Can Agents Add and Subtract When Forming Beliefs? Evidence from the Lab and Field

69 Pages Posted: 3 Aug 2020 Last revised: 22 Jun 2022

See all articles by Pascal Kieren

Pascal Kieren

Heidelberg University - Alfred Weber Institute for Economics

Jan Müller-Dethard

University of Mannheim

Martin Weber

University of Mannheim - Department of Banking and Finance

Date Written: July 6, 2020

Abstract

We study an intrinsic property of Bayesian information processing that does not rely on individuals having rational absolute beliefs: two equally-diagnostic signals of opposite direction should cancel out. Using five preregistered experiments and financial market data on analyst forecasts and earnings announcements, we show that this is not always the case. In both settings, investors systematically overreact to new information that disconfirms prior signals. As mechanism, we identify that individuals update their expectations as if they must selectively allocate their cognitive resources. Overall, our study provides novel insights to the paradoxical co-existence of both over- and underreaction to new information.

Keywords: Belief Formation, Bayes' Theorem, Information Processing, Overreaction

JEL Classification: D81, D83, D84, G41

Suggested Citation

Kieren, Pascal and Müller-Dethard, Jan and Weber, Martin, Can Agents Add and Subtract When Forming Beliefs? Evidence from the Lab and Field (July 6, 2020). Proceedings of Paris December 2021 Finance Meeting EUROFIDAI - ESSEC, Available at SSRN: https://ssrn.com/abstract=3644226 or http://dx.doi.org/10.2139/ssrn.3644226

Pascal Kieren (Contact Author)

Heidelberg University - Alfred Weber Institute for Economics ( email )

Grabengasse 14
Heidelberg, D-69117
Germany

Jan Müller-Dethard

University of Mannheim ( email )

Department of Finance, L9, 1-2
Mannheim, 68131
Germany

Martin Weber

University of Mannheim - Department of Banking and Finance ( email )

D-68131 Mannheim
Germany
+49 621 181 1532 (Phone)
+49 621 181 1534 (Fax)

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