Advanced Search
MyIDEAS: Login to save this paper or follow this series

Volume, Volatility, Price and Profit When All Traders Are Above Average

Contents:

Author Info

  • Terrance Odean

    (Haas School of Business, University of California, Berkeley)

Registered author(s):

    Abstract

    Psychological studies establish that people are usually overconfident and that they systematically overweight some types of information while underweighting others. How overconfidence affects a financial market depends on who in the market is overconfident and on how information is distributed. This paper examines markets in which price-taking traders, a strategic-trading insider, and risk-averse market-makers are overconfident. It also analyzes the effects of overconfidence when information is costly. In all scenarios, overconfidence increases expected trading volume and market depth while lowering the expected utility of those who are overconfident. However, its effect on volatility and price quality depend on who is overconfident. Overconfident traders can cause markets to underreact to the information of rational traders. Markets also underreact to abstract, statistical, or highly relevant information, while they overreact to salient, anecdotal, or less relevant information.

    Download Info

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
    File URL: http://128.118.178.162/eps/fin/papers/9803/9803001.pdf
    Download Restriction: no

    File URL: http://128.118.178.162/eps/fin/papers/9803/9803001.ps.gz
    Download Restriction: no

    Bibliographic Info

    Paper provided by EconWPA in its series Finance with number 9803001.

    as in new window
    Length: 49 pages
    Date of creation: 12 Mar 1998
    Date of revision:
    Handle: RePEc:wpa:wuwpfi:9803001

    Note: 49 pages, including table and figures. Revised copy of text, Submitted as postscript.
    Contact details of provider:
    Web page: http://128.118.178.162

    Related research

    Keywords:

    Find related papers by JEL classification:

