Overconfidence, Investor Sentiment, and Evolution

We examine the survival of nonrational investors in an evolutionary game model with a population dynamic for a large economy. The dynamic indicates that the growth rate of wealth accumulation drives the evolutionary process. We focus our analysis on the survival of overconfidence and investor sentiment.We find that underconfidence or pessimism cannot survive, but moderate overconfidence or optimism can survive and even dominate, particularly when the fundamental risk is large. These findings provide new empirical implications for the survivability of active fund management. Our results lend support to the relevance of the psychology of investors in studying financial markets.

Journal of Economic Literature Classification Numbers: G10, G14.

Prof. F. Albert Wang