Overconfidence and Correlated Information Structures

This paper analyses overconfident strategic traders whose private information involves correlated errors. The analysis on the effects of two types of overconfidence—overconfidence in own signals and underconfidence in others’ signals—provides richer implications than our typical understanding of overconfidence as follows. First, trading volume decreases (increases) with underconfidence in others’ signals (overconfidence in own signals). Second, whereas overconfidence in own signals can explain large trading volume more easily, underconfidence in others’ signals may cause trading volume and price informativeness to decrease with the number of traders. Third, overconfidence in own signals can lead to equilibrium multiplicity in information acquisition.