A Tale of Two Investors: Estimating Optimism and Overconfidence

50 Pages Posted: 2 Sep 2013

See all articles by Giovanni Barone-Adesi

Giovanni Barone-Adesi

University of Lugano; Swiss Finance Institute

Loriano Mancini

USI Lugano - Institute of Finance; Swiss Finance Institute

Hersh Shefrin

Santa Clara University - Leavey School of Business

Date Written: July 18, 2013

Abstract

We estimate investors’ sentiment from option and stock prices by anchoring objective beliefs to a neoclassical pricing kernel. Our estimates of sentiment correlate well with other sentiment measures such as the Baker–Wurgler index, the Yale/Shiller crash confidence index and the Duke/CFO survey responses, and yet contain additional information. Our analysis points out three significant issues related to overconfidence. First, the Baker–Wurgler index strongly reflects excessive optimism but not overconfidence. Second, overconfidence drives the pricing kernel puzzle. Third, the dynamics of optimism and overconfidence generate a perceived negative risk-return relationship, while objectively the relationship is positive. Optimism and overconfidence about market returns co-move together, inflating asset prices in good times and exacerbating market crashes in bad times.

Keywords: Sentiment, Pricing Kernel, Optimism, Overconfidence

JEL Classification: G02, G12

Suggested Citation

Barone-Adesi, Giovanni and Mancini, Loriano and Shefrin, Hersh, A Tale of Two Investors: Estimating Optimism and Overconfidence (July 18, 2013). 26th Australasian Finance and Banking Conference 2013. Available at SSRN: https://ssrn.com/abstract=2319260 or http://dx.doi.org/10.2139/ssrn.2319260

Giovanni Barone-Adesi (Contact Author)

University of Lugano ( email )

Via Buffi 13
CH-6904 Lugano
Switzerland
+41 58 666 4671 (Phone)
+41 58 666 46 47 (Fax)

Swiss Finance Institute

c/o University of Geneva
40 Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Loriano Mancini

USI Lugano - Institute of Finance ( email )

Via Giuseppe Buffi 6
6904 Lugano, CH-6904
Switzerland
+41 (0)91 912 46 47 (Fax)

HOME PAGE: http://www.people.usi.ch/mancil/

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Hersh Shefrin

Santa Clara University - Leavey School of Business ( email )

Dept. of Finance
Santa Clara, CA 95053
United States
408-554-6893 (Phone)
408-554-4029 (Fax)

Register to save articles to
your library

Register

Paper statistics

Downloads
396
Abstract Views
1,419
rank
74,276
PlumX Metrics