Overconfidence and Market Efficiency with Heterogeneous Agents

Diego Garcia, Francesco Sangiorgi and Branko Urosevic

No 11, Carlo Alberto Notebooks from Collegio Carlo Alberto

Abstract: We study financial markets in which both rational and overconfident agents coexist and make endogenous information acquisition decisions. We demonstrate the following irrele- vance 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 conse- quence the overconfidence bias does not affect informational efficiency, price volatility, ra- tional 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 overcon- fident. 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 acquisition; price informativeness. (search for similar items in EconPapers)
JEL-codes: D80 G10 (search for similar items in EconPapers)
Pages: 30 pages
Date: 2005
New Economics Papers: this item is included in nep-fin, nep-fmk and nep-mst
References: View references in EconPapers View complete reference list from CitEc
Citations:

Forthcoming in Economic Theory

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Related works:
Journal Article: Overconfidence and Market Efficiency with Heterogeneous Agents (2007)
Working Paper: Overconfidence and market efficiency with heterogeneous agents (2004)
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Persistent link: https://EconPapers.repec.org/RePEc:cca:wpaper:11

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