Overconfidence, Information Diffusion, and Mispricing Persistence
97 Pages Posted: 24 Dec 2018 Last revised: 4 Feb 2020
Date Written: January 31, 2020
Short-sale constrained past-winners and losers both underperform strongly in the first year post-formation, earning market-adjusted returns of −13%, and −17%, respectively. However, constrained winners continue to underperform for the following four years, earning a cumulative market-adjusted return of −40% (t = −6.33), while past-losers earn 6% (t = 0.55). This persistence differential cannot be explained by existing models or by simple extensions of existing models. We propose a dynamic heterogeneous agents model featuring overconfidence and slow information diffusion which is able to both explain this asymmetry in mispricing persistence among short-sale constrained stocks, and to match value and momentum effects for unconstrained stocks.
Keywords: overconfidence, information diffusion, short-sale constraints, momentum, value, mispricing
JEL Classification: G02, G12, G14
Suggested Citation: Suggested Citation