Overconfidence, Information Diffusion, and Mispricing Persistence

Short-sale constrained past-winners and losers both underperform strongly in the first year post-formation, earning market-adjusted returns of −13%, and −17%, respectively. However, constrained winners continue to underperform for the following four years, earning a cumulative market-adjusted return of −40% (t = −6.33), while past-losers earn 6% (t = 0.55). This persistence differential cannot be explained by existing models or by simple extensions of existing models. We propose a dynamic heterogeneous agents model featuring overconfidence and slow information diffusion which is able to both explain this asymmetry in mispricing persistence among short-sale constrained stocks, and to match value and momentum effects for unconstrained stocks.