The observation that people are often overconfident and over.docx

1、The observation that people are often overconfident and overCountering Over-confidence and Over-optimism By Creating Awareness and Experiential Learning amongst Stock Market Players“We have met the enemy and he is us” - No words seem more apt to understand the issues associated with behavioral econo

2、mics than this famous quote in Walt Kellys political cartoon Pogo. Behavioral economics is a combination of psychology and economics that investigates what happens in markets in which some agents display human limitations and complications. Traditionally, economics theories have been developed on th

3、e basis of the rational man assumption, i.e. individuals are selfish actors who seek maximum utility, and when presented with a set of alternatives, select the alternative offering greatest utility to them. Behavioral economists question this assumption. They ask how this rational man assumption can

4、 explain, inter alia, altruistic actions such as charitable donations or tipping waiters in restaurants while on vacation. For example, tourists visiting Hawaii are likely to tip waiters in Hawaiian restaurants at the same rates as in their hometown, even though they may never visit the same restaur

5、ant again. Such behavior does not maximize their utility but they may still continue to do so at each of their vacations. While traditional economists would ignore such behavior as being irrational or irregular, behavioral economists accept such behavior and try to study its economic implications.Be

6、havioral economics, while first written about in 1955, began to gather momentum only in the seventies, mostly due to Daniel Kahneman and Amor Tverskys publication on the strong linkage between psychology and economics. Thereafter, scholars began to identify a pattern of anomalies in the rational dec

7、ision-making approach relied upon by economists. Anomalies were observed in numerous fields of economic activity, ranging from common-value auctions where the winner often pays a premium (incurs a loss) for winning an auction, to stock markets, where individuals are unable to maximize their wealth a

8、s a result of their own biases. At first, the behavioral finance theory was aggressively disputed by traditional economists, as incomplete and unreliable. Traditional economists rejected the behavioral theory primarily because they claimed it was only accurate for post-facto evaluation and lacked pr

9、edictive value. Today, with extensive research and improved understanding of psychology, behavioral science and its impact on economic theory and law is an accepted fact. In fact, scholars continue to explore newer dimensions of behavioral theory and its usage in other disciplines such as biology.Ov

10、er the years, securities law academics have identified numerous behavioral patterns that limit an investors ability to make rational decisions in the stock market. There has been extensive writing on bounded rationality, indicating that investors are unable to process the extensive information made

11、available to them through disclosure; bounded willpower, which proves that investors are unable to make the right decisions about when to sell or when to buy their securities because of their wishful thinking; and bounded self-interest, which implies that often investors are unable to act in their b

12、est interests of wealth maximization due to their behavioral biases such as loss aversion or status quo bias.In this research paper, the author studies the over-confidence and over-optimism bias, which are ubiquitous amongst investors in the securities market. The primary reason for choosing to stud

13、y these biases over the others is that the author believes that these biases strike at the root of the question why investors trade. Thus, it is essential to understand these biases and determine an appropriate response (legal or otherwise) that would aid investors to overcome these biases. In Part

14、I, the author elaborates on the meaning and presence of the over-confidence and over-optimism biases amongst players in the stock markets and notes their continued presence amongst investors. In Part II, the author observes the key effects of these biases and estimates the economic costs incurred as

15、 a result of these biases. She concludes that they are substantially high and mandate efforts to minimize these biases amongst investors in the stock markets. In Part III, the author explores ways in which legal policy can respond to these biases effectively.Part I: Understanding Over-optimism and O

16、ver-ConfidenceOver-optimism posits individuals to assume that general risks “do not apply with equal force to themselves.” An over-optimistic person will tend to overestimate how frequently he/she will experience favorable outcomes and underestimate the frequency of experiencing unfavorable outcomes. For example, the average American estimates a one in five chance of personally being the victim of a non-terrorist violent crime, yet believes that an average American ha