Biased information weight processing in stock markets

Mohrschladt H, Langer T

Abstract

The concepts of over- and underreaction are frequently used in behavioral financial research to explain investor behavior and resulting market phenomena. This research often makes arbitrary assumptions about which of the two biases is prevalent in a specific situation although psychological research offers more explicit insights. Investors overreact towards information of low weight and underreact if the information has high weight (high reliability). We propose a model that transfers these experimental findings to a financial market setting. Our time-series and cross-sectional empirical analyses support the hypothesis that investors misperceive information weight, which leads to short-term predictability in returns.