Examining Confirmation Bias as Systematic Investor Behavior

Abstract

A significant portion of the literature uses fundamental analysis models to improve the performance of financial investments. However, the evidence on financial investment and fundamental analysis has a major weakness in that the assumptions of return models are very different from the real world. Evidence from research in this area shows that risk-based studies are inconsistent. However, unless we can reject a testable alternative hypothesis, the debate about whether the observed evidence is consistent with the efficient market hypothesis is far from resolved. This study aims to improve current understanding of market behavior by introducing a behavioral framework that can explain observed excess returns. When risk-based assumptions are rejected, the risk premium is often explained by investors' overreaction, while abnormal returns from trading strategies based on fundamental analysis are claimed to be the result of investors' underreaction. Considering value-based investment and trading strategies based on fundamental analysis, the question arises as to why investors overreact to the future expectations of some stocks and underreact to financial information about other stocks.