Confidence and the welfare of less-informed investors

In response to recommendations by the AICPA Special Committee on Financial Reporting and the Association for Investment Management and Research, the F ASB recently invited comment regarding the question, "Given [efficient] mar kets, would any disservice be done to the interests of individual investors by allowing professional investors access to more extensive information?" [AICPA (1996) Report of the Special Committee on Financial Reporting and th e Association for Investment Management and Research, New York, p. 22]. Res earch in psychology [e.g. Griffin & Tversky (1992) The weighing of evidence and the determinants of confidence. Cognitive Psychology, 411-435] suggest s that less-informed investors may suffer from over-confidence and trade to o aggressively given their information. This paper reports on an experiment designed to address these issues. In the experiment, security values are d etermined by the price/book ratios of actual firms, "more-informed" investo rs observe three value-relevant financial ratios derived from Value-Line re ports, and "less-informed" investors observe only one of those signals. Eve n after market prices have stabilized after many rounds of trading, less-in formed investors systematically transfer wealth to more-informed investors as a result of biased prices and overly aggressive trading. However, alerti ng less-informed investors to the extent of their informational disadvantag e eliminates these welfare losses. The results thus suggest that providing information to only professional investors could harm the welfare of less-i nformed investors if less-informed investors are not aware of the extent of their informational disadvantage. (C) 1999 Elsevier Science Ltd. All right s reserved.