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Overconfidence and Diversification

Author

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  • Yuval Heller

Abstract

Experimental evidence suggests that people tend to be overconfident in the sense that they overestimate the accuracy of their private information. In this paper, we show that risk-averse principals might prefer overconfident agents in various strategic interactions because these agents help diversify the aggregate risk. This may help understanding why successful analysts and entrepreneurs tend to be overconfident. In addition, a different interpretation of the model presents a novel evolutionary foundation for overconfidence, and explains various stylized facts about this bias.

Suggested Citation

  • Yuval Heller, 2014. "Overconfidence and Diversification," American Economic Journal: Microeconomics, American Economic Association, vol. 6(1), pages 134-153, February.
    • Handle: RePEc:aea:aejmic:v:6:y:2014:i:1:p:134-53
    Note: DOI: 10.1257/mic.6.1.134
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    References listed on IDEAS

    as
    1. Eric Van den Steen, 2004. "Rational Overoptimism (and Other Biases)," American Economic Review, American Economic Association, vol. 94(4), pages 1141-1151, September.
    2. Waldman, Michael, 1994. "Systematic Errors and the Theory of Natural Selection," American Economic Review, American Economic Association, vol. 84(3), pages 482-497, June.
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    Citations

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    Cited by:

    1. Berman, Ron & Heller, Yuval, 2020. "Naive Analytics Equilibrium," MPRA Paper 103824, University Library of Munich, Germany.
    2. Markus Spiwoks & Kilian Bizer, 2018. "Correlation Neglect and Overconfidence. An Experimental Study," Journal of Applied Finance & Banking, SCIENPRESS Ltd, vol. 8(3), pages 1-5.
    3. Yuval Heller & Eyal Winter, 2020. "Biased-Belief Equilibrium," American Economic Journal: Microeconomics, American Economic Association, vol. 12(2), pages 1-40, May.
    4. Andres Espitia, 2024. "Confidence and Organizations," CRC TR 224 Discussion Paper Series crctr224_2024_521, University of Bonn and University of Mannheim, Germany.
    5. Sawa, Ryoji, 2021. "A prospect theory Nash bargaining solution and its stochastic stability," Journal of Economic Behavior & Organization, Elsevier, vol. 184(C), pages 692-711.
    6. Heller, Yuval & Robson, Arthur J., 2021. "Evolution, heritable risk and skewness loving," Theoretical Economics, Econometric Society, vol. 16(2), May.
    7. Heller, Yuval & NEHAMA, Ilan, 2021. "Evolutionary Foundation for Heterogeneity in Risk Aversion," MPRA Paper 110194, University Library of Munich, Germany.
    8. Heller, Yuval & Nehama, Ilan, 2023. "Evolutionary foundation for heterogeneity in risk aversion," Journal of Economic Theory, Elsevier, vol. 208(C).
    9. Roee Teper, 2014. "The Endowment Effect as a Blessing," Working Paper 5862, Department of Economics, University of Pittsburgh.
    10. Lindbeck, Assar & Weibull, Jörgen, 2015. "Pay Schemes, Bargaining, and Competition for Talent," Working Paper Series 1100, Research Institute of Industrial Economics.
    11. Heller, Yuval & Robson, Arthur, 2019. "Evolution and Preference for Local Risk," MPRA Paper 95264, University Library of Munich, Germany.

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    More about this item

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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