Chapter 4. Inefficient Markets: The Third Theme

Author: Shefrin, Hersh

Source: Beyond Greed and Fear, October 2002 , pp. 33-43(11)

Publisher: Oxford Scholarship Online Monographs

Key:

- Free Content

- New Content

- Subscribed Content

- Free Trial Content

Abstract:

Markets are efficient when prices coincide with intrinsic value. Heuristic-driven bias and frame dependence combine to render markets inefficient. Representativeness leads to the winner–loser effect, whereby investor overreaction causes prior long-term winners to become future long-term losers, and prior long-term losers to become future short-term winners. Conservatism leads security analysts to underreact to earnings surprises, thereby generating short-term momentum in stock prices. Frame dependence leads investors to frame stock returns in terms of short horizons instead of long horizons. As a result, investors require a larger equity premium than they would if they framed returns using longer horizons. Prices can deviate from fundamental value for long periods, with excess volatility the result.

Keywords: winner–loser effect; overreaction; overconfidence; representativeness; post-earnings announcement drift; Long-term Capital Management; equity premium puzzle; irrational exuberance

Document Type: Research article

This article is hosted on another website.

You may be required to register, activate a subscription or purchase the article before you can obtain the full text.

Proceed