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Overconfidence and market efficiency with heterogeneous agents

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  • Diego Garcia
  • Francesco Sangiorgi
  • Branko Urosevic

Abstract

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.

Suggested Citation

  • Diego Garcia & Francesco Sangiorgi & Branko Urosevic, 2004. "Overconfidence and market efficiency with heterogeneous agents," Economics Working Papers 786, Department of Economics and Business, Universitat Pompeu Fabra.
    • Handle: RePEc:upf:upfgen:786
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Ko, K. Jeremy & (James) Huang, Zhijian, 2007. "Arrogance can be a virtue: Overconfidence, information acquisition, and market efficiency," Journal of Financial Economics, Elsevier, vol. 84(2), pages 529-560, May.
    2. Zhou, Deqing, 2013. "Irrational confidence, imperfect and long-lived information," International Review of Economics & Finance, Elsevier, vol. 27(C), pages 383-405.
    3. M. Middeldorp & S. Rosenkranz, 2008. "Information acquisition in an experimental asset market," Working Papers 08-25, Utrecht School of Economics.
    4. Benoît, Jean-Pierre & Dubra, Juan, 2007. "Overconfidence?," MPRA Paper 6017, University Library of Munich, Germany, revised Nov 2007.
    5. Jean‐Pierre Benoît & Juan Dubra, 2011. "Apparent Overconfidence," Econometrica, Econometric Society, vol. 79(5), pages 1591-1625, September.
    6. Juan Dubra & Jean-Pierre Benoit, 2011. "Apparent Overconfidence," Documentos de Trabajo/Working Papers 1106, Facultad de Ciencias Empresariales y Economia. Universidad de Montevideo..
    7. Blancheton, Bertrand & Jégourel, Yves, 2009. "Les fonds souverains : un nouveau mode de régulation du capitalisme financier ?," Revue de la Régulation - Capitalisme, institutions, pouvoirs, Association Recherche et Régulation, vol. 5.
    8. Rietveld, C.A. & Groenen, P.J.F. & Koellinger, Ph.D. & van der Loos, M.J.H.M. & Thurik, A.R., 2013. "Living Forever: Entrepreneurial Overconfidence at Older Ages," ERIM Report Series Research in Management ERS-2013-012-STR, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam.
    9. Jean-Pierre Benoit & Juan Dubra & Don Moore, 2013. "Does the better –than- average effect show that people are Overconfident?: two experiments," Documentos de Trabajo/Working Papers 1301, Facultad de Ciencias Empresariales y Economia. Universidad de Montevideo..
    10. Jean-Pierre Benoît & Juan Dubra & Don A. Moore, 2015. "Does The Better-Than-Average Effect Show That People Are Overconfident?: Two Experiments," Journal of the European Economic Association, European Economic Association, vol. 13(2), pages 293-329, April.
    11. Luca Rigotti & Matthew Ryan & Rhema Vaithianathan, 2011. "Optimism and firm formation," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 46(1), pages 1-38, January.
    12. Bertrand BLANCHETON (GREThA UMR CNRS 5113) & Yves JEGOUREL (LAREFI), 2009. "Sovereign wealth funds: toward a new state capitalism? (In French)," Cahiers du GREThA 2009-04, Groupe de Recherche en Economie Théorique et Appliquée.
    13. Alan Schwartz, 2008. "How Much Irrationality Does the Market Permit?," The Journal of Legal Studies, University of Chicago Press, vol. 37(1), pages 131-159, January.
    14. Benoît, Jean-Pierre & Dubra, Juan & Moore, Don, 2009. "Does the Better-Than-Average Effect Show That People Are Overconfident?: An Experiment," MPRA Paper 13168, University Library of Munich, Germany.

    More about this item

    Keywords

    Partially revealing equilibria; overconfidence; rational expectations; information;

    JEL classification:

    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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