Subject Perceptions of Confidence and Predictive Validity in Financial Information Cues

Abstract

Traditional financial theory holds that financial decision makers make choices based on an asset's mean return and its standard deviation in the context of the normal distribution. These statistics, however, may be vague concepts to decision makers, and more difficult to use relative to specific details of a simple discrete probability distribution. Therefore, this study shows which of ten information cues subjects use in making decisions designed to look like simplified bonds, stocks, and options. The cues consist of the mean, standard deviation, and other distribution features such as highest payoff. More importantly, this study relates subjects' usage of various information cues in making financial valuation judgments to their self-assessments of 1) an information cue's ability to best reveal the value of an asset (its predictive validity), and 2) their confidence in using that information cue. The results are related to the overconfidence literature in psychology.