Optimism and overconfidence investors' biases: a methodological note

In literature, there are little evidence about interactions and respective roles of optimism and overconfidence on characteristic variables of cash-flows like mean and variance [Barberis and Thaler (2003)]. The starting point of this paper consists in explaining the change between two dates of mean and variance of financial cash-flows as a result of two biases: optimism and overconfidence of investors. The main conclusion of this paper is the following one: all the profiles of decision-makers and thus their change in their behavior can be described by three parameters of biases which are the degree of overconfidence, the degree of optimism in unfavorable and favorable state. These three parameters allow describing the complex relation between biases and their consequences on investors. In the first part, the framework of the model is detailed. In a second time, overconfidence and optimism bias are taken into account into the model but separately. In a next part, overconfidence is combined with optimism bias in order to have a more realistic model about investor?s behavior. In an ultimate part, the decision-maker of the economic theory without any influence on the market equilibrium is given up in order to consider the case where only a part of investors are the victims of behavioral biases.