Investment Strategy and Selection Bias: An Equilibrium Perspective on Overoptimism
AbstractInvestors implement projects based on idiosyncratic signal observations, without knowing how signals and returns are jointly distributed. The following heuristic is studied: investors collect information on previously implemented projects with the same signal realization and invest if the associated mean return exceeds the cost. The corresponding steady states result in suboptimal investments, due to selection bias and the heterogeneity of signals across investors. When higher signals are associated with higher returns, investors are overoptimistic, resulting in overinvestment. Rational investors increase the overoptimism of sampling investors, thereby illustrating a negative externality imposed by rational investors.
CitationJehiel, Philippe. 2018. "Investment Strategy and Selection Bias: An Equilibrium Perspective on Overoptimism." American Economic Review, 108 (6): 1582-97. DOI: 10.1257/aer.20161696
- D82 Asymmetric and Private Information; Mechanism Design
- G11 Portfolio Choice; Investment Decisions
- G31 Capital Budgeting; Fixed Investment and Inventory Studies; Capacity
- L26 Entrepreneurship
- M13 New Firms; Startups