Overconfidence and bubbles in experimental asset markets

Michailova, Julija and Schmidt, Ulrich (2011): Overconfidence and bubbles in experimental asset markets. Forthcoming in: Journal of Behavioral Finance

Abstract

This paper investigates the relationship between market overconfidence and occurrence of stock-price bubbles. Sixty participants traded stocks in ten experimental asset markets. Markets were constructed on the basis of subjects’ overconfidence: The most overconfident subjects form high overconfidence markets, and the least overconfident subjects low overconfidence markets. Prices in low overconfidence markets tend to track the fundamental asset value more accurately than prices in high overconfidence markets and are significantly lower and less volatile. Additionally we observe significantly higher bubble measures and trading volume in high overconfidence markets. Two possible explanations for these differences are analyzed: While price expectations are significantly higher in high overconfidence markets no differences in the average degree of risk aversion were detected.

• Item Type: MPRA Paper
• Language: English
• Keywords: Overconfidence, miscalibration, overprecision, overestimation, price bubbles, experimental asset market, risk aversion.
• Subjects: G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates; C - Mathematical and Quantitative Methods > C9 - Design of Experiments > C92 - Laboratory, Group Behavior

References

Ackert, L. F., Charupat, N., Deaves, R., and Kluger, B. D. “Probability Judgment Error and Speculation in Laboratory Asset Market Bubbles.” Journal of Financial and Quantitative Analysis, 44, (2009), pp. 719–744.

Barber, B., and Odean, T. “Boys Will Be Boys: Gender, Overconfidence and Common Stocks Investments.” Quarterly Journal of Economics, 116, (2001), pp. 261–292.

Benos, A. “Aggressiveness and Survival of Overconfident Traders.” Journal of Financial Markets, 1, (1998), pp. 353–383.

Biais, B., Hilton, D., Mazurier, K., and Pouget, S. “Judgmental overconfidence, self-monitoring and trading performance in an experimental financial market.” Review of Economic Studies, 72, (2005), pp. 287–312.

Caballé, J., and Sákovics, J. “Speculating Against an Overconfident Market.” Journal of Financial Markets, 6, (2003), pp. 199–225.

Cohen, J. Statistical Power Analysis for the Behavioural Sciences (2nd ed.). New Jersey: Lawrence Erlbaum, 1988.

Daniel, K., Hirshleifer, D., and Subrahmanyam A. “Investor Psychology and Security Market Under-And Overreactions.” Journal of Finance, 53, (1998), pp. 1839–1885.

De Bondt, W. F. M., and Thaler R. “Does the Stock Market Overreact?” The Journal of Finance, 40, (1985), pp. 793–805.

Dufwenberg, M., Lindqvist, T., and Moore, E. “Bubbles and Experience: An Experiment”. The American Economic Review, 95, (2005), pp. 1731–1737.

Fischbacher, U. “z-Tree: Zurich Toolbox for Ready-made Economic Experiments.” Experimental Economics, 10, (2007), pp. 171–178.

Gigerenzer, G., Hoffrage, U., and Kleinbölting, H. “Probabilistic Mental Models: A Brunswikian Theory of Confidence.” Psychological Review, 98, (1991), pp. 506–528.

Glaser, M., M. Nöth, and Weber, M. “Behavioral Finance.” In D. Koehler, and N. Harvey, eds., Blackwell Handbook of Judgment and Decision Making. Malden Mass.: Blackwell, 2004, pp. 527–546.

Glaser, M., Langer, T., and Weber, M. “Overconfidence of professionals and lay men: Individual differences within and between tasks?” Working paper, University of Mannheim, April 2005.

Glaser, M., and Weber, M. “Overconfidence and trading volume.” The Geneva Risk and Insurance Review, 32, (2007), pp. 1–36.

Griffin, D., and Brenner, L. “Perspectives on probability judgment calibration.” In D. Koehler, and N. Harvey, eds., Blackwell Handbook of Judgment and Decision Making. Malden Mass.: Blackwell, 2004, pp. 177–199.

