This paper aims to give an overview of two related human traits that have attracted particularly wide interest, namely overconfidence and overoptimism. The two are closely related to each other, and often used synonymously. Broadly speaking, overconfidence results in underestimation of future risks, e.g. the riskiness of future cash flows, whilst overoptimism leads to an overestimation of future positive outcomes, e.g. the future returns of a company. Besides, the paper wants to deduct suggestions for further research, by systematically identifying uncovered topics in existing literature.
This paper also provides a closer look at the empirical methods normally applied in
field studies. Although the phenomena are intuitively understandable, empirical researchstill presents itself as a mosaic of fragmented testing rather than a coherent
framework. One may assume that this is mainly caused by the difficult measurability of overconfidence and overoptimism: On the one hand, the decision maker, convinced of his own rationality, contributes zero overconfidence or overoptimism to his actions.
On the other hand, even a neutral observer cannot specify any degree of biasedness a priori, as stochastic outcomes per definition do not allow for perfect prediction. Therefore, scientists frequently rely on proxy variables that at least allow for measuring a group’s average overoptimism or overconfidence.
Furthermore, this paper empirically examines several considerations regarding existing
research and measurement methods. It particularly aims to connect biasedness with certain personal and economic characteristics, namely participants’ gender, industry affiliation, company life cycle, success and risk preferences. Additionally, different methods are employed for measuring overoptimism. By comparing the strength of bias indicated by each scaling, one gets interesting insights into the influence that question design has on test results.
Table of Contents
1. INTRODUCTION
2. LITERATURE REVIEW
2.1. DEFINITIONS
2.2. CHARACTERISTICS
2.2.1. Inherent Bias Structure
2.2.2. Agent Characteristics
2.2.3. Project Characteristics
2.2.4. Agent-Project Relationship
2.3. IMPACT ON ECONOMIC BEHAVIOR
2.3.1. Impact on Private Behavior
2.3.2. Impact on Business Behavior
2.4. IMPACT ON COMPANY VALUE AND OVERALL WELFARE
2.5. PRELIMINARY CONCLUSION
3. MEASUREMENT METHODS
3.1. METHODS BASED ON QUALITATIVE EXPRESSIONS
3.2. METHODS BASED ON SUBJECTIVE VALUATION
3.2.1. Subjective Valuation and Overoptimism
3.2.2. Subjective Valuation and Overconfidence
3.3. ACTION-BASED METHODS
3.4. PRELIMINARY CONCLUSION
4. EMPIRICAL EVIDENCE
4.1. DEFINITIONS
4.2. DATA
4.3. BIAS AND GENDER
4.4. BIAS AND INDUSTRY AFFILIATION
4.5. BIAS AND COMPANY LIFE CYCLE
4.6. BIAS AND REMUNERATION RISK PROFILE
4.7. BIAS AND INDIVIDUAL SUCCESS
4.8. PRELIMINARY CONCLUSION
5. CONCLUSION
Research Objectives and Core Themes
This thesis examines the influence of overoptimism and overconfidence on economic behavior. It aims to synthesize existing literature, identify robust measurement methods for these traits, and provide empirical evidence regarding their prevalence and impact on decision-making across different individual and professional contexts.
- Theoretical definitions and structural characteristics of overoptimism and overconfidence.
- Impact of cognitive biases on private and business decision-making processes.
- Methodological analysis of qualitative, subjective, and action-based measurement techniques.
- Empirical investigation into the correlations between biasedness and demographic/professional characteristics.
- Analysis of the broader implications of behavioral biases for corporate value and economic welfare.
Excerpt from the Book
2.1. DEFINITIONS
In existing research, definitions of overoptimism and overconfidence usually differ according to the dimension looked at: One group of papers concentrates on individuals’ justification for biasedness, i.e. individual skills versus external development. The other group refers to the parameter underlying individuals’ expectations, i.e. risk estimations versus return estimations.
Camerer and Lovallo (1999) or Malmendier and Tate (2005) for example belong to the first group. Accordingly, an overconfident person expects his own behavior to be abnormally successful, which is often referred to as the “better-than-average effect”. An overