Self-Enhancing Transmission Bias and Active Investing

Individual investors often invest actively and lose thereby. Social interaction seems to exacerbate the bias toward active trading. In the model here, conversational biases in the social transmission of performance information favor active over passive investment strategies. Senders’ propensity to communicate their returns is increasing in returns. Receivers’ propensity to attend to and be converted by senders is increasing and convex in sender return. Active strategies (high variance, skewness, and personal involvement) dominate the population unless the mean return penalty to active investing is too large. Thus, the model can explain overvaluation of assets with these characteristics even if investors have no inherent preference over them.