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Unrealistic Expectations and Misguided Learning

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  • Paul Heidhues
  • Botond Kőszegi
  • Philipp Strack

Abstract

We explore the learning process and behavior of an individual with unrealistically high expectations (overconfidence) when outcomes also depend on an external fundamental that affects the optimal action. Moving beyond existing results in the literature, we show that the agent's beliefs regarding the fundamental converge under weak conditions. Furthermore, we identify a broad class of situations in which “learning” about the fundamental is self‐defeating: it leads the individual systematically away from the correct belief and toward lower performance. Due to his overconfidence, the agent—even if initially correct—becomes too pessimistic about the fundamental. As he adjusts his behavior in response, he lowers outcomes and hence becomes even more pessimistic about the fundamental, perpetuating the misdirected learning. The greater is the loss from choosing a suboptimal action, the further the agent's action ends up from optimal. We partially characterize environments in which self‐defeating learning occurs, and show that the decisionmaker learns to take the optimal action if, and in a sense only if, a specific non‐identifiability condition is satisfied. In contrast to an overconfident agent, an underconfident agent's misdirected learning is self‐limiting and therefore not very harmful. We argue that the decision situations in question are common in economic settings, including delegation, organizational, effort, and public‐policy choices.

Suggested Citation

  • Paul Heidhues & Botond Kőszegi & Philipp Strack, 2018. "Unrealistic Expectations and Misguided Learning," Econometrica, Econometric Society, vol. 86(4), pages 1159-1214, July.
  • Handle: RePEc:wly:emetrp:v:86:y:2018:i:4:p:1159-1214
    DOI: 10.3982/ECTA14084
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    Cited by:

    1. Razin, Ronny & Levy, Gilat & Young, Alwyn, 2022. "Misspecified politics and the recurrence of populism," LSE Research Online Documents on Economics 112544, London School of Economics and Political Science, LSE Library.
    2. Inga Deimen & Julia Wirtz, 2021. "Control, Cost, and Confidence:Perseverance and Procrastination in the Face of Failure," Bristol Economics Discussion Papers 21/738, School of Economics, University of Bristol, UK.
    3. Joshua Schwartzstein & Adi Sunderam, 2021. "Using Models to Persuade," American Economic Review, American Economic Association, vol. 111(1), pages 276-323, January.
    4. Kocourek, Pavel & Netzer, Nick & Robson, Arthur & Steiner, Jakub, 2021. "Endogenous Risk Attitudes," CEPR Discussion Papers 16190, C.E.P.R. Discussion Papers.
    5. Razin, Ronny & Levy, Gilat, 2020. "Combining forecasts in the presence of ambiguity over correlation structures," LSE Research Online Documents on Economics 104641, London School of Economics and Political Science, LSE Library.
    6. Islam, Marco, 2021. "Motivated Risk Assessments," Working Papers 2021:12, Lund University, Department of Economics, revised 26 Jul 2022.
    7. Hestermann, Nina & Le Yaouanq, Yves, 2018. "It\'s not my Fault! Self-Confidence and Experimentation," Rationality and Competition Discussion Paper Series 124, CRC TRR 190 Rationality and Competition.
    8. Kaplan, Steven N. & Sørensen, Morten & Zakolyukina, Anastasia A., 2022. "What is CEO overconfidence? Evidence from executive assessments," Journal of Financial Economics, Elsevier, vol. 145(2), pages 409-425.
    9. Deborah A. Cobb-Clark & Tiffany Ho & Nicolás Salamanca, 2021. "Parental Responses to Children’s Achievement Test Results," Melbourne Institute Working Paper Series wp2021n17, Melbourne Institute of Applied Economic and Social Research, The University of Melbourne.
    10. Mira Frick & Ryota Iijima & Yuhta Ishii, 2020. "Misinterpreting Others and the Fragility of Social Learning," Econometrica, Econometric Society, vol. 88(6), pages 2281-2328, November.
    11. Kai Barron, 2021. "Belief updating: does the ‘good-news, bad-news’ asymmetry extend to purely financial domains?," Experimental Economics, Springer;Economic Science Association, vol. 24(1), pages 31-58, March.
    12. Philippe Choné & Laurent Linnemer, 2022. "A Class of Behavioral Models for the Profit-Maximizing Firm," CESifo Working Paper Series 9718, CESifo.
    13. Mira Frick & Ryota Iijima & Yuhta Ishii, 2020. "Stability and Robustness in Misspecified Learning Models," Cowles Foundation Discussion Papers 2235, Cowles Foundation for Research in Economics, Yale University.
    14. Levy, Gilat & Razin, Ronny, 2022. "Combining forecasts in the presence of ambiguity over correlation structures," Journal of Economic Theory, Elsevier, vol. 199(C).
    15. Chen, Si & Schildberg-Hörisch, Hannah, 2019. "Looking at the bright side: The motivational value of confidence," European Economic Review, Elsevier, vol. 120(C).
    16. Pons Rotger, Gabriel & Rosholm, Michael, 2020. "The Role of Beliefs in Long Sickness Absence: Experimental Evidence from a Psychological Intervention," IZA Discussion Papers 13582, Institute of Labor Economics (IZA).
    17. Gagnon-Bartsch, Tristan & Bushong, Benjamin, 2022. "Learning with misattribution of reference dependence," Journal of Economic Theory, Elsevier, vol. 203(C).
    18. Deimen, Inga & Wirtz, Julia, 2022. "Control, cost, and confidence: Perseverance and procrastination in the face of failure," Games and Economic Behavior, Elsevier, vol. 134(C), pages 52-74.
    19. Aislinn Bohren & Daniel Hauser, 2018. "Social Learning with Model Misspeciification: A Framework and a Robustness Result," PIER Working Paper Archive 18-017, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 01 Jul 2018.
    20. Fudenberg, Drew & Lanzani, Giacomo & Strack, Philipp, 0. "Pathwise concentration bounds for Bayesian beliefs," Theoretical Economics, Econometric Society.
    21. Chen, Jaden Yang, 2022. "Biased learning under ambiguous information," Journal of Economic Theory, Elsevier, vol. 203(C).
    22. Andrew Ellis & Heidi Christina Thysen, 2021. "Subjective Causality in Choice," Papers 2106.05957, arXiv.org, revised Dec 2022.

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