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Feedback and the Success of Irrational Investors

Journal of Financial Economics, Vol. 81, No. 2, pp. 311-338, August 2006

Dice Center Working Paper No. 2003-22

40 Pages Posted: 28 Jul 2003 Last revised: 13 Dec 2008

David A. Hirshleifer

University of California, Irvine - Paul Merage School of Business; NBER

Avanidhar Subrahmanyam

University of California, Los Angeles (UCLA) - Finance Area; Institute of Global Finance, UNSW Business School; Financial Research Network (FIRN)

Sheridan Titman

University of Texas at Austin - Department of Finance; National Bureau of Economic Research (NBER)

Date Written: September 10, 2003

Abstract

We provide a model in which irrational investors trade based upon considerations that are not inherently related to fundamentals. However, because trading activity affects market prices, and because of feedback from security prices to cash flows, the irrational trades influence underlying cash flows. As a result, irrational investors can, in some situations, earn positive expected profits. These expected profits are not market compensation for bearing risk, and can exceed the expected profits of rational informed investors. The trades of irrational investors can distort real investment choices and lower ex ante firm values, even though stocks prices follow a random walk.

JEL Classification: G14, D82, D84, E3

Suggested Citation

Hirshleifer, David A. and Subrahmanyam, Avanidhar and Titman, Sheridan, Feedback and the Success of Irrational Investors (September 10, 2003). Dice Center Working Paper No. 2003-22; Dice Center Working Paper No. 2003-22. Available at SSRN: https://ssrn.com/abstract=422181 or http://dx.doi.org/10.2139/ssrn.422181

David A. Hirshleifer (Contact Author)

University of California, Irvine - Paul Merage School of Business ( email )

Irvine, CA California 92697-3125
United States

HOME PAGE: http://sites.uci.edu/dhirshle/

NBER ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Avanidhar Subrahmanyam

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-5355 (Phone)
310-206-5455 (Fax)

Institute of Global Finance, UNSW Business School

Sydney, NSW 2052
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

Sheridan Titman

University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States
512-232-2787 (Phone)
512-471-5073 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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