Chapter 13 Efficient Markets and Behavioral Finance 341
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entrepreneurs think that they have a better than 70% chance of success.^23 Si m i la rly,
most investors think they are better-than-average stock pickers. Two speculators who
trade with each other cannot both make money, but nevertheless they may be prepared
to continue trading because each is confident that the other is the patsy. Overconfidence
also shows up in the certainty that people express about their judgments. They consis-
tently overestimate the odds that the future will turn out as they say and underestimate
the chances of unlikely events.You can see how these behavioral characteristics may help to explain the Japanese and dot.
com bubbles. As prices rose, they generated increased optimism about the future and stimu-
lated additional demand. The more that investors racked up profits, the more confident they
became in their views and the more willing they became to bear the risk that next month
might not be so good.
Sentiment
Behavioral economists stress the importance of investor sentiment in determining stock prices,
and they point to evidence of major swings in sentiment. For example, every week the Ameri-
can Association of Individual Investors surveys its members and asks them whether they are
bullish, bearish, or neutral on the stock market over the next six months. Anyone who believed
that all the good or bad news was already reflected in stock prices would tick the neutral box.
But you can see from Figure 13.6 that private investors swing quite strongly between being
bullish or bearish. In January 2000 at the height of the dot.com boom, a massive 75% of inves-
tors said they were bullish, 62% more than claimed to be bearish. Perhaps these periods of
(^23) See D. Kahneman, Thinking Fast and Slow (New York: Farrar, Straus, and Giroux, 2011).
◗ FIGURE 13.6 The spread between the percentage of investors claiming to be bullish and those claiming
to be bearish in the weekly sentiment survey of the American Association of Individual Investors.
Source: http://www.aaii.com/SentimentSurvey?
260
240
220
0
20
40
60
80
Percent bullish minus percent bearish, %
Jul-87Jul-88Jul-89Jul-90Jul-91Jul-92Jul-93Jul-94Jul-95Jul-96Jul-97Jul-98Jul-99Jul-00Jul-01Jul-02Jul-03Jul-04Jul-05Jul-06Jul-07Jul-08Jul-09Jul-10Jul-11Jul-12Jul-13Jul-14