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Overconfidence in Psychology and Finance – an Interdisciplinary Literature Review

  • Skala, Dorota

This paper reviews the literature on one of the most meaningful concepts in modern behavioural finance, the overconfidence phenomenon. Overconfidence is presented as a well-developed psychological theory, with main facets comprising miscalibration, betterthan- average effect, illusion of control and unrealistic optimism. The primary applications of overconfidence in contemporary finance are analysed, from the perspective of financial markets and corporate behaviour. Experimental studies, formal models and analyses of market data demonstrate that overconfidence at least partially solves some financial market puzzles that cannot be accounted for by standard economic theory. Overconfidence in the corporate context may affect not only a company’s internal financing structure, but also its interactions with other market participants through merger and acquisition activity.

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File URL: http://mpra.ub.uni-muenchen.de/26386/1/MPRA_paper_26386.pdf
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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 26386.

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Date of creation: Apr 2008
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Handle: RePEc:pra:mprapa:26386
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  6. J. Bradford De Long & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann,, . "The Survival of Noise Traders in Financial Markets," J. Bradford De Long's Working Papers _123, University of California at Berkeley, Economics Department.
  7. Friesen, Geoffrey & Weller, Paul A., 2006. "Quantifying cognitive biases in analyst earnings forecasts," Journal of Financial Markets, Elsevier, vol. 9(4), pages 333-365, November.
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  10. Maciejovsky, B. & Kirchler, E., 2001. "Simultaneous Over-and Underconfidence: Evidence from Experimental Aseet Markets," Papers 185, Flinders of South Australia - Discipline of Economics.
  11. Hirshleifer, David & Luo, Guo Ying, 2001. "On the survival of overconfident traders in a competitive securities market," Journal of Financial Markets, Elsevier, vol. 4(1), pages 73-84, January.
  12. J. Bradford De Long & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, . "Noise Trader Risk in Financial Markets," J. Bradford De Long's Working Papers _124, University of California at Berkeley, Economics Department.
  13. Juslin, Peter, 1994. "The Overconfidence Phenomenon as a Consequence of Informal Experimenter-Guided Selection of Almanac Items," Organizational Behavior and Human Decision Processes, Elsevier, vol. 57(2), pages 226-246, February.
  14. Gilles Hilary & Lior Menzly, 2006. "Does Past Success Lead Analysts to Become Overconfident?," Management Science, INFORMS, vol. 52(4), pages 489-500, April.
  15. Terrance Odean, 1999. "Do Investors Trade Too Much?," American Economic Review, American Economic Association, vol. 89(5), pages 1279-1298, December.
  16. Daniel Kahneman & Dan Lovallo, 1993. "Timid Choices and Bold Forecasts: A Cognitive Perspective on Risk Taking," Management Science, INFORMS, vol. 39(1), pages 17-31, January.
  17. Dawes, Robyn M. & Mulford, Matthew, 1996. "The False Consensus Effect and Overconfidence: Flaws in Judgment or Flaws in How We Study Judgment?," Organizational Behavior and Human Decision Processes, Elsevier, vol. 65(3), pages 201-211, March.
  18. J B Heaton, 2002. "Managerial Optimism and Corporate Finance," Financial Management, Financial Management Association, vol. 31(2), Summer.
  19. Soll, Jack B., 1996. "Determinants of Overconfidence and Miscalibration: The Roles of Random Error and Ecological Structure," Organizational Behavior and Human Decision Processes, Elsevier, vol. 65(2), pages 117-137, February.
  20. Brad M. Barber & Terrance Odean, 2000. "Trading Is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors," Journal of Finance, American Finance Association, vol. 55(2), pages 773-806, 04.
  21. Dan Lovallo & Colin Camerer, 1999. "Overconfidence and Excess Entry: An Experimental Approach," American Economic Review, American Economic Association, vol. 89(1), pages 306-318, March.
  22. Chuang, Wen-I & Lee, Bong-Soo, 2006. "An empirical evaluation of the overconfidence hypothesis," Journal of Banking & Finance, Elsevier, vol. 30(9), pages 2489-2515, September.
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