The Contribution of Self-Deceptive Behavior on Price Discovery: An Experimental Approach

Abstract

Research in psychology suggests that less informed individuals may suffer from overconfidence. Empirical research shows that overconfident investors tend to overvalue the price of the securities so that they unconsciously buy the security at a higher price or sell the security at a lower price than its fundamental value leading to transaction losses. As an experimental research project, this paper addresses these issues. According to the research design, all investors are classified into three groups based on their scores of overconfidence, namely the less informed investors, the rational (average) investors, and the more informed investors. In order to observe the responses of the groups of investors when they receive valuable information, the research employs four different types of treatments consisting of the condition of no market information, the provision of guidance of security prediction, the good news and the bad news. The research findings demonstrate that the less informed investors are inclined to assess the precision of their knowledge and information excessively so that they produce a higher mean of prediction and price errors than those of the more informed investors in all experimental market sessions, except in the market session of good news. The phenomenon indicates that less informed investors conduct a self deceptive behavior. The result of the research also shows that less informed investors do not always suffer from transaction losses although they have a higher mean of prediction or price errors than those of the more informed investors. The less informed investors have a chance to gain profit as long as they are able to deliver the predicted value of the security accurately which is closer to the market price that reflects the expected price of the majority of the market players.