Investments, tenth edition

  Sample Size Neglect and Representativeness   

The notion of    representative-

ness bias    holds that people commonly do not take into account the size of a sample, acting 

as if a small sample is just as representative of a population as a large one. They may there-

fore infer a pattern too quickly based on a small sample and extrapolate apparent trends 

too far into the future. It is easy to see how such a pattern would be consistent with over-

reaction and correction anomalies. A short-lived run of good earnings reports or high stock 

returns would lead such investors to revise their assessments of likely future performance, 

and thus generate buying pressure that exaggerates the price run-up. Eventually, the gap 

between price and intrinsic value becomes glaring and the market corrects its initial error. 

Interestingly, stocks with the best recent performance suffer reversals precisely in the few 

days surrounding earnings announcements, suggesting that the correction occurs just as 

investors learn that their initial beliefs were too extreme.  

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 N. Chopra, J. Lakonishok, and J. Ritter, “Measuring Abnormal Performance: Do Stocks Overreact?”  Journal of 

Financial Economics  31 (1992), pp. 235–68. 

 We saw in the previous chapter that stocks seem to exhibit a pattern of short- to middle-term momentum, 

along with long-term reversals. How might this pattern arise from an interplay between the conservatism 

and representativeness biases? 

 CONCEPT CHECK