Underreactions and Overreactions: The Influence of Information Reliability and Portfolio Formation Rules

50 Pages Posted: 18 Oct 1998

See all articles by Robert J. Bloomfield

Robert J. Bloomfield

Cornell University - Samuel Curtis Johnson Graduate School of Management

Robert Libby

Cornell University - Samuel Curtis Johnson Graduate School of Management

Mark W. Nelson

Cornell University - Samuel Curtis Johnson Graduate School of Management

Date Written: September 24, 1998

Abstract

This paper shows that whether laboratory markets over- or under-react to information is influenced by two factors: the reliability of investors' information and the portfolio formation rule used to identify price anomalies. Consistent with research in psychology, prices tend to over-react to unreliable information and under-react to highly reliable information, because investors' confidence in their information is moderated toward a central level. Forming portfolios on the basis of price changes tends to yield larger apparent overreactions than forming portfolios on the basis of information that is independent of market price, because market prices include mean-reverting random errors (in addition to systematic price errors due to moderated confidence). These results can help empirical researchers develop specific alternative hypotheses to market efficiency, by helping them predict ex ante whether a given research study is likely to reveal over- or underreactions.

JEL Classification: G12, C92

Suggested Citation

Bloomfield, Robert J. and Libby, Robert and Nelson, Mark W., Underreactions and Overreactions: The Influence of Information Reliability and Portfolio Formation Rules (September 24, 1998). Available at SSRN: https://ssrn.com/abstract=132168 or http://dx.doi.org/10.2139/ssrn.132168

Robert J. Bloomfield (Contact Author)

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

450 Sage Hall
Ithaca, NY 14853
United States
607-255-9407 (Phone)
607-254-4590 (Fax)

Robert Libby

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States
607-255-3348 (Phone)
607-254-4590 (Fax)

Mark W. Nelson

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

448 Sage Hall
Ithaca, NY 14853
United States
607-255-6323 (Phone)
607-254-4590 (Fax)

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