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Overconfidence and Market Efficiency with Heterogeneous Agents

  • Diego García

    ()

  • Francesco Sangiorgi

    ()

  • Branko Urošević

    ()

We study financial markets in which both rational and overconfident agents coexist and make endogenous information acquisition decisions. We demonstrate the following irrelevance result: when a positive fraction of rational agents (endogeneously) decides to become informed in equilibrium, prices are set as if all investors were rational, and as a consequence the overconfidence bias does not a ect informational efficiency, price volatility, rational traders’ expected profits or their welfare. Intuitively, as overconfidence goes up, so does price infornativeness, which makes rational agents cut their information acquisition activities, effectively undoing the standard effect of more aggressive trading by the overconfident.

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File URL: http://hdl.handle.net/10.1007/s00199-005-0048-4
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Article provided by Springer & Society for the Advancement of Economic Theory (SAET) in its journal Economic Theory.

Volume (Year): 30 (2007)
Issue (Month): 2 (February)
Pages: 313-336

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Handle: RePEc:spr:joecth:v:30:y:2007:i:2:p:313-336
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