SSRN-A Theory of Overconfidence, Self-Attribution, and Security Market Under- and Over-reactions by Kent Daniel, David Hirshleifer, Avanidhar Subrahmanyam

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A Theory of Overconfidence, Self-Attribution, and Security Market Under- and Over-reactions

KENT D. DANIEL
QS; National Bureau of Economic Research (NBER); Northwestern University - Kellogg School of Management
DAVID A. HIRSHLEIFER
University of California, Irvine - Paul Merage School of Business
AVANIDHAR SUBRAHMANYAM
University of California, Los Angeles - Finance Area

February 19, 1997

Abstract:
We propose a theory based on investor overconfidence and biased self-attribution to explain several of the securities returns patterns that seem anomalous from the perspective of efficient markets with rational investors. The theory is based on two premises derived from evidence in psychological studies. The first is that individuals are overconfident about their ability to evaluate securities, in the sense that they overestimate the precision of their private information signals. The second is that investors' confidence changes in a biased fashion as a function of their decision outcomes. The first premise implies overreaction to private information arrival and underreaction to public information arrival. This is consistent with (1) post-corporate event and post-earnings announcement stock price 'drift', (2) negative long-lag autocorrelations (long-run 'overreaction'), and (3) excess volatility of asset prices. Adding the second premise leads to (4) positive short-lag autocorrelations ('momentum'), and (5) short-run post-earnings announcement 'drift,' and negative correlation between future stock returns and long-term measures of past accounting performance. The model also offers several untested empirical implications and implications for corporate financial policy.

JEL Classifications: G12, G14, G30

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Suggested Citation

Daniel, Kent D., Hirshleifer, David A. and Subrahmanyam, Avanidhar, "A Theory of Overconfidence, Self-Attribution, and Security Market Under- and Over-reactions" (February 19, 1997). Available at SSRN: http://ssrn.com/abstract=2017 or DOI: 10.2139/ssrn.2017

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Contact Information for KENT D. DANIEL (Contact Author) Email address for KENT D. DANIEL QS 32 Old Slip 24th Floor New York , NY 10005 United States 212-855-9120 (Phone)
(No e-mail address available for KENT D. DANIEL National Bureau of Economic Research (NBER) 1050 Massachusetts Avenue Cambridge , MA 02138 United States
Email address for KENT D. DANIEL Northwestern University - Kellogg School of Management 2001 Sheridan Road Evanston , IL 60208 United States 847-491-4113 (Phone) 847-491-5719 (Fax)
Contact Information for DAVID A. HIRSHLEIFER Email address for DAVID A. HIRSHLEIFER University of California, Irvine - Paul Merage School of Business Irvine , CA 92697 United States
Contact Information for AVANIDHAR SUBRAHMANYAM Email address for AVANIDHAR SUBRAHMANYAM University of California, Los Angeles - Finance Area Los Angeles , CA 90095-1481 United States 310-825-5355 (Phone) 310-206-5455 (Fax)

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