Investor Psychology and Security Market Under- and Over-Reactions

Journal of Finance, Vol. 53, No. 6, pp. 1839-1885, December 1998

THE INTERNATIONAL LIBRARY OF CRITICAL WRITINGS IN FINANCIAL ECONOMICS, Hersh Shefrin, ed., Edward Elgar Publishers, 2002

ADVANCES IN BEHAVIORAL FINANCE II, Richard Thaler, ed., Princeton, 2002

Posted: 1 Dec 2008 Last revised: 15 Aug 2014

See all articles by Kent D. Daniel

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; NBER

Avanidhar Subrahmanyam

University of California, Los Angeles (UCLA) - Finance Area; Institute of Global Finance, UNSW Business School; Financial Research Network (FIRN)

Abstract

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.

Suggested Citation

Daniel, Kent D. and Hirshleifer, David A. and Subrahmanyam, Avanidhar, Investor Psychology and Security Market Under- and Over-Reactions. Journal of Finance, Vol. 53, No. 6, pp. 1839-1885, December 1998 ; THE INTERNATIONAL LIBRARY OF CRITICAL WRITINGS IN FINANCIAL ECONOMICS, Hersh Shefrin, ed., Edward Elgar Publishers, 2002; ADVANCES IN BEHAVIORAL FINANCE II, Richard Thaler, ed., Princeton, 2002. Available at SSRN: https://ssrn.com/abstract=1288967

Kent D. Daniel

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States
212-854-4679 (Phone)
212-854-4679 (Fax)

HOME PAGE: http://kentdaniel.net/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

David A. Hirshleifer (Contact Author)

University of California, Irvine - Paul Merage School of Business ( email )

Irvine, CA California 92697-3125
United States

HOME PAGE: http://sites.uci.edu/dhirshle/

NBER ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Avanidhar Subrahmanyam

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-5355 (Phone)
310-206-5455 (Fax)

Institute of Global Finance, UNSW Business School

Sydney, NSW 2052
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

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