The observation that people are often overconfident and over.docx

The observation that people are often overconfident and over.docx

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Theobservationthatpeopleareoftenoverconfidentandover

CounteringOver-confidenceandOver-optimismByCreatingAwarenessandExperientialLearningamongstStockMarketPlayers

“Wehavemettheenemyandheisus”-NowordsseemmoreapttounderstandtheissuesassociatedwithbehavioraleconomicsthanthisfamousquoteinWaltKelly’spoliticalcartoon‘Pogo’.Behavioraleconomicsisacombinationofpsychologyandeconomicsthatinvestigateswhathappensinmarketsinwhichsomeagentsdisplayhumanlimitationsandcomplications.

Traditionally,economicstheorieshavebeendevelopedonthebasisofthe‘rationalman’assumption,i.e.individualsareselfishactorswhoseekmaximumutility,andwhenpresentedwithasetofalternatives,selectthealternativeofferinggreatestutilitytothem.Behavioraleconomistsquestionthisassumption.Theyaskhowthis‘rationalman’assumptioncanexplain,interalia,altruisticactionssuchascharitabledonationsortippingwaitersinrestaurantswhileonvacation.Forexample,touristsvisitingHawaiiarelikelytotipwaitersinHawaiianrestaurantsatthesameratesasintheirhometown,eventhoughtheymaynevervisitthesamerestaurantagain.Suchbehaviordoesnotmaximizetheirutilitybuttheymaystillcontinuetodosoateachoftheirvacations.Whiletraditionaleconomistswouldignoresuchbehaviorasbeingirrationalorirregular,behavioraleconomistsacceptsuchbehaviorandtrytostudyitseconomicimplications.

Behavioraleconomics,whilefirstwrittenaboutin1955,begantogathermomentumonlyintheseventies,mostlyduetoDanielKahnemanandAmorTversky’spublicationonthestronglinkagebetweenpsychologyandeconomics.Thereafter,scholarsbegantoidentifyapatternofanomaliesintherationaldecision-makingapproachrelieduponbyeconomists.Anomalieswereobservedinnumerousfieldsofeconomicactivity,rangingfromcommon-valueauctionswherethewinneroftenpaysapremium（incursaloss）forwinninganauction,tostockmarkets,whereindividualsareunabletomaximizetheirwealthasaresultoftheirownbiases.

Atfirst,thebehavioralfinancetheorywasaggressivelydisputedbytraditionaleconomists,asincompleteandunreliable.Traditionaleconomistsrejectedthebehavioraltheoryprimarilybecausetheyclaimeditwasonlyaccurateforpost-factoevaluationandlackedpredictivevalue.Today,withextensiveresearchandimprovedunderstandingofpsychology,behavioralscienceanditsimpactoneconomictheoryandlawisanacceptedfact.Infact,scholarscontinuetoexplorenewerdimensionsofbehavioraltheoryanditsusageinotherdisciplinessuchasbiology.

Overtheyears,securitieslawacademicshaveidentifiednumerousbehavioralpatternsthatlimitaninvestor’sabilitytomakerationaldecisionsinthestockmarket.Therehasbeenextensivewritingonboundedrationality,indicatingthatinvestorsareunabletoprocesstheextensiveinformationmadeavailabletothemthroughdisclosure;boundedwillpower,whichprovesthatinvestorsareunabletomaketherightdecisionsaboutwhentosellorwhentobuytheirsecuritiesbecauseoftheirwishfulthinking;andboundedself-interest,whichimpliesthatofteninvestorsareunabletoactintheirbestinterestsofwealthmaximizationduetotheirbehavioralbiasessuchaslossaversionorstatusquobias.

Inthisresearchpaper,theauthorstudiestheover-confidenceandover-optimismbias,whichareubiquitousamongstinvestorsinthesecuritiesmarket.Theprimaryreasonforchoosingtostudythesebiasesovertheothersisthattheauthorbelievesthatthesebiasesstrikeattherootofthequestionwhyinvestorstrade.Thus,itisessentialtounderstandthesebiasesanddetermineanappropriateresponse（legalorotherwise）thatwouldaidinvestorstoovercomethesebiases.InPartI,theauthorelaboratesonthemeaningandpresenceoftheover-confidenceandover-optimismbiasesamongstplayersinthestockmarketsandnotestheircontinuedpresenceamongstinvestors.InPartII,theauthorobservesthekeyeffectsofthesebiasesandestimatestheeconomiccostsincurredasaresultofthesebiases.Sheconcludesthattheyaresubstantiallyhighandmandateeffortstominimizethesebiasesamongstinvestorsinthestockmarkets.InPartIII,theauthorexploreswaysinwhichlegalpolicycanrespondtothesebiaseseffectively.

PartI:

UnderstandingOver-optimismandOver-Confidence

Over-optimismpositsindividualstoassumethatgeneralrisks“donotapplywithequalforcetothemselves.”Anover-optimisticpersonwilltendtooverestimatehowfrequentlyhe/shewillexperiencefavorableoutcomesandunderestimatethefrequencyofexperiencingunfavorableoutcomes.Forexample,theaverageAmericanestimatesaoneinfivechanceofpersonallybeingthevictimofanon-terroristviolentcrime,yetbelievesthatanaverageAmericanha