Haruvy, E., Lahav, Y., and Noussair, C. “Traders’ Expectations in Asset Markets: Experimental Evidence.” American Economic Review, 97, pp. 1901–1920.

Kirchler, E., and Maciejovsky, B. “Simultaneous Over- and Underconfidence: Evidence from Experimental Asset Markets.” Journal of Risk and Uncertainty, 25, (2002), pp. 65–85.

Kirchler, M., Huber, J., and Stöckl, T. “Thar She Bursts – Reducing Confusion Reduces Bubbles.” American Economic Review, 102, (2012), pp. 865–883.

Klayman, J., Soll., J. B., Gonzáles-Vallejo, C., and Barlas, S. “Overconfidence: It Depends on How, What, and Whom You Ask.” Organizational Behavior and Human Decision Processes, 79, (1999), pp. 216–247.

Langer, E. “The Illusion of Control.” Journal of Personality and Social Psychology, 32, (1975), pp. 311–328.

Liu, Y., and Taffler, R. “Damned out of their own mouths: CEO overconfidence in M&A decision making and its impact on firm performance.” Working paper, University of Edinburgh, 2008.

Lichtenstein S., Fischhoff B., and Phillips L.D. “Calibration of Probabilities: The State of the Art to 1980.” In D. Kahneman, P. Slovic, and A. Tversky, eds., Judgment under uncertainty: heuristics and biases, New York: Cambridge University Press, 1982, pp 306–334.

Michailova, J., and Katter, J.K.Q. “Quantifying Overconfidence in Experimental Finance”. International Journal of Behavioural Accounting and Finance, 4, (2014), pp. 351–367.

Milgrom, R., and Stokey N. “Information, Trade and Common Knowledge.” Journal of Economic Theory, 26, (1982), pp. 17–27.

Menkhoff, L., Schmeling, M., and Schmidt, U. “Overconfidence, Experience, and Professionalism: An Experimental Study.” Journal of Economic Behavior and Organization, 86, (2013), pp. 92–101.

Moore, D.A, and Healy P.J. “The Trouble with Overconfidence.” Psychological Review, 115, (2008), pp. 502–517.

Noussair, C., and Tucker, S. “Futures Markets and Bubble Formation in Experimental Asset Markets.” Pacific Economic Review, 11, (2006), pp. 167–184.

Odean, T. “Do Investors Trade Too Much?” American Economic Review, 89, (1999), pp. 1278–1298.

Porter, D., and Smith, V. “Futures Contracting and Dividend Uncertainty in Experimental Asset Markets.” Journal of Business, 68, (1995), pp. 509–541.

Russo, J. E., and Schoemaker, P. J. H. “Managing Overconfidence.” Sloan Management Review, 33, (1992), pp. 7–17.

Sautner, Z., and Weber, M. “How do managers behave in stock option plans? Clinical evidence from exercise and survey data.” Journal of Financial Research, 32, (2009), pp. 123–155.

Scheinkman, J. A., and Xiong, W. “Overconfidence and Speculative Bubbles.” Journal of Political Economy, 111, (2003), pp. 1183–1219.

Shiller, R. J. Irrational Exuberance. Princeton, N.J.: Princeton Univ. Press, 2000.

Smith, V. L., Suchanek G. L., and Williams A. W. “Bubbles, Crashes, and Endogenous Expectations in Experimental Spot Asset Markets.” Econometrica, 56, (1988), pp. 1119–1151.

Statman, M., Thorley, S., and Vorkink, K. “Investor Overconfidence and Trading Volume.” Review of Financial Studies, 19, (2006), pp. 1531–1565.

Stöckl, T., Huber, J., and Kirchler, M. “Bubble Measures In Experimental Asset Markets.” Experimental Economics, 13, (2010), pp. 284–298.

Taylor, S. E., and Brown, J.D. “Illusion and Well-Being: A Social Psychological Perspective on Mental Health.” Psychological Bulletin, 103, (1988), pp. 193–210.