Behavioral finance FAQ / Glossary (Overconfidence)

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Dates of related message(s) in the
Behavioral-Finance group (*):
Year/month, d: developed / discussed,
i: incidental

Overconfidence bias, overconfident

(+ under confidence)

 



Seen in many messages, as a
BF classic
+ see attribution,

certainty effect, under-confidence,
optimism bias, illusion of control /
of knowledge, winner'scurse,
perverse effect, narcissism,
magical thinking, greater fool

I'm the best poker player in town. And the best gun.

I'm dead sure I cannot lose any bet!

As you can read on my tombstone.

Definition:

An overconfidence bias is seen when somebody relies
too much on his own judgment, foresight and
abilities.

=> Better be self-confident to take initiatives and
      make
progress, or better say, just to live,
=> Except that too much of the good thing can be fatal !

This bias does not leave much room for adaptation to
    realities
, thus  it becomes easily a source of wrong decisions
.

This attitude can encompass various illusions (see below).
In its extreme form, it can rest on a systematic certainty to be right (see
certainty effect / pseudo-certainty
), a mental blindness
(see selective perception).

How to be overconfident...

...or preferably not.

Overconfidence can result either from inexperience or from (happy or
paranoid) self-admiration (and sometimes both!).

The overconfident person tends to:

Overestimate the chances of success of its own moves
  (complacency),

It reflects an illusion of control / of competence / of
knowledge / of experience
(see the illusion gossary page).

Genius inside!

It might include magical thinking and narcissism

(see those phrases).

Those are typical biases for people with an extreme belief that
luck is always on their side. They might not realise that, in their
previous successes, luck had its place and luck tend to regress
to the mean.


Underestimate the associated risks (and perverse
   effects) of its decisions.


In both aspects, overestimate the rightness of its own thinking.

What does it leads to?

Sensorial deprivation?


Overconfidence
and
over-optimism
are not always
the same

although they
might coexist.

 

 





Overconfidence is a biased self-centered
anticipation that can cause

Either over-optimism (see optimism)

This is the case when taking a naive initiative
on what is seen as a favorable situation,
by neglecting all the pitfalls and drawbacks,
and forgetting the base rate (see that phrase)
of success of comparable ventures.

As well as over-pessimism

This is the opposite case, for example
when deciding to avoid such an initiative,
by seeing those prospects as doomed
from the start, without exploring all its
possibilities.

Overconfidence
and

rashness 
are not always
the same

although they might
coexist.


Overconfidence can lead to:

Either rushing into not well thought and  

poorly informed wild moves, overtrading
for example,

Or on the contrary delaying (see that

word) decisions about needed changes
of practices.

A self-attribution (see attribution) of past
successes or failures can trigger those feelings.

Individual and group overconfidence

Blinded by the crowd.


As reality is often seen as an unpleasant limitation against our desires,
overconfidence is rather common in most aspects of life. It can be:

Either an individual attitude.

   For example, most car drivers think their abilities as superior
   to those of the other members of the motorized crowd

Also, for some people, overconfidence reaches extremes of
self-admiration and becomes narcissism (see that word).

Or a group contamination.

People who belong to a group (corporation, profession, organization,
ethnic group, community, country):

* Tend to be more confident than when they are alone.

* Might also think that "their" group's abilities are superior to
   those of other groups
.


This common blindness can lead to poor decisions by the group's
members.
Still worse, it falls sometimes into extreme moves
Some under-confident / insecure people choose to belong to a strong-
looking group,as a way to feel more secure and confident.

=> It might explain the success of some absolutist self-centered cults
     or fanatical political movements
.

More generally group overconfidence sometimes leads to
extremes of:

Arrogance, hubris, complacency and distrust of things / ideas /

info coming from the outside ("not invented here").

It results in irrational decisions or in neglect to take into account
external realities.

Aversion to "strangers" (xenophobia, racism, parochialism...).

Overconfidence in management and in finance

Going to the business war with flowers and no helmet.

Overconfidence seems more common than under-confidence in many fields
of life.

How many wars were started because of overconfidence!

This is notably the case in business and financial decisions.

Maybe entrepreneurs, managers and traders are specific species of warriors,
even conquerors.

And maybe it is a luck in some circumstances, as without their fighting
instinct
, things would be at a standstill.

Another well known overconfidence effect is seen in project management,
as many projects needs much more money and time than originally planned.

In asset markets, overconfident investors / traders (and also
borrowers, corporate managers, advisers...) tend to overestimate

Their information (knowledge illusion),

The accuracy of their estimates

Their abilities to win

(control illusion, experience illusion).

Inexperienced traders tend to be overconfident ...until the day when things
turn bad.

In a lesser degree, about every trader thinks (s)he can beat the market.

This may induce him/her to take undue risks

and / or to overpay its prey and its victory (see winner's curse).

It is often a factor in overtrading (see that word), overconfident
   traders have the idea
that whatever moves they make, they will be the
   right ones.

Under-confidence (*), overconfidence
     and market sentiment

When the individual investor, or the market crowd,
feels self-confident,
or on the contrary starts to wonder and to have doubts.


In financial matters, under- /over- confidence is about ones' own abilities
to take the right buy or sell decisions, not about market prospects.

For example, an investor can be pessimistic about the market
and confident in his/her own ability to take advantage of it.

But some social mood theorist link market rises and falls to waves of
collective over- and under-confidence that foster widespread and
exaggerated hope or gloom.

That thesis is partly true as:

A random streak of luck in the market could fuel overconfidence
   (see self-attribution)
and lead to take more and more frequent, large
   and risky bets.

     Obviously, no surprise here, overconfidence reaches more

and more people in bullish markets.

Well, about every investor feels lucky or smart then.

He thinks he will be able to find in time a less smart one, a "greater
fool" (see that phrase) to sell him the burning log.

This makes him keep his assets for too long, and to buy new ones,
even when warned that they got grossly overpriced.

This behavior sustains and develops price bubbles.

Also, any outside event that creates a "feel good" sentiment, even if
   it has nothing to do
with economy and finance, can boost confidence
   and self esteem.

(*) For underconfidence (as the mirror sentiment of overconfidence

and thus related to as well its causes as its consequences) see the article
on that phrase.

(*) To find those messages: reach that BF group and, once there,
      1) click "messages", 2) enter your query in "search archives".

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This page last update: 19/07/15           

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