On the Impacts of Overconfidence under Information Diversity*

• Published date: 01 March 2021
• Author: Deqing Zhou,Fang Zhen
• Date: 01 March 2021
• DOI: http://doi.org/10.1111/irfi.12264

On the Impacts of Overconfidence

under Information Diversity*

DEQING ZHOU

†

AND FANG ZHEN

‡

†

School of Finance, Central University of Finance and Economics, Beijing,

P.R. China and

‡

China Economics and Management Academy, Central University of Finance

and Economics, Beijing, P.R. China

ABSTRACT

This work examines the competition between two groups of overconfident

agents when they are informed with different dimensional information.

Their strategies could be complementary through a “liquidity improvement

effect.”When agents informed in one-dimension trade more aggressively

due to overconfidence, the market liquidity could be improved and agents

informed in the other dimension would also trade more aggressively and

become better off. In addition, increasing one group’s population and infor-

mation precision could also benefit the other group, while these impacts are

mitigated by the overestimation of one’s own group population.

JEL classification: C72; D82; G14

Accepted: 4 March 2019

I. INTRODUCTION

Theroleplayedbyoverconfident beliefs has been a central concern for decades

since psychology literature (Weinstein 1980; Plous 1993; Bazerman and Moore

2012) suggests that people have the tendency to be overconfident about their abili-

ties. Within the context of competition between one-dimensionally informed

rational and overconfident agents, Kyle and Wang (1997) find that overconfidence

plays as a commitment to trade more, thereby ensuring the survival of over-

confident agents. Based on their framework, we introduce “information diversity”

into the competition between two groups of overconfident agents, who are endo-

wed with private signals pertaining to independent dimensional fundamentals.

We find that when agents informed in one dimension become more over-

confident, they trade more aggressively and the market could be more liquid.

This enables agents informed in the other dimension to also trade more aggres-

sively. Interestingly, under certain conditions, increasing one group’s

* Deqing Zhou has been supported by the Program for Innovation Research from the Central Uni-

versity of Finance and Economics, and the National Natural Science Foundation of China (Grant

No. 11301563). Fang Zhen has been supported by the Research Fund from the Central University of

Finance and Economics (Project No. 023063022002/010).

© 2019 International Review of Finance Ltd. 2019

International Review of Finance, 21:1, 2021: pp. 345–357

DOI: 10.1111/irfi.12264