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Overconfidence by Bayesian Rational Agents

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  • Eric Van den Steen

    (Harvard Business School, Strategy Unit)

Abstract

This paper derives two mechanisms through which Bayesian-rational individuals with differing priors will tend to be relatively overconfident about their estimates and predictions, in the sense of overestimating the precision of these estimates. The intuition behind one mechanism is slightly ironic: in trying to update optimally, Bayesian agents overweight information of which they over-estimate the precision and underweight in the opposite case. This causes overall an over-estimation of the precision of the final estimate, which tends to increase as agents get more data.

Suggested Citation

  • Eric Van den Steen, 2010. "Overconfidence by Bayesian Rational Agents," Harvard Business School Working Papers 11-049, Harvard Business School.
    • Handle: RePEc:hbs:wpaper:11-049
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    8. Mikael Apel & Carl Andreas Claussen & Petra Gerlach-Kristen & Petra Lennartsdotter & Øistein Røisland, 2013. "Monetary policy decisions – comparing theory and “inside” information from MPC members," Working Paper 2013/03, Norges Bank.
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    10. J. A. García & Rosa Rodriguez-Sánchez & J. Fdez-Valdivia, 2016. "Why the referees’ reports I receive as an editor are so much better than the reports I receive as an author?," Scientometrics, Springer;Akadémiai Kiadó, vol. 106(3), pages 967-986, March.
    11. Louis Lévy-Garboua & Muniza Askari & Marco Gazel, 2018. "Confidence biases and learning among intuitive Bayesians," Theory and Decision, Springer, vol. 84(3), pages 453-482, May.
    12. Ellina, Polina & Mascarenhas, Briance & Theodossiou, Panayiotis, 2020. "Clarifying managerial biases using a probabilistic framework," Journal of Behavioral and Experimental Finance, Elsevier, vol. 27(C).
    13. Louis Lévy-Garboua & Muniza Askari & Marco Gazel, 2018. "Confidence biases and learning among intuitive Bayesians," Post-Print hal-01558394, HAL.
    14. Kataria, Mitesh, 2017. "How long do you think it will take? Field Evidence on Gender Differences in Time Optimism," Working Papers in Economics 694, University of Gothenburg, Department of Economics.
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    16. Martin Koudstaal & Randolph Sloof & Mirjam van Praag, 2015. "Are Entrepreneurs more Optimistic and Overconfident than Managers and Employees?," Tinbergen Institute Discussion Papers 15-124/VII, Tinbergen Institute.
    17. Choi, Tsan-Ming, 2018. "Incorporating social media observations and bounded rationality into fashion quick response supply chains in the big data era," Transportation Research Part E: Logistics and Transportation Review, Elsevier, vol. 114(C), pages 386-397.
    18. Hendrik Hakenes & Svetlana Katolnik, 2018. "Optimal Team Size and Overconfidence," Group Decision and Negotiation, Springer, vol. 27(4), pages 665-687, August.
    19. Alonso, Ricardo & Câmara, Odilon, 2016. "Bayesian persuasion with heterogeneous priors," Journal of Economic Theory, Elsevier, vol. 165(C), pages 672-706.
    20. Xiaochao Wei & Yanfei Zhang & Qi Liao & Guihua Nie, 2022. "Multi-Agent Simulation of Product Diffusion in Online Social Networks from the Perspective of Overconfidence and Network Effects," Sustainability, MDPI, vol. 14(11), pages 1-18, May.
    21. Uri Gneezy & Moshe Hoffman & Mark A Lane & John A List & Jeffrey A Livingston & Michael J Seiler, 2023. "Can wishful thinking explain evidence for overconfidence? An experiment on belief updating," Oxford Economic Papers, Oxford University Press, vol. 75(1), pages 35-54.
    22. Shoufeng Ji & Dan Zhao & Xiaoshuai Peng, 2018. "Joint Decisions on Emission Reduction and Inventory Replenishment with Overconfidence and Low-Carbon Preference," Sustainability, MDPI, vol. 10(4), pages 1-21, April.
    23. Citci, Sadettin Haluk & Inci, Eren, 2016. "Career concerns and Bayesian overconfidence of managers," International Journal of Industrial Organization, Elsevier, vol. 46(C), pages 137-159.
    24. Johannes Binswanger & Anja Garbely & Manuel Oechslin, 2023. "Investor beliefs about transformative innovations under uncertainty," Economica, London School of Economics and Political Science, vol. 90(360), pages 1119-1144, October.
    25. Jiang, Li & Hao, Zhongyuan, 2024. "Holding diverse market beliefs by firms: Information flow, profit performances, and channel structure," Omega, Elsevier, vol. 126(C).

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