Overconfidence and risk dispersion
Experimental evidence suggests that people tend to be overconfident in the sense that they overestimate the accuracy of their own predictions. In this paper we present a simple principal-agent model in which principal's interest in dispersing risk motivates him to hire overconfident agents. We show that the induced overconfidence satisfies experimental stylized facts (such as, hard-easy effect, false certainty effect and underuse of base rates). In addition, we show that overconfidence is a unique stable evolutionary strategy, and that it can Pareto-improve social welfare. Finally, we demonstrate applicability by: 1) demonstrating why CEOs hire overconfident intermediate managers, and 2) explaining why investors prefer overconfident entrepreneurs.
|Date of creation:||26 Sep 2010|
|Date of revision:|
|Contact details of provider:|| Postal: Ludwigstraße 33, D-80539 Munich, Germany|
Web page: https://mpra.ub.uni-muenchen.de
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- Bruce A. Weinberg, 2009.
"A Model Of Overconfidence,"
Pacific Economic Review,
Wiley Blackwell, vol. 14(4), pages 502-515, October.
- Simon Gervais & Terrance Odean, .
"Learning To Be Overconfident,"
Rodney L. White Center for Financial Research Working Papers
5-97, Wharton School Rodney L. White Center for Financial Research.
- Simon Gervais & Terrance Odean, . "Learning To Be Overconfident," Rodney L. White Center for Financial Research Working Papers 05-97, Wharton School Rodney L. White Center for Financial Research.
- Robson, Arthur J., 1996. "A Biological Basis for Expected and Non-expected Utility," Journal of Economic Theory, Elsevier, vol. 68(2), pages 397-424, February.
- Skala, Dorota, 2008. "Overconfidence in Psychology and Finance – an Interdisciplinary Literature Review," MPRA Paper 26386, University Library of Munich, Germany.
- David V. Budescu & Ning Du, 2007. "Coherence and Consistency of Investors' Probability Judgments," Management Science, INFORMS, vol. 53(11), pages 1731-1744, November.
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