Confirming Signals Are Hard to Resist: Blessing and Curse of Information Under Confirmation Bias

Abstract

In a world of increasingly extensive information, rational investors can make better decisions. However, investors who are paying special attention to reinforcing information are also more likely to observe preferred signals close to their prior estimate. A focus on these signals reduces belief adaptation. Thus, under the empirically well-documented reinforcement theory, additional information can decrease perception correctness. It explains why wider information accessibility has not increased price efficiency significantly. Managers have an incentive to provide more, diffuse (fewer, precise) signals in case of negative (positive) information. This results in post-earnings-announcement drift and dispersion anomaly. An extension covers the impact of the signal distribution shape.