Overconfidence, Under-Reaction, and Warren Buffett’s Investments

Abstract

Warren Buffett is a long-term investor, but is required by law to disclose his trades on a quarterly basis. The market seems to under-react to the revelation of his trades. From 1980 to 2006, it has been possible to achieve investment results similar to Buffett’s own simply by following his trades disclosed by Berkshire Hathaway. We consider overconfidence by sophisticated market participants as a contributing factor to the apparent under reaction to information contained in public disclosures of changes in Berkshire Hathaway’s holdings of stocks. Net sales of corporate insiders of stocks held by Berkshire Hathaway tend to decrease when those holdings increase consistent with shared private information. However, financial analysts’ recommendations tend to downgrade and institutions tend to sell at those times. This behavior by analysts and fund managers is consistent with pejorative experts displaying overconfidence by over estimating their stock picking abilities or precision of their independent private information and, as a consequence, underweighting public information in making their decisions.

Keywords: Warren Buffett, Behavioral Finance, Under-reaction, Analyst, Institutional Investors, Insiders

JEL Classification: G11, G12, M40