NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Market Efficiency in an Irrational World

Kent Daniel, Sheridan Titman

NBER Working Paper No. 7489
Issued in January 2000
NBER Program(s):   AP

This paper explains why investors are likely to be overconfident and how this behavioral bias affects investment decisions. Our analysis suggests that investor overconfidence can potentially generate stock return momentum and that this momentum effect is likely to be the strongest in those stocks whose valuation requires the interpretation of ambiguous information. Consistent with this, we find that momentum effects are stronger for growth stocks than value stocks. A portfolio strategy based on this hypothesis generates strong abnormal returns that do not appear to be attributable to risk. Although these results violate the traditional efficient markets hypothesis, they do not necessarily imply that rational but uniformed investors, without the benefit of hindsight, could have actually achieved the returns. We argue that to examine whether unexploited profit opportunities exist, one must test for what we call adaptive-efficiency, which is a somewhat weaker form of market efficiency that allows for the appearance of profit opportunities in historical data, but requires these profit opportunities to dissipate when they become apparent. Our tests reject this notion of adaptive-efficiency.

download in pdf format
   (380 K)

email paper

This paper is available as PDF (380 K) or via email.

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w7489

Published: Financial Analyst Journal (1999).

Users who downloaded this paper also downloaded these:
Schwert w9277 Anomalies and Market Efficiency
Bondt and Thaler w4777 Financial Decision-Making in Markets and Firms: A Behavioral Perspective
Bollerslev and Hodrick w4108 Financial Market Efficiency Tests
Jegadeesh and Titman w7159 Profitability of Momentum Strategies: An Evaluation of Alternative Explanations
Baker and Wurgler w13189 Investor Sentiment in the Stock Market
 
Publications
Activities
Meetings
NBER Videos
Data
People
About

Support
National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us