Overconfidence Effect - Practical Implications

Practical Implications

"Overconfident professionals sincerely believe they have expertise, act as experts and look like experts. You will have to struggle to remind yourself that they may be in the grip of an illusion."

Overconfidence has been called the most “pervasive and potentially catastrophic” of all the cognitive biases to which human beings fall victim. It has been blamed for lawsuits, strikes, wars, and stock market bubbles and crashes.

Strikes, lawsuits, and wars could arise from overplacement. If plaintiffs and defendants were prone to believe that they were more deserving, fair, and righteous than their legal opponents, that could help account for the persistence of inefficient enduring legal disputes. If corporations and unions were prone to believe that they were stronger and more justified than the other side, that could contribute to their willingness to endure labor strikes. If nations were prone to believe that their militaries were stronger than were those of other nations, that could explain their willingness to go to war.

Overprecision could have important implications for investing behavior and stock market trading. Because Bayesians cannot agree to disagree, classical finance theory has trouble explaining why, if stock market traders are fully rational Bayesians, there is so much trading in the stock market. Overprecision might be one answer. If market actors are too sure their estimates of an asset’s value is correct, they will be too willing to trade with others who have different information than they do.

Oskamp (1965) tested groups of clinical psychologists and psychology students on a multiple-choice task in which they drew conclusions from a case study. Along with their answers, subjects gave a confidence rating in the form of a percentage likelihood of being correct. This allowed confidence to be compared against accuracy. As the subjects were given more information about the case study, their confidence increased from 33% to 53%. However their accuracy did not significantly improve, staying under 30%. Hence this experiment demonstrated overconfidence which increased as the subjects had more information to base their judgment on.

Even if there is no general tendency toward overconfidence, social dynamics and adverse selection could conceivably promote it. For instance, those most likely to have the courage to start a new business are those who most overplace their abilities relative to those of other potential entrants. And if voters find confident leaders more credible, then contenders for leadership learn that they should express more confidence than their opponents in order to win election.

Overconfidence can be beneficial to individual self-esteem as well as giving an individual the will to succeed in their desired goal. Just believing in oneself may give one the will to take one's endeavours further than those who do not.