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Overconfidence and market efficiency with heterogeneous agents

  • Diego Garcia
  • Francesco Sangiorgi
  • Branko Urosevic

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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Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 786.

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Date of creation: Oct 2004
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Handle: RePEc:upf:upfgen:786
Contact details of provider: Web page: http://www.econ.upf.edu/

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  1. Diamond, Douglas W, 1985. " Optimal Release of Information by Firms," Journal of Finance, American Finance Association, vol. 40(4), pages 1071-94, September.
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  4. Simon Gervais & Terrance Odean, . "Learning To Be Overconfident," Rodney L. White Center for Financial Research Working Papers 5-97, Wharton School Rodney L. White Center for Financial Research.
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  8. Verrecchia, Robert E, 1982. "Information Acquisition in a Noisy Rational Expectations Economy," Econometrica, Econometric Society, vol. 50(6), pages 1415-30, November.
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  11. Benos, Alexandros V., 1998. "Aggressiveness and survival of overconfident traders," Journal of Financial Markets, Elsevier, vol. 1(3-4), pages 353-383, September.
  12. Andrei Shleifer & Robert W. Vishny, 1995. "The Limits of Arbitrage," NBER Working Papers 5167, National Bureau of Economic Research, Inc.
  13. KENT D. DANIEL & David Hirshleifer & AVANIDHAR SUBRAHMANYAM, 2004. "A Theory of Overconfidence, Self-Attribution, and Security Market Under- and Over-reactions," Finance 0412006, EconWPA.
  14. Shleifer, Andrei, 2000. "Inefficient Markets: An Introduction to Behavioral Finance," OUP Catalogue, Oxford University Press, number 9780198292272, March.
  15. J. Bradford De Long & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann,, . "The Survival of Noise Traders in Financial Markets," J. Bradford De Long's Working Papers _123, University of California at Berkeley, Economics Department.
  16. Hirshleifer, David & Luo, Guo Ying, 2000. "On the Survival of Overconfident Traders in a Competitive Securities Market," MPRA Paper 15347, University Library of Munich, Germany.
  17. Bernardo, Antonio & Welch, Ivo, 1997. "On the Evolution of Overconfidence and Entrepreneurs," University of California at Los Angeles, Anderson Graduate School of Management qt6668s4pz, Anderson Graduate School of Management, UCLA.
  18. Sanford J Grossman & Joseph E Stiglitz, 1997. "On the Impossibility of Informationally Efficient Markets," Levine's Working Paper Archive 1908, David K. Levine.
  19. Admati, Anat R. & Pfleiderer, Paul, 1987. "Viable allocations of information in financial markets," Journal of Economic Theory, Elsevier, vol. 43(1), pages 76-115, October.
  20. Dubra, J., 1999. "Overconfidence in Search," Working Papers 99-10, C.V. Starr Center for Applied Economics, New York University.
  21. Admati, Anat R. & Pfleiderer, Paul, 1986. "A monopolistic market for information," Journal of Economic Theory, Elsevier, vol. 39(2), pages 400-438, August.
  22. Jordi Caballe & Jozsef Sakovics, 2004. "Speculating against an overconfident market," ESE Discussion Papers 62, Edinburgh School of Economics, University of Edinburgh.
  23. Jose A. Scheinkman & Wei Xiong, 2003. "Overconfidence and Speculative Bubbles," Journal of Political Economy, University of Chicago Press, vol. 111(6), pages 1183-1219, December.
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