Confidence and the Welfare of Less-Informed Investors

54 Pages Posted: 30 Mar 1998

See all articles by Robert J. Bloomfield

Robert J. Bloomfield

Cornell University - Samuel Curtis Johnson Graduate School of Management

Robert Libby

Cornell University - Samuel Curtis Johnson Graduate School of Management

Mark W. Nelson

Cornell University - Samuel Curtis Johnson Graduate School of Management

Date Written: January 1998

Abstract

In response to recommendations by the AICPA Special Committee on Financial Reporting and the Association for Investment Management and Research, the FASB has recently invited comment regarding the question ?Given [efficient] markets, would any disservice be done to the interests of individual investors by allowing professional investors access to more extensive information?? (AICPA, 1996, p 22). Research in psychology (e.g., Griffin & Tversky, 1992) suggests that less-informed investors may suffer from overconfidence and trade too aggressively given their information. This paper reports two experiments designed to address these issues. In both experiments, security values are determined by the price/book ratios of actual firms, ?more-informed? investors observe three value-relevant financial ratios derived from Value-Line reports, and ?less-informed? investors observe only one of those signals. Experiment 1 provides evidence from a pencil-and-paper task that less-informed investors are overconfident relative to their more-informed counterparts, and that this relative overconfidence is reduced by alerting investors to the extent of their informational disadvantage. Trading behavior follows the same pattern as confidence assessments. Experiment 2 provides evidence from laboratory markets that, even after market prices have stabilized after many rounds of trading, less-informed investors systematically transfer wealth to more-informed investors as a result of biased prices and overly aggressive trading, but that alerting less-informed investors to the extent of their informational disadvantage eliminates these welfare losses. The results of both experiments thus suggest that providing information to only professional investors could harm the welfare of less-informed investors if less-informed investors are not aware of the extent of their informational disadvantage.

JEL Classification: M41, M45, G14

Suggested Citation

Bloomfield, Robert J. and Libby, Robert and Nelson, Mark W., Confidence and the Welfare of Less-Informed Investors (January 1998). Available at SSRN: https://ssrn.com/abstract=72068 or http://dx.doi.org/10.2139/ssrn.72068

Robert J. Bloomfield

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

450 Sage Hall
Ithaca, NY 14853
United States
607-255-9407 (Phone)
607-254-4590 (Fax)

Robert Libby (Contact Author)

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States
607-255-3348 (Phone)
607-254-4590 (Fax)

Mark W. Nelson

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

448 Sage Hall
Ithaca, NY 14853
United States
607-255-6323 (Phone)
607-254-4590 (Fax)

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