Investor Psychology and Security Market Under- and Overreactions


  • Kent Daniel,

  • David Hirshleifer,

  • Avanidhar Subrahmanyam

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    • Daniel is at Northwestern University and NBER, Hirshleifer is at the University of Michigan, Ann Arbor, and Subrahmanyam is at the University of California at Los Angeles. We thank two anonymous referees, the editor (René Stulz), Michael Brennan, Steve Buser, Werner DeBondt, Eugene Fama, Simon Gervais, Robert Jones, Blake LeBaron, Tim Opler, Canice Prendergast, Andrei Shleifer, Matt Spiegel, Siew Hong Teoh, and Sheridan Titman for helpful comments and discussions, Robert Noah for excellent research assistance, and participants in the National Bureau of Economic Research 1996 Asset Pricing Meeting, and 1997 Behavioral Finance Meeting, the 1997 Western Finance Association Meetings, the 1997 University of Chicago Economics of Uncertainty Workshop, and finance workshops at the Securities and Exchange Commission and the following universities: University of California at Berkeley, University of California at Los Angeles, Columbia University, University of Florida, University of Houston, University of Michigan, London Business School, London School of Economics, Northwestern University, ohio State University, Stanford University, and Washington University at St. Louis for helpful comments. Hirshleifer thanks the Nippon Telephone and Telegraph Program of Asian Finance and Economics for financial support.


We propose a theory of securities market under- and overreactions based on two well-known psychological biases: investor overconfidence about the precision of private information; and biased self-attribution, which causes asymmetric shifts in investors' confidence as a function of their investment outcomes. We show that overconfidence implies negative long-lag autocorrelations, excess volatility, and, when managerial actions are correlated with stock mispricing, public-event-based return predictability. Biased self-attribution adds positive short-lag autocorrelations (“momentum”), short-run earnings “drift,” but negative correlation between future returns and long-term past stock market and accounting performance. The theory also offers several untested implications and implications for corporate financial policy.