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Paper Stats:
Abstract Views: 2994
Downloads: 84
Download Rank: 52833
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Market Efficiency in an Irrational World
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KENT D. DANIEL
QS; National Bureau of Economic Research (NBER); Northwestern University - Kellogg School of Management
SHERIDAN TITMAN
University of Texas at Austin - Department of Finance; National Bureau of Economic Research (NBER)
January 2000
NBER Working Paper No. W7489
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Abstract:
This paper explains why investors are likely to be overconfident and how this behavioral bias affects investment decisions. Our analysis suggests that investor overconfidence can potentially generate stock return momentum and that this momentum effect is likely to be the strongest in those stocks whose valuation requires the interpretation of ambiguous information. Consistent with this, we find that momentum effects are stronger for growth stocks than value stocks. A portfolio strategy based on this hypothesis generates strong abnormal returns that do not appear to be attributable to risk. Although these results violate the traditional efficient markets hypothesis, they do not necessarily imply that rational but uniformed investors, without the benefit of hindsight, could have actually achieved the returns. We argue that to examine whether unexploited profit opportunities exist, one must test for what we call adaptive-efficiency, which is a somewhat weaker form of market efficiency that allows for the appearance of profit opportunities in historical data, but requires these profit opportunities to dissipate when they become apparent. Our tests reject this notion of adaptive-efficiency.
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JEL Classifications: G1
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Working Paper Series
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Suggested Citation
Daniel, Kent D. and Titman, Sheridan , "Market Efficiency in an Irrational World"
(January 2000).
NBER Working Paper No. W7489. Available at SSRN: http://ssrn.com/abstract=207708
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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)
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(No e-mail address available for KENT
D.
DANIEL
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge
, MA
02138
United States
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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)
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Contact Information for
SHERIDAN
TITMAN
Email address for SHERIDAN
TITMAN
University of Texas at Austin - Department of Finance
Red McCombs School of Business
Austin
, TX
78712
United States
512-232-2787 (Phone)
512-471-5073 (Fax)
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(No e-mail address available for SHERIDAN
TITMAN
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge
, MA
02138
United States
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