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Investor Psychology and Security Market Under- and Overreactions

Author

Listed:
  • Kent Daniel

    (Northwestern University and NBER,)

  • David Hirshleifer

    (University of Michigan, Ann Arbor,)

  • Avanidhar Subrahmanyam

    (University of California at Los Angeles)

Abstract

We propose a theory of securities market under- and overreactions based on two well-known psychological biases: investor overconfidence about the precision of private information; and biased self-attribution, which causes asymmetric shifts in investors' confidence as a function of their investment outcomes. We show that overconfidence implies negative long-lag autocorrelations, excess volatility, and, when managerial actions are correlated with stock mispricing, public-event-based return predictability. Biased self-attribution adds positive short-lag autocorrelations ("momentum"), short-run earnings "drift," but negative correlation between future returns and long-term past stock market and accounting performance. The theory also offers several untested implications and implications for corporate financial policy. Copyright The American Finance Association 1998.

Suggested Citation

  • Kent Daniel & David Hirshleifer & Avanidhar Subrahmanyam, 1998. "Investor Psychology and Security Market Under- and Overreactions," Journal of Finance, American Finance Association, vol. 53(6), pages 1839-1885, December.
  • Handle: RePEc:bla:jfinan:v:53:y:1998:i:6:p:1839-1885
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