The Presence of Representativeness Heuristic and Conservatism Bias in an Asset Market
- 869 Downloads
The models in Chaps. 2–5 prove analytically that either conservatism or representativeness is capable of generating asset price overreaction or underreaction to good news or bad news. This chapter extends the model of Kyle (Econom 53:1315–1335, 1985) and attempts to explain the phenomena of asset price overreaction or underreaction to new information by using psychological biases, namely conservatism and representativeness heuristic. This chapter views conservatism and representativeness as two popular types of psychological biases among traders. For example, the strategies of technical traders’ extrapolation based on the past patterns are popularly used among traders and they are examples of representativeness heuristic. Also, a lot of other strategies used by traders resemble the characteristics of conservatism. Hence, this chapter sets up a static model of an asset market with one asset and one market maker. The payoff for the asset is unknown but all traders (rational, conservatism and heuristic traders) receive an informational signal about the asset payoff before any trade takes place.