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Investment Strategy and Selection Bias: An Equilibrium Perspective on Overoptimism

Author

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  • Philippe Jehiel

    (PSE - Paris School of Economics - UP1 - Université Paris 1 Panthéon-Sorbonne - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris sciences et lettres - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement, PJSE - Paris Jourdan Sciences Economiques - UP1 - Université Paris 1 Panthéon-Sorbonne - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris sciences et lettres - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement)

Abstract

Investors implement projects based on idiosyncratic signal observations, without knowing how signals and returns are jointly distributed. The following heuristic is studied: investors collect information on previously implemented projects with the same signal realization and invest if the associated mean return exceeds the cost. The corresponding steady states result in suboptimal investments, due to selection bias and the heterogeneity of signals across investors. When higher signals are associated with higher returns, investors are overoptimistic, resulting in overinvestment. Rational investors increase the overoptimism of sampling investors, thereby illustrating a negative externality imposed by rational investors.

Suggested Citation

  • Philippe Jehiel, 2018. "Investment Strategy and Selection Bias: An Equilibrium Perspective on Overoptimism," Post-Print halshs-01884380, HAL.
    • Handle: RePEc:hal:journl:halshs-01884380
    DOI: 10.1257/aer.20161696
    Note: View the original document on HAL open archive server: https://shs.hal.science/halshs-01884380
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • L26 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Entrepreneurship
    • M13 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Administration - - - New Firms; Startups

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