Overconfidence and risk dispersion
AbstractExperimental evidence suggests that people tend to be overconfident in the sense that they overestimate the accuracy of their own predictions. In this paper we present a simple principal-agent model in which principal's interest in dispersing risk motivates him to hire overconfident agents. We show that the induced overconfidence satisfies experimental stylized facts (such as, hard-easy effect, false certainty effect and underuse of base rates). In addition, we show that overconfidence is a unique stable evolutionary strategy, and that it can Pareto-improve social welfare. Finally, we demonstrate applicability by: 1) demonstrating why CEOs hire overconfident intermediate managers, and 2) explaining why investors prefer overconfident entrepreneurs.
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Bibliographic InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 25893.
Date of creation: 26 Sep 2010
Date of revision:
overconfidence; risk dispersion; hard-easy effect; evolutionary stability;
Find related papers by JEL classification:
- C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
- C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-10-23 (All new papers)
- NEP-ENT-2010-10-23 (Entrepreneurship)
- NEP-EVO-2010-10-23 (Evolutionary Economics)
- NEP-EXP-2010-10-23 (Experimental Economics)
- NEP-NEU-2010-10-23 (Neuroeconomics)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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