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Learning To Be Overconfident

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  • Simon Gervais
  • Terrance Odean

Abstract

We develop a multiperiod market model describing both the process by which traders learn about their ability and how a bias in this learning can create overconfident traders. A trader in our model initially does not know his own ability. He infers this ability from his successes and failures. In assessing his ability the trader takes too much credit for his successes. This leads him to become overconfident. A trader's expected level of overconfidence increases in the early stages of his career. Then, with more experience, he comes to better recognize his own ability. The patterns in trading volume, expected profits, price volatility, and expected prices resulting from this endogenous overconfidence are analyzed. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.
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Suggested Citation

  • Simon Gervais & Terrance Odean, "undated". "Learning To Be Overconfident," Rodney L. White Center for Financial Research Working Papers 05-97, Wharton School Rodney L. White Center for Financial Research.
    • Handle: RePEc:fth:pennfi:05-97
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