Investor Psychology and Security Market Under‐ and Overreactions

Abstract

We propose a theory of securities market under-and overreactions based on two well-known psychological biases: investor overconfidence about the precision of private information; and biased self-attribution, which causes asymmetric shifts in investors' confidence as a function of their investment outcomes. We show that overconfidence implies negative long-lag autocorrelations, excess volatility, and, when managerial actions are correlated with stock mispricing, public-event-based return predictability. Biased self-attribution adds positive short-lag autocorrelations ("momentum"), short-run earnings "drift," but negative correlation between future returns and long-term past stock market and accounting performrance. The theory also offers several untested implications and implications for corporate financial policy. IN RECENT YEARS

Stock Market Integration, Return Forecastability and Implications for Market Efficiency: A Panel Study

“…In an efficient markets explanation, revealing the expected returns pattern should make no difference for the future path of expected returns; in a quasi-rational view such as the overreaction hypothesis represents, an explicit choice-theoretic basis is needed to predict public reaction to the uncovered profit opportunities. The work by Barberis, Shleifer, and Vishny (1998), Daniel, Hirshleifer, and Subrahmanyam (1998), and Hong and Stein (1999 has already made important strides in that direction. J=3,6,9,12; K=3,6,9,12) are the combinations of J and K originally examined by Jegadeesh and Titman (1993) for U.S. stock data.…”

Explanations of Asset Price Bubbles

“…Daniel et al (1998) explain asset price bubbles with the combination of overconfidence and biased self-attribution. The essence of overconfidence in the model is that investors regard their private information concerning the fundamental value of the asset to be more accurate than it actually is; biased self-attribution means that investors attribute past successes to themselves and failures to outside factors.…”

Empirical study on conservative and representative heuristics of Hong Kong small investors adopting momentum and contrarian trading strategies

“…On the other hand, Daniel, et al (1998) argue that the market will experience short-term underreaction and long term overreaction if some investors are overconfident.…”