Overconfidence, Information Diffusion, and Mispricing Persistence
86 Pages Posted: 24 Dec 2018
Date Written: December 1, 2018
We propose a dynamic heterogeneous agents model which generates testable hypotheses about the formation, timing and bursting of asset price bubbles in the presence of short-sale constraints, given a calibration that is consistent with momentum and reversal effects for unconstrained assets. Consistent with the model, all short-sale constrained stocks earn strong negative risk-adjusted returns in the first year after portfolio formation. However, the calibrated model predicts strong differences in the mispricing persistence of past-winners and losers. After one year, the alpha of past-losers is approximately zero (0.23 %/mo, t=0.85), while the alpha for past-winners is -0.75 %/mo (t=-5.82) over the following four years.
Keywords: overconfidence, information diffusion, bubbles, short-sale constraints, momentum, value, mispricing
JEL Classification: G02, G12, G14
Suggested Citation: Suggested Citation