Lecture 10–11: Conservatism and Overconfidence Flashcards
(12 cards)
What is conservatism bias?
The tendency to underreact to new information and rely too heavily on prior beliefs.
What are the market effects of conservatism bias?
Underreaction to news
Momentum in asset prices
Delayed price adjustment
What is the empirical evidence for conservatism in finance?
Post-earnings announcement drift (PEAD)
Gradual stock price response to public news
What behavioral model incorporates conservatism?
Barberis et al. (1998) — includes conservatism and representativeness to explain momentum and reversals.
What is overconfidence?
The tendency to overestimate one’s own abilities, precision, or knowledge.
What are the three types of overconfidence?
Overplacement: Believing you’re better than others
Overprecision: Overestimating accuracy
Overoptimism: Believing good outcomes are more likely
What behavioral effects stem from overconfidence?
Excessive trading
High market volatility
Poor diversification (e.g., home bias)
What evidence supports overconfidence in investing?
Barber & Odean (2000): Overconfident investors trade more
Men trade more than women and perform worse on average
How does overconfidence impact forecasting?
Overconfident analysts give narrow forecasts with high conviction — often leading to errors and overreaction.
How do conservatism and overconfidence differ in market impact?
Conservatism → underreaction → momentum
Overconfidence → overreaction → reversals
Can both biases exist simultaneously?
Yes — models like Barberis et al. (1998) explain short-term momentum (conservatism) and long-term reversals (overconfidence).
What causes overconfidence to persist?
Self-attribution bias: Success = skill, failure = bad luck
Asymmetric learning: Learning more from wins than losses
