Biased Beliefs, Asset Prices, and Investment: A Structural Approach
University of Texas at Austin - Department of Finance
Paul C. Tetlock
Columbia Business School - Finance and Economics
Journal of Finance, Forthcoming
We structurally estimate a model in which agents' information processing biases can cause predictability in firms’ asset returns and investment inefficiencies. We generalize the neoclassical investment model by allowing for two biases -- overconfidence and over-extrapolation of trends -- that distort agents' expectations of firm productivity. Our model’s predictions closely match empirical data on asset pricing and firm behavior. The estimated bias parameters are well-identified and exhibit plausible magnitudes. Alternative models without either bias or with efficient investment fail to match observed return predictability and firm behavior. These results suggest that biases affect firm behavior, which in turn affects return anomalies.
Number of Pages in PDF File: 59
Keywords: mispricing, market efficiency, behavioral biases, overconfidence, extrapolation, investment efficiency
JEL Classification: G10, G12, G30
Date posted: May 12, 2011 ; Last revised: October 31, 2013
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