Master in Economics of Business and Strategy

2M3E14 – Behavioral Economics (2023/24)

Anna Rubinchik

Overconfidence

These slides are adapted from course materials by Prof. Ricardo Gonçalves and Jo o Correia da Silva
based on Bazerman and Moore, “Judgement in Managerial Decision Making”.
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 OVERCONFIDENCE

A widely studied concept.

Its effects are reported to be potent, pervasive and
pernicious
Overconfidence is blamed for wars, stock market bubbles,
strikes, lawsuits, bankruptcy, horrible accidents
What is overconfidence?

Overcon dent professionals sincerely believe ey have exper se, act as experts and look like experts.
You wi have s u le remind yourself at ey may be in e grip of an i usion.
—Daniel Kahneman

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 OVERCONFIDENCE

From Wikipedia:
“The overcon dence effect is a well-established bias in which a
person's subjective con dence in their judgments is reliably greater
than the objective accuracy of those judgments.”

How would you measure objective accuracy of judgments?

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 OVERCONFIDENCE COMES IN THREE FLAVORS

Overprecision
▪ Be too sure that our judgments and decisions are accurate.
➢ Uninterested in testing our assumptions, and dismissive of contrarian evidence
➢ Draw overly narrow confidence intervals.

Overestimation
▪ Think we are better, smarter and more capable than we really are.
➢ Overestimate our ability to do things under time or resource constraints
➢ Believe we have more control than we actually do.

Overplacement
▪ Think we rank higher than others, especially in competitive contexts.
➢ Leads to excessive competition and impasses in negotiations.
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 PUT YOURSELF TO TEST
Make your best estimate and put a lower and upper bound so that you are right 95% of the time:

Question Estimate Lower Upper

1. Volkswagen’s revenue in 2021 (in EUR)
2. Google’s revenue in 2021 (in USD)
3. Portuguese GDP in 2021 (in EUR)
4. World population (July 1, 2020)

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 PUT YOURSELF TO TEST
Were you right 95% of the time?

Question Estimate
1. Volkswagen’s revenue in 2021 (in EUR) 250 billion EUR
2. Google’s revenue in 2021 (in USD) 258 billion USD
3. Portuguese GDP in 2021 (in EUR) 211 billion EUR
4. World population (July 1, 2020) 7 975 million

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 OVERPRECISION
In experiments the researchers claim that
▪ For the domains of expertise, intervals are
How should one narrower
measure overprecision? ▪ Experts might still miss the right answer.

Overprecision is blamed for

Is there a clear way to attribute ▪ Ship and plane crashes
bad outcomes to overprecision? Bad investment decisions
▪

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 REASONS FOR OVERPRECISION

▪ Desire to relieve internal dissonance regarding the right decision

➢ When seeking advice, we tend to prefer perspectives similar to ours.
➢ Our mind is better at searching for evidence that confirms our beliefs.
➢ Considering a different, contradictory, viewpoint is costly.

▪ Our expression of confidence might be beneficial: it helps others feel sure about us
➢ Politicians: confident individuals are more persuasive

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 OVERPRECISION AND RELATED PHENOMENA
Consequences of overprecision
▪ Being reluctant to revise our opinion, we ignore or attach lower weight to opinions of others.

Examples

1: When hiring an employee

▪ Grades and test results are better predictors of job performance than interviews
▪ But many managers believe they can screen the best candidates in a face-to-face interview.
2: Naïve realism
▪ Widespread belief that our view of the world is the
only sensible view

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 OVERESTIMATION

Control fallacy
▪ Overestimate of Control
Tendency to overestimate one's ability, performance, level of
control, ➢ If I choose our Euromillion numbers, I will have a
or chance of success.
better chance at winning!
➢ If I open a book shop, I will earn a lot!
This phenomenon is most likely to occur on hard tasks,
when failure is likely or when the individual making the ➢ I can climb this mountain without any equipment
estimate is not especially skilled.
that others bring!
▪ Underestimate of Control
➢ People are often fatalistic about health.

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 OVERESTIMATION

The planning fallacy

▪ We overestimate our speed at completing tasks
➢ Sydney Opera House was completed 10 years later and 14 times
over budget
▪ Despite knowledge that previous tasks have generally taken
longer than planned
➢ Students acknowledge they have typically finished past assignments
very close to their deadlines, and still insist they will finish the next
project well ahead of the deadline.
▪ We appear to base our estimates on an idealized and optimistic
scenario
➢ We should consider potential obstacles, temptations, interruptions,
and competing uses of time.
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 OVERESTIMATION

▪ Unrealistic optimism
➢ Savoring the prospect of a rosy future feels good.
▪ Defensive pessimism
➢ Pessimistic assessments about ourselves help avoid disappointment.
▪ We manage expectations strategically
➢ Start very optimistic: Enjoy anticipatory satisfaction
➢ Become pessimistic before receiving performance feedback
❑ Avoid bitter disappointment
❑ Experience pleasure of positive surprise.

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 OVERPLACEMENT

We believe to be better than others when we actually are not

▪ Known as the ‘better-than-average’ effect
➢ Do you believe you are an above-average student in this class?
➢ 93% of American drivers reported themselves to be more skillful than the median.
➢ Self-enhancement
➢ The place where where I live is the nicest in the world!
➢ I have the most brilliant cat!
▪ This is really system 1 thinking
➢ Upon reflection, people change their views and provide a more balanced perspective.

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 OVERPLACEMENT AND UNDERPLACEMENT

Underplacement also exists, most often on difficult tasks.

▪ We believe we perform above average on easy tasks and below average on difficult tasks
➢ 96% of students expect to lose a quiz on baroque music against a randomly selected student
➢ We believe we are more likely than others to experience common events (own a house, or live past 70)
and less likely to experience rare events (own an island, or live past 100).

Both extremes are problematic

▪ Overplacement leads us to engage in competitive situations that we will often lose
➢ Entrepreneurship, lawsuits, mergers, wars of attrition
➢ If you turn out to be worse than average at managing your firm, you may go bankrupt.
▪ Underplacement leads to missed opportunities

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 OVERCONFIDENCE
Overconfidence may be good…
▪ Optimism may enhance our psychological resilience and improve well-being
▪ Positive illusions about ourselves may enhance and protect our self-esteem

… but not necessarily good for decision making!

▪ We might behave arrogantly, carelessly and be self-centered

Strive to assess all alternatives clearly

▪ Gather and consider all available information, even if unpleasant.
▪ Learn from failure and identify what aspects of the decision can be improved.

Think about alternative perspectives

Question your beliefs and seek advice that does so as well

You may not like what you hear, but your final decision will be better.
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