Communicating to Be Over- and Undercon dent

A multi-period market model is developed to examine the evolution of risk averse agents' con dence degrees in learning their abilities to obtain precise information and the properties of resulting market trading patterns in price volatility, trading volume, and expected pro ts. Agents initially do not know their abilities which are related to the qualities of private signals. They assess abilities from communicating and comparing quality of their own signals with that of others. Motivated by recent experimental ndings that overand/or undercon dence in ability are often observed, agents are assumed to credit (blame) themselves strongly for favorable (unfavorable) outcomes. I demonstrate that under reasonable circumstances excessive price volatility can be associated with undercon dence. The non-monotonic relation between expected volume and expected pro ts is established, and the positive correlation between con dence level and risk aversion is emphasized. I am grateful to my advisor, Jan Werner, and my committee members, Beth Allen, Raj Singh, for their invaluable suggestions and extensive guidance. I thank Rui Cao, Erzo Luttmer, Han Ozsoylev, Aldo Rustichini and seminar participants at University of Minnesota, the Spring 2007 Midwest Economic Theory Meeting, and the 2007 North American Summer Meeting of the Econometric Society for useful comments. Correspondence with Simon Gervais and Terrace Odean is very helpful. All remaining errors are my own. E-mail: [email protected]