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Rationally misplaced confidence

Author

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  • Derek Lemoine

    (Department of Economics, University of Arizona, NBER, and CEPR)

Abstract

I show that persistent underconfidence and overconfidence can each arise from rational Bayesian learning when effort and ability are complementary. Which arises depends on the decision-making environment, and in particular on the effect that greater effort has on the variance of outcomes. Agents learn away overconfidence and underconfidence at asymmetric rates because (i) Bayesian updating requires that their sensitivity to new information depend on their effort choices and (ii) their effort choices in turn depend on beliefs about their own ability. As one implication, I show that management can credibly induce additional effort from employees by designing feedback that generates average overconfidence through being conditionally vague.

Suggested Citation

  • Derek Lemoine, 2025. "Rationally misplaced confidence," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 80(1), pages 1-38, August.
    • Handle: RePEc:spr:joecth:v:80:y:2025:i:1:d:10.1007_s00199-024-01618-0
    DOI: 10.1007/s00199-024-01618-0
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    More about this item

    Keywords

    Learning; Effort; Confidence; Ability; Talent; Feedback; Appraisals;
    All these keywords.

    JEL classification:

    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets
    • M54 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics - - - Labor Management

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