Does Society Benefit from Investor Overconfidence in the Ability of Financial Market Experts?

Journal of Economic Behavior and Organization, Vol. 58, pp. 95-116, 2005

22 Pages Posted: 15 Oct 2010

See all articles by Nathan Berg

Nathan Berg

University of Otago, Department of Economics

Donald D. Lien

University of Texas at San Antonio - College of Business - Department of Economics

Date Written: 2005

Abstract

This paper develops a securities market model in which participants’ beliefs diverge and prices are monotonic in beliefs. Relative to rational expectations (i.e., correct and unanimous beliefs), overconfidence among uninformed traders about the precision of experts’ information leads to Pareto-superior equilibria. Efficiency-enhancing departures from rational expectations occur over a dense subset of parameter space, but only for one configuration of beliefs: uninformed traders must be more confident than informed experts. Overconfidence in the form of excessive trust in the predictive ability of experts sets off a virtuous cycle of increased trading that improves liquidity and reduces transaction costs for everyone.

Keywords: Overconfidence, Heterogeneous beliefs, Disagreement, Financial markets, Expert, Trust

JEL Classification: D03, D84, D82, G12, D62

Suggested Citation

Berg, Nathan and Lien, Donald, Does Society Benefit from Investor Overconfidence in the Ability of Financial Market Experts? (2005). Journal of Economic Behavior and Organization, Vol. 58, pp. 95-116, 2005. Available at SSRN: https://ssrn.com/abstract=1691934

Nathan Berg (Contact Author)

University of Otago, Department of Economics ( email )

P.O. Box 56
Dunedin, Otago 9016
New Zealand

Donald Lien

University of Texas at San Antonio - College of Business - Department of Economics ( email )

6900 North Loop 1604 West
San Antonio, TX 78249
United States
210-458-4313 (Phone)
210-458-4308 (Fax)

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