer & Robert W. Vishny, 1997. "A Model of Investor Sentiment," NBER Working Papers 5926, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  19. Terrance Odean., 1996. "Volume, Volatility, Price and Profit When All Trader Are Above Average," Research Program in Finance Working Papers RPF-266, University of California at Berkeley. [Downloadable!]
  20. Nam, Jouahn & Wang, Jun & Zhang, Ge, 2004. "Strategic trading against retail investors with disposition effects," Working Papers 2004-11, University of New Orleans, Department of Economics and Finance. [Downloadable!]
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    Other versions:
  22. JOSHUA D. COVAL & David Hirshleifer & TYLER G. SHUMWAY, 2004. "Can Individual Investors Beat the Market?," Finance 0412005, EconWPA. [Downloadable!]
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