CHAPTER 6
OVERCONFIDENCE
https://www.youtube.com/watch?v=E0X3xxV8upI
OVERCONFIDENCE
Various biases that
abet overconfidence
formation and
durability
Overconfidence: the tendency for
people to overestimate their
knowledge, abilities, and the
precision of their information, or
to be overly sanguine of the
future
and their ability to control it
Better-than- Illusion of Excessive
Miscalibration
average effect control optimism
MISCALIBRATION
Miscalibration is the tendency for people to overestimate the
precision of their knowledge.
Measured through calibration tests.
Ask people 50 multiple choice questions.
Then ask how many right? And compare the two numbers.
If you think you got 25 right…but you only got 15 right
You appear to be overconfident
BETTER-THAN-AVERAGE EFFECT
Better-than-average effect
Many rate themselves as above average on those attributes.
e.g. athletic skill or driving ability
One researcher surveyed a sample of students, reporting that 82% rated
themselves in the top 30% of their group on driving safety.
But only 50% of us can really be better than average.
ILLUSION OF CONTROL BIAS
Reveals itself when people think that they have more control over
events than objectively can be true.
E.g. gamblers may think that they can control the dice or the cards.
In one experiment, in a gambling contest, subjects made significantly higher
bets when they were facing the “schnook” than when facing the “dapper”.
Perhaps subjects’ feelings of superiority induced a mindset that they
could influence chance events.
EXCESSIVE OPTIMISM
Present when people’s predictions about the future are unrealistically
optimistic.
People assign probabilities to favourable/unfavorable outcomes that
are just too high/low given historical experience or reasoned analysis.
– E.g. winning the lottery (very positive events) or dying of cancer (very
negative events)
EXCESSIVE OPTIMISM
Planning fallacy: people often think that they can accomplish more
than they actually end up accomplishing, and that any costs incurred
will be as expected.
The Sydney Opera House, for instance, was supposed to be
completed in 1963 at a cost of $7 million. Instead, it was finished
10 years later at a cost of $102 million.
BEING OVERCONFIDENT IN MORE
THAN ONE SENSE
Excessive optimism and miscalibration can go hand in hand.
Suppose you purchase a stock
True distribution for the return on this stock over the next year entails an
expected return of 10%, with a 90% confidence range of -10% to 30%
You (optimistic) distribution, has expectation of 20%, with a 90%
confidence range of 10% to 30%
ARE PEOPLE EQUALLY
OVERCONFIDENT?
The extent of overconfidence may be a function of demographics.
Highly educated, high-income people are more overconfident.
Both men and women expected their portfolios to outperform the market –
but gap greater for men.
People have been shown to be sometimes overconfident and
sometimes underconfident, depending on the test
FACTORS IMPEDING CORRECTION
Why don’t we learn?
Self-attribution bias, the tendency for people to attribute successes or
good outcomes to their own abilities, while blaming failures on
circumstances beyond their control, can lead to an increase in
overconfidence.
Hindsight bias pushes people into thinking that “they knew it all along.”
Confirmation bias, the tendency to search out evidence consistent with
one’s prior beliefs and to ignore conflicting data.
Overconfidence may not be an unmitigated flaw.
FINANCIAL APPLICATIONS
In 15 surveys conducted between 1998 and 2000 by the Gallup
Organization for UBS PaineWebber, respondents were asked what they
expected the rates of return on the stock market and on their portfolios to
be in the following 12 months.
On average, respondents expected their portfolios to outperform the market—
that is, they were excessively optimistic. Interestingly, men expected their
portfolios to outperform by a higher margin than did women.
What would be the consequences?
CHAPTER WRAP-UP
https://www.youtube.com/watch?v=9erChFSHix4&t=40s
Quizzes
Test: Behavioral Finance Chapter 6: Overconfidence | Quizlet
