Behavioral finance FAQ / Glossary (Underconfidence)
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See overconfidence, delaying
Afraid to be wrong and unable to choose?
People might be under-confident in their possible performance
compared to what they deem could bring a good result.
Effect #1: when it freezes decision
Underconfidence tends to make people freeze decision making,.
Yes it can affect nvestors (even if, you guessed it, the words
"underconfident" and "investor" are rarely found together,
s investing is to commit money.
Actually there is a rather general decision aversion (see decision /
indecision), or an action aversion, because not only it is an effort
(thus laziness might interfere) to decide or act but also because of
=> It might be one of the explanations why the status quo bias, or
the default solution, or delaying tactics (see those phrases) are
Effect #1 :
Delayed economic / financial adjustment
Many investors might procrastinate when they face events
that change the prospects. They delay the needed action (buying, selling...).
This has "macro effects" as it translates into an underreaction in
Market price adjustments are not instantaneous, they take place gradually
And then overconfidence / overreaction (see those words) can strike
in their turn and lead to excessive prices in the other direction.
This is seen as the main explanation
of momentum / trends.
Effect #2: when it leads to mimicry
In some cases, underconfidence makes investor lose their autonomy and
be easily influenced by other people advices without
checking by themselves if those advices are sound and if those people
can be trusted.
Underconfidence seems to be also one of the factors of
herding, groupthink, peer pressure...
Underconfidence should not be confused
with pessimism (or optimism)
As under / over confidence is about ones' own abilities, about how far
we trust or not our judgment. It does not necessarily entail pessimism or
optimism about market prospects.
You can be certain or uncertain that your pessimism or
optimism is right or wrong in the present state of the
market. Just choose your combination ;-)
On the other hand, some social mood theorists link market rises and falls
to waves of collective over- / underconfidence, leading to general optimism
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