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Volume, Volatility, Price, and Profit When All Traders Are Above Average
Author(s) -
Odean Terrance
Publication year - 1998
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/0022-1082.00078
Subject(s) - overconfidence effect , volatility (finance) , economics , insider trading , financial economics , rational expectations , insider , financial market , profit (economics) , monetary economics , business , microeconomics , econometrics , finance , psychology , social psychology , political science , law
People are overconfident. Overconfidence affects financial markets. How depends on who in the market is overconfident and on how information is distributed. This paper examines markets in which price‐taking traders, a strategic‐trading insider, and risk‐averse marketmakers are overconfident. Overconfidence increases expected trading volume, increases market depth, and decreases the expected utility of overconfident traders. Its effect on volatility and price quality depend on who is overconfident. Overconfident traders can cause markets to underreact to the information of rational traders. Markets also underreact to abstract, statistical, and highly relevant information, and they overreact to salient, anecdotal, and less relevant information.