Two essays on investor overconfidence and asset prices
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[ACCESS RESTRICTED TO THE UNIVERSITY OF MISSOURI AT AUTHOR'S REQUEST.] This dissertation contains two essays about the impact of investor overconfidence on asset prices. The first essay examines the role of investor overconfidence in explaining the momentum effect. Using a comprehensive sample of U.S. equity mutual funds, I develop two new measures of investor overconfidence based on the characteristics and trading patterns of the fund managers. I find that stocks held by more overconfident managers experience greater momentum profits and stronger return reversals than stocks held by less overconfident managers. The difference in momentum profits between stocks held by more- and less-overconfident managers is not a compensation for risk, nor is it attributable to stock characteristics that influence momentum. My results provide direct support for the argument that stock return momentum is caused by investor overconfidence and biased self-attribution. In the second essay I investigate the impact of investor overconfidence on firm value and cost of capital. Consistent with theoretical predictions, I show that firms held by more overconfident investors exhibit significantly higher market-to-book ratios and significantly lower implied cost of capital. Firms with more overconfident investors experience lower subsequent stock returns, consistent with prices slowly moving back to fundamental values. Moreover, I find that firms with more overconfident investors issue more equity and make more investments, consistent with corporate managers exploiting market misvaluation in making financing and investment decisions.
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