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Speculation Duopoly with Agreement to Disagree: Can Overconfidence Survive the Market Test?

Authors

  • ALBERT S. KYLE,

  • F. ALBERT WANG

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    • Kyle is from Duke University. Wang is from Columbia University. We benefited from helpful discussions with Jim Friedman, Larry Glosten, Jim Peck and S. Viswanathan, and received valuable comments from René Stulz (the editor), two anonymous referees, and seminar participants at Duke University, the University of North Carolina at Chapel Hill, and the 1997 Winter Meetings of the Econometric Society. Wang is also grateful to two members of his dissertation committee, Jennifer Conrad and Mustafa Gültekin for encouragement.


ABSTRACT

In a duopoly model of informed speculation, we show that overconfidence may strictly dominate rationality since an overconfident trader may not only generate higher expected profit and utility than his rational opponent, but also higher than if he were also rational. This occurs because overconfidence acts like a commitment device in a standard Cournot duopoly. As a result, for some parameter values the Nash equilibrium of a two-fund game is a Prisoner's Dilemma in which both funds hire overconfident managers. Thus, overconfidence can persist and survive in the long run.

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