Investor Psychology and Security Market Under- and Over-Reactions
Kent D. Daniel
Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)
David A. Hirshleifer
University of California, Irvine - Paul Merage School of Business
University of California, Los Angeles (UCLA) - Finance Area
THE INTERNATIONAL LIBRARY OF CRITICAL WRITINGS IN FINANCIAL ECONOMICS, Hersh Shefrin, ed., Edward Elgar Publishers, 2002
Journal of Finance, Vol. 53, No. 6, pp. 1839-1885, December 1998
ADVANCES IN BEHAVIORAL FINANCE II, Richard Thaler, ed., Princeton, 2002
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 performance. The theory also offers several untested implications and implications for corporate financial policy.
Accepted Paper Series
Date posted: December 1, 2008
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