Overconfidence, Information Diffusion, and Mispricing Persistence
89 Pages Posted: 24 Dec 2018 Last revised: 2 Jul 2019
Date Written: July 1, 2019
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=-6.31), while past-losers earn 6% (t=0.56). 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 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