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Overconfidence and Market Efficiency with Heterogeneous Agents

28 Pages Posted: 23 Jun 2004 Last revised: 13 Sep 2016

Diego Garcia

University of Colorado at Boulder - Leeds School of Business

Francesco Sangiorgi

Frankfurt School of Finance & Management; Swedish House of Finance

Branko Urosevic

Universitat Pompeu Fabra - Faculty of Economic and Business Sciences

Date Written: September 1, 2005

Abstract

We study financial markets in which both rational and overconfident agents coexist and make endogenous information acquisition decisions. We demonstrate the following irrelevance result: when a positive fraction of rational agents (endogenously) decides to become informed in equilibrium, prices are set as if all investors were rational, and as a consequence the overconfidence bias does not affect informational efficiency, price volatility, rational traders' expected profits or their welfare. Intuitively, as overconfidence goes up, so does price informativeness, which makes rational agents cut their information acquisition activities, effectively undoing the standard effect of more aggressive trading by the overconfident. The main intuition of the paper, if not the irrelevance result, is shown to be robust to different model specifications.

Keywords: partially revealing equilibria, overconfidence, rational expectations, information

JEL Classification: D80, G10

Suggested Citation

Garcia, Diego and Sangiorgi, Francesco and Urosevic, Branko, Overconfidence and Market Efficiency with Heterogeneous Agents (September 1, 2005). Economic Theory, Vol. 30, No. 2, 2007. Available at SSRN: https://ssrn.com/abstract=557085

Diego Garcia

University of Colorado at Boulder - Leeds School of Business ( email )

Boulder, CO 80309-0419
United States

Francesco Sangiorgi

Frankfurt School of Finance & Management ( email )

Sonnemannstra├če 9-11
Frankfurt am Main, 60314
Germany

Swedish House of Finance ( email )

Drottninggatan 98
111 60 Stockholm
Sweden

Branko Urosevic (Contact Author)

Universitat Pompeu Fabra - Faculty of Economic and Business Sciences ( email )

Ramon Trias Fargas 25-27
Barcelona, 08005
Spain
34-93-542-2590 (Phone)

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