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Overconfidence by Bayesian-Rational Agents

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  • Eric Van den Steen

    ()
    (Harvard Business School, Harvard University, Boston, Massachusetts 02163)

Abstract

This paper derives two mechanisms through which Bayesian-rational individuals with differing priors will tend to be relatively overconfident about their estimates and predictions, in the sense of overestimating the precision of these estimates. The intuition behind one mechanism is slightly ironic: In trying to update optimally, Bayesian agents overweight information of which they overestimate the precision and underweight in the opposite case. This causes overall an overestimation of the precision of the final estimate, which tends to increase as agents get more data. This paper was accepted by Teck Ho, decision analysis.

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File URL: http://dx.doi.org/10.1287/mnsc.1110.1323
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Bibliographic Info

Article provided by INFORMS in its journal Management Science.

Volume (Year): 57 (2011)
Issue (Month): 5 (May)
Pages: 884-896

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Handle: RePEc:inm:ormnsc:v:57:y:2011:i:5:p:884-896

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Keywords: overconfidence; decision analysis; risk; Bayesian updating; differing priors; heterogeneous priors;

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Cited by:
  1. Vilkkumaa, Eeva & Liesiƶ, Juuso & Salo, Ahti, 2014. "Optimal strategies for selecting project portfolios using uncertain value estimates," European Journal of Operational Research, Elsevier, vol. 233(3), pages 772-783.

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