Abstract

https://ssrn.com/abstract=207708
 
 

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Market Efficiency in an Irrational World


Kent D. Daniel


Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

Sheridan Titman


University of Texas at Austin - Department of Finance; National Bureau of Economic Research (NBER)

January 2000

NBER Working Paper No. w7489

Abstract:     
This paper explains why investors are likely to be overconfident and how this behavioral bias affects investment decisions. Our analysis suggests that investor overconfidence can potentially generate stock return momentum and that this momentum effect is likely to be the strongest in those stocks whose valuation requires the interpretation of ambiguous information. Consistent with this, we find that momentum effects are stronger for growth stocks than value stocks. A portfolio strategy based on this hypothesis generates strong abnormal returns that do not appear to be attributable to risk. Although these results violate the traditional efficient markets hypothesis, they do not necessarily imply that rational but uniformed investors, without the benefit of hindsight, could have actually achieved the returns. We argue that to examine whether unexploited profit opportunities exist, one must test for what we call adaptive-efficiency, which is a somewhat weaker form of market efficiency that allows for the appearance of profit opportunities in historical data, but requires these profit opportunities to dissipate when they become apparent. Our tests reject this notion of adaptive-efficiency.

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Date posted: May 6, 2000  

Suggested Citation

Daniel, Kent D. and Titman, Sheridan, Market Efficiency in an Irrational World (January 2000). NBER Working Paper No. w7489. Available at SSRN: https://ssrn.com/abstract=207708

Contact Information

Kent D. Daniel (Contact Author)
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://www.columbia.edu/~kd2371/

National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Sheridan Titman
University of Texas at Austin - Department of Finance ( email )
Red McCombs School of Business
Austin, TX 78712
United States
512-232-2787 (Phone)
512-471-5073 (Fax)

National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
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