Overconfidence, Information Diffusion, and Mispricing Persistence
We propose a dynamic heterogeneous agents model which generates testable hypotheses about the formation, timing and bursting of asset price bubbles in the presence of short-sale constraints, given a calibration that is consistent with momentum and reversal effects for unconstrained assets. Consistent with the model, all short-sale constrained stocks earn strong negative risk-adjusted returns in the first year after portfolio formation. However, the calibrated model predicts strong differences in the mispricing persistence of past-winners and losers. After one year, the alpha of past-losers is approximately zero (0.23%/mo, t=0.85), while the alpha for past-winners is -0.75%/mo (t=-5.82) over the following four years.
We thank Nick Barberis, John Campbell, Alex Chinco, Robin Greenwood, Alexander Hillert, Heiko Jacobs, Ravi Jagannathan, Sven Klingler, Dong Lou, Andreas Neuhierl, Jeff Pontiff, Andrei Shleifer, Sheridan Titman, Luis Viceira, Tuomo Vuolteenaho, Ed van Wesep and Greg Weitzner for helpful comments as well as Zahi Ben-David, Sam Hanson and Byoung Hwang for helpful insights about the short-interest data. We appreciate the feedback from seminar and conference participants at the NBER Spring Meeting, American Finance Association, European Finance Association, German Finance Association, Paris December Finance Meeting, Columbia, Copenhagen, Hannover, Kiel, Lausanne, Maryland, Münster, Notre Dame, Oxford, AQR, Arrowstreet, Barclays, Martingale Asset Management and Society of Quantitative Analysts. Financial support from the German Research Foundation (grant KL2365/3-1) is gratefully acknowledged. All remaining errors are our own. The paper subsumes our older work circulated under the titles “Betting Against Winners” and “Overpriced Winners.” The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
The author declares that he consults for financial firms, and serves on the academic advisory boards of several financial firms, but has no relevant or material financial interests that bear upon the research described in this paper.