Confidence and the welfare of less-informed investors

Confidence and the welfare of less-informed investors In response to recommendations by the AICPA Special Committee on Financial Reporting and the Association for Investment Management and Research, the FASB recently invited comment regarding the question, “Given (efficient) markets, would any disservice be done to the interests of individual investors by allowing professional investors access to more extensive information?” ( AICPA (1996) Report of the Special Committee on Financial Reporting and the Association for Investment Management and Research, New York, p. 22 ). Research in psychology (e.g. Griffin & Tversky (1992) The weighing of evidence and the determinants of confidence. Cognitive Psychology , 411–435 ) suggests that less-informed investors may suffer from over-confidence and trade too aggressively given their information. This paper reports on an experiment designed to address these issues. In the experiment, security values are determined by the price/book ratios of actual firms, “more-informed” investors observe three value-relevant financial ratios derived from Value-Line reports, and “less-informed” investors observe only one of those signals. Even after market prices have stabilized after many rounds of trading, less-informed investors systematically transfer wealth to more-informed investors as a result of biased prices and overly aggressive trading. However, alerting less-informed investors to the extent of their informational disadvantage eliminates these welfare losses. The results thus suggest that providing information to only professional investors could harm the welfare of less-informed investors if less-informed investors are not aware of the extent of their informational disadvantage. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Accounting, Organizations and Society Elsevier

Confidence and the welfare of less-informed investors

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Publisher
Elsevier
Copyright
Copyright © 1999 Elsevier Science Ltd
ISSN
0361-3682
D.O.I.
10.1016/S0361-3682(99)00025-2
Publisher site
See Article on Publisher Site

Abstract

In response to recommendations by the AICPA Special Committee on Financial Reporting and the Association for Investment Management and Research, the FASB recently invited comment regarding the question, “Given (efficient) markets, would any disservice be done to the interests of individual investors by allowing professional investors access to more extensive information?” ( AICPA (1996) Report of the Special Committee on Financial Reporting and the Association for Investment Management and Research, New York, p. 22 ). Research in psychology (e.g. Griffin & Tversky (1992) The weighing of evidence and the determinants of confidence. Cognitive Psychology , 411–435 ) suggests that less-informed investors may suffer from over-confidence and trade too aggressively given their information. This paper reports on an experiment designed to address these issues. In the experiment, security values are determined by the price/book ratios of actual firms, “more-informed” investors observe three value-relevant financial ratios derived from Value-Line reports, and “less-informed” investors observe only one of those signals. Even after market prices have stabilized after many rounds of trading, less-informed investors systematically transfer wealth to more-informed investors as a result of biased prices and overly aggressive trading. However, alerting less-informed investors to the extent of their informational disadvantage eliminates these welfare losses. The results thus suggest that providing information to only professional investors could harm the welfare of less-informed investors if less-informed investors are not aware of the extent of their informational disadvantage.

Journal

Accounting, Organizations and SocietyElsevier

Published: Nov 1, 1999

References

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