Munich Personal RePEc Archive

Overconfidence and risk dispersion

Heller, Yuval (2010): Overconfidence and risk dispersion.

WarningThere is a more recent version of this item available.
[img]
Preview
PDF
MPRA_paper_25893.pdf

Download (972Kb) | Preview

Abstract

Experimental evidence suggests that people tend to be overconfident in the sense that they overestimate the accuracy of their own predictions. In this paper we present a simple principal-agent model in which principal's interest in dispersing risk motivates him to hire overconfident agents. We show that the induced overconfidence satisfies experimental stylized facts (such as, hard-easy effect, false certainty effect and underuse of base rates). In addition, we show that overconfidence is a unique stable evolutionary strategy, and that it can Pareto-improve social welfare. Finally, we demonstrate applicability by: 1) demonstrating why CEOs hire overconfident intermediate managers, and 2) explaining why investors prefer overconfident entrepreneurs.

Available Versions of this Item

UB_LMU-Logo
MPRA is a RePEc service hosted by
the Munich University Library in Germany.