Overconfidence, Investor Sentiment, and Evolution

Abstract

We examine the survival of nonrational investors in an evolutionary game model with a population dynamic for a large economy. The dynamic indicates that the growth rate of wealth accumulation drives the evolutionary process. We focus our analysis on the survival of overconfidence and investor sentiment. We find that underconfidence or pessimism cannot survive, but moderate overconfidence or optimism can survive and even dominate, particularly when the fundamental risk is large. These findings provide new empirical implications for the survivability of active fund management. Our results lend support to the relevance of the psychology of investors in studying financial markets. Journal of Economic Literature Classification Numbers: G10, G14. C 2001 Academic Press

Overconfidence, Compensation Contracts, and Capital Budgeting

“…Our work also complements that of Bernardo and Welch (2001), who provide an evolutionary rationale for the presence of overconfident entrepreneurs in a society, and that of Wang (2001), who shows how overconfident traders can survive in the long run.…”

Overconfidence and Investor Size

“…nurses, engineers, attorneys and market professionals. Moreover, Barber and Odean (2000, 2001) document empirical evidence of some investors being overconfident, and Kyle and Wang (1997), Benos (1998) and Wang (2001) theoretically propose that overconfident investors can survive in a stock market. Overconfidence is furthermore intrinsically intertwined with other observed phenomena in the stock market, of which herding is an excellent example, as described by Hirshleifer and Hong Teoh (2003).…”

“…(1990, 1991), Kyle and Wang (1997), Benos (1998), Daniel et al . (1998), Odean (1998a), Hong and Stein (1999), Gervais and Odean (2001), and Wang (2001) for discussion regarding overconfident investors in financial markets.…”

Predicting Stock Returns and Volatility With Investor Sentiment Indices: A Reconsideration Using a Nonparametric Causality‐in‐quantiles Test

“…These include: (a) levels of discounts on closed‐end funds (Zweig, ; Neal and Wheatley, ; Bathia and Bredin, ); (b) the ratio of odd‐lot (transactions involving less than 100 shares) sales to purchases (Neal and Wheatley, ); (c) net mutual fund redemptions (Neal and Wheatley, ; Beaumont et al ., ; Bathia and Bredin, ); (d) the volatility index (VIX: Simon and Wiggins, ); (e) the put–call ratio (Simon and Wiggins, ; Wang et al. , ; Bathia and Bredin, ); (f) the trading index (TRIN) for Standard & Poor's (S&P) 500 futures returns (Simon and Wiggins, ); (g) stock turnover (Baker and Stein, ); (h) IPO's related measures (Brown and Cliff, ; Baker and Wurgler, ); (i) the share of equity issues in total equity and debt issues (Baker and Wurgler, 2000); (j) the dividend premium (Baker and Wurgler, 2004), and; (k) the traders’ current aggregate positions as well as their extreme historical values (Wang, ).…”