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|
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- Weinberg, Bruce A., 2009.
"A Model of Overconfidence,"
IZA Discussion Papers
4285, Institute for the Study of Labor (IZA).
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- 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.
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- Skala, Dorota, 2008. "Overconfidence in Psychology and Finance – an Interdisciplinary Literature Review," MPRA Paper 26386, University Library of Munich, Germany.
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