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Risk, Overconfidence and Production in a Competitive Equilibrium

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  • Just, David R.
  • Cao, Ying
  • Zilberman, David

Abstract

Previous studies have found underestimation of risk, or overconfidence, to be pervasive. In this paper, we model overconfidence as a reduction in perceived variance. We generalize the analysis of Sandmo and examine the effects of competition on firms displaying overconfidence. Cases for both competitive equilibrium and imperfect competition are investigated. We show that overconfidence may strictly dominate rationality in a competitive market by leading risk averse producers to invest greater amounts and produce more. This leads to a higher average profit, and greater variance of profits, leaving the producer a greater probability of surviving competitive pressures. Despite the greater variance of profits, if enough producers underestimate their risk, they should collectively drive more rational decision makers from the market. Our results suggest that overconfidence may be as important a determinant of market behavior as diminishing marginal utility of wealth.

Suggested Citation

  • Just, David R. & Cao, Ying & Zilberman, David, 2009. "Risk, Overconfidence and Production in a Competitive Equilibrium," 2009 Annual Meeting, July 26-28, 2009, Milwaukee, Wisconsin 49161, Agricultural and Applied Economics Association.
  • Handle: RePEc:ags:aaea09:49161
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    References listed on IDEAS

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    6. Daniel A. Sumner & Christopher A. Wolf, 1996. "Quotas without Supply Control: Effects of Dairy Quota Policy in California," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 78(2), pages 354-366.
    7. Arathi Bhaskar & John C. Beghin, 2010. "Decoupled Farm Payments and the Role of Base Acreage and Yield Updating Under Uncertainty," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 92(3), pages 849-858.
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    Keywords

    Overconfidence; Misperception; Production; Competition; Production Economics; Risk and Uncertainty;

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