Do Asset Market Prices Reflect Traders' Judgment Biases?
Journal of Risk and Uncertainty, Vol. 20, No.3, pp. 219-245, 2000
Posted: 5 Dec 2006
The existence of base rate fallacy (BRF) bias is explored employing: (i) a context treatment with a narrative story applied to asset markets and (ii) an isomorphic abstract setting using balls-and-bingo cages. Probability estimates reflect a BRF bias in both treatments, but is stronger with context. Prices track highest expected dividend values (HEDVs) with context, resulting in strongly biased prices relative to the Bayesian norm when biased traders have HEDVs. In the abstract treatment prices do not track HEDVs nearly as closely, resulting in prices closer to the BRF bias only when most traders hold biased beliefs.
Keywords: asset markets, base rate fallacy, overreaction, Bayesian norm, experiment, optimism, pessimism
JEL Classification: G12, D84, C11, C91, C92, D70, E30, G14
Suggested Citation: Suggested Citation