    References

    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.:
    as in new window
    1. Terry A. Marsh and Robert C. Merton., 1986. "Dividend Behavior for the Aggregate Stock Market," Research Program in Finance Working Papers 163, University of California at Berkeley.
    2. Robert J. Shiller, 1980. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," NBER Working Papers 0456, National Bureau of Economic Research, Inc.
    3. Nicholas Barberis & Andrei Shleifer & Robert W. Vishny, 1997. "A Model of Investor Sentiment," NBER Working Papers 5926, National Bureau of Economic Research, Inc.
    4. Cooper, Arnold C. & Woo, Carolyn Y. & Dunkelberg, William C., 1988. "Entrepreneurs' perceived chances for success," Journal of Business Venturing, Elsevier, vol. 3(2), pages 97-108.
    5. Leland, Hayne E, 1985. " Option Pricing and Replication with Transactions Costs," Journal of Finance, American Finance Association, vol. 40(5), pages 1283-1301, December.
    6. Jaffe, Jeffrey F & Winkler, Robert L, 1976. "Optimal Speculation against an Efficient Market," Journal of Finance, American Finance Association, vol. 31(1), pages 49-61, March.
    7. Ikenberry, David & Lakonishok, Josef & Vermaelen, Theo, 1995. "Market underreaction to open market share repurchases," Journal of Financial Economics, Elsevier, vol. 39(2-3), pages 181-208.
    8. Gervais, Simon & Odean, Terrance, 2001. "Learning to be Overconfident," Review of Financial Studies, Society for Financial Studies, vol. 14(1), pages 1-27.
    9. Grinblatt, Mark & Titman, Sheridan, 1993. "Performance Measurement without Benchmarks: An Examination of Mutual Fund Returns," The Journal of Business, University of Chicago Press, vol. 66(1), pages 47-68, January.
    10. Harris, Milton & Raviv, Artur, 1993. "Differences of Opinion Make a Horse Race," Review of Financial Studies, Society for Financial Studies, vol. 6(3), pages 473-506.
    11. Lowenstein, George & Prelec, Drazen, 1991. "Negative Time Preference," American Economic Review, American Economic Association, vol. 81(2), pages 347-52, May.
    12. Loewenstein, George & Thaler, Richard H, 1989. "Intertemporal Choice," Journal of Economic Perspectives, American Economic Association, vol. 3(4), pages 181-93, Fall.
    13. Karpoff, Jonathan M, 1986. " A Theory of Trading Volume," Journal of Finance, American Finance Association, vol. 41(5), pages 1069-87, December.
    14. Takatoshi Ito, 1988. "Foreign Exchange Rate Expectations: Micro Survey Data," NBER Working Papers 2679, National Bureau of Economic Research, Inc.
    15. Bernard, Victor L. & Thomas, Jacob K., 1990. "Evidence that stock prices do not fully reflect the implications of current earnings for future earnings," Journal of Accounting and Economics, Elsevier, vol. 13(4), pages 305-340, December.
    16. Lakonishok, Joseph & Shleifer, Andrei & Vishny, Robert W., 1992. "The Structure and Performance of the Money Management Industry," Scholarly Articles 10498059, Harvard University Department of Economics.
    17. Grether, David M, 1980. "Bayes Rule as a Descriptive Model: The Representativeness Heuristic," The Quarterly Journal of Economics, MIT Press, vol. 95(3), pages 537-57, November.
    18. Womack, Kent L, 1996. " Do Brokerage Analysts' Recommendations Have Investment Value?," Journal of Finance, American Finance Association, vol. 51(1), pages 137-67, March.
    19. Arrow, Kenneth J, 1986. "Rationality of Self and Others in an Economic System," The Journal of Business, University of Chicago Press, vol. 59(4), pages S385-99, October.
    20. Jegadeesh, Narasimhan & Titman, Sheridan, 1993. " Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency," Journal of Finance, American Finance Association, vol. 48(1), pages 65-91, March.
    21. Sanford J Grossman & Joseph E Stiglitz, 1997. "On the Impossibility of Informationally Efficient Markets," Levine's Working Paper Archive 1908, David K. Levine.
    22. Kandel, Eugene & Pearson, Neil D, 1995. "Differential Interpretation of Public Signals and Trade in Speculative Markets," Journal of Political Economy, University of Chicago Press, vol. 103(4), pages 831-72, August.
    23. Bagwell, Laurie Simon, 1992. " Dutch Auction Repurchases: An Analysis of Shareholder Heterogeneity," Journal of Finance, American Finance Association, vol. 47(1), pages 71-105, March.
    24. Diamond, Douglas W. & Verrecchia, Robert E., 1981. "Information aggregation in a noisy rational expectations economy," Journal of Financial Economics, Elsevier, vol. 9(3), pages 221-235, September.
    25. Roll, Richard, 1986. "The Hubris Hypothesis of Corporate Takeovers," The Journal of Business, University of Chicago Press, vol. 59(2), pages 197-216, April.
    26. Lakonishok, Josef & Vermaelen, Theo, 1990. " Anomalous Price Behavior around Repurchase Tender Offers," Journal of Finance, American Finance Association, vol. 45(2), pages 455-77, June.
    27. De Long, J. Bradford & Shleifer, Andrei & Summers, Lawrence H. & Waldmann, Robert J., 1990. "Noise Trader Risk in Financial Markets," Scholarly Articles 3725552, Harvard University Department of Economics.
    28. Dowie, Jack A, 1976. "On the Efficiency and Equity of Betting Markets," Economica, London School of Economics and Political Science, vol. 43(17), pages 139-50, May.
    29. Keren, Gideon, 1987. "Facing uncertainty in the game of bridge: A calibration study," Organizational Behavior and Human Decision Processes, Elsevier, vol. 39(1), pages 98-114, February.
    30. George M. Constantinides, 1979. "Multiperiod Consumption and Investment Behavior with Convex Transactions Costs," Management Science, INFORMS, vol. 25(11), pages 1127-1137, November.
    31. Grinblatt, Mark & Titman, Sheridan, 1994. "A Study of Monthly Mutual Fund Returns and Performance Evaluation Techniques," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 29(03), pages 419-444, September.
    32. Marsh, Terry A & Merton, Robert C, 1986. "Dividend Variability and Variance Bounds Tests for the Rationality ofStock Market Prices," American Economic Review, American Economic Association, vol. 76(3), pages 483-98, June.
    33. Shefrin, Hersh & Statman, Meir, 1994. "Behavioral Capital Asset Pricing Theory," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 29(03), pages 323-349, September.
    34. Demski, Joel S. & Feltham, Gerald A., 1994. "Market response to financial reports," Journal of Accounting and Economics, Elsevier, vol. 17(1-2), pages 3-40, January.
    35. Hellwig, Martin F., 1980. "On the aggregation of information in competitive markets," Journal of Economic Theory, Elsevier, vol. 22(3), pages 477-498, June.
    36. Ritter, Jay R, 1991. " The Long-run Performance of Initial Public Offerings," Journal of Finance, American Finance Association, vol. 46(1), pages 3-27, March.
    37. Loughran, Tim & Ritter, Jay R, 1995. " The New Issues Puzzle," Journal of Finance, American Finance Association, vol. 50(1), pages 23-51, March.
    38. Donald B. Hausch & William T. Ziemba & Mark Rubinstein, 1981. "Efficiency of the Market for Racetrack Betting," Management Science, INFORMS, vol. 27(12), pages 1435-1452, December.
    39. De Bondt, Werner F M & Thaler, Richard H, 1987. " Further Evidence on Investor Overreaction and Stock Market Seasonalit y," Journal of Finance, American Finance Association, vol. 42(3), pages 557-81, July.
    40. Pontiff, Jeffrey, 1997. "Excess Volatility and Closed-End Funds," American Economic Review, American Economic Association, vol. 87(1), pages 155-69, March.
    41. Hirshleifer, David & Subrahmanyam, Avanidhar & Titman, Sheridan, 1994. " Security Analysis and Trading Patterns When Some Investors Receive Information before Others," Journal of Finance, American Finance Association, vol. 49(5), pages 1665-98, December.
    42. Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, vol. 47(2), pages 263-91, March.
    43. Shefrin, Hersh & Statman, Meir, 1985. " The Disposition to Sell Winners Too Early and Ride Losers Too Long: Theory and Evidence," Journal of Finance, American Finance Association, vol. 40(3), pages 777-90, July.
    44. Terrance Odean., 1996. "Are Investors Reluctant to Realize Their Losses?," Research Program in Finance Working Papers RPF-269, University of California at Berkeley.
    45. Carhart, Mark M, 1997. " On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March.
    46. KENT D. DANIEL & David Hirshleifer & AVANIDHAR SUBRAHMANYAM, 2004. "A Theory of Overconfidence, Self-Attribution, and Security Market Under- and Over-reactions," Finance 0412006, EconWPA.
    47. Avraham Beja., 1976. "The Limited Information Efficiency of Market Processes," Research Program in Finance Working Papers 43, University of California at Berkeley.
    48. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
    49. Jegadeesh, Narasimhan, 1990. " Evidence of Predictable Behavior of Security Returns," Journal of Finance, American Finance Association, vol. 45(3), pages 881-98, July.
    50. Kleidon, Allan W, 1986. "Variance Bounds Tests and Stock Price Valuation Models," Journal of Political Economy, University of Chicago Press, vol. 94(5), pages 953-1001, October.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as in new window

    Cited by:
    This item has more than 25 citations. To prevent cluttering this page, these citations are listed on a separate page.

    Lists

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    Statistics

    Access and download statistics

    Corrections

    When requesting a correction, please mention this item's handle: RePEc:wpa:wuwpfi:9803001. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (EconWPA).

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.