Posted: September 21st, 2016

The Behavior of Individual Investors

Your brother Joe is a surgeon who suffers badly from the overconfidence bias. He loves to trade
stocks and believes his predictions with 100% confidence. In fact, he is uninformed like most investors.
Rumors are that Vital Signs (a startup that makes warning labels in the medical industry) will
receive a takeover offer at $20 per share. Absent the takeover offer, the stock will trade at $15 per
share. The uncertainty will be resolved in the next few hours. Your brother believes that the takeover
will occur with certainty and has instructed his broker to buy the stock at any price less than $20. In
fact, the true probability of a takeover is 50%, but a few people are informed and know whether the
takeover will actually occur. They also have submitted orders. Nobody else is trading in the stock