A Theory of Overconfidence, Self-Attribution, and Security Market Under- and Over-reactions

59 Pages Posted: 1 May 1997  

Kent D. Daniel

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

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)

Date Written: February 19, 1997

Abstract

We propose a theory based on investor overconfidence and biased self-attribution to explain several of the securities returns patterns that seem anomalous from the perspective of efficient markets with rational investors. The theory is based on two premises derived from evidence in psychological studies. The first is that individuals are overconfident about their ability to evaluate securities, in the sense that they overestimate the precision of their private information signals. The second is that investors' confidence changes in a biased fashion as a function of their decision outcomes. The first premise implies overreaction to private information arrival and underreaction to public information arrival. This is consistent with (1) post-corporate event and post-earnings announcement stock price 'drift', (2) negative long-lag autocorrelations (long-run 'overreaction'), and (3) excess volatility of asset prices. Adding the second premise leads to (4) positive short-lag autocorrelations ('momentum'), and (5) short-run post-earnings announcement 'drift,' and negative correlation between future stock returns and long-term measures of past accounting performance. The model also offers several untested empirical implications and implications for corporate financial policy.

JEL Classification: G12, G14, G30

Suggested Citation

Daniel, Kent D. and Hirshleifer, David A. and Subrahmanyam, Avanidhar, A Theory of Overconfidence, Self-Attribution, and Security Market Under- and Over-reactions (February 19, 1997). Available at SSRN: https://ssrn.com/abstract=2017 or http://dx.doi.org/10.2139/ssrn.2017

Kent D. Daniel (Contact Author)

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States
212-854-4679 (Phone)
212-854-4679 (Fax)

HOME PAGE: http://www.columbia.edu/~kd2371/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

David A. Hirshleifer

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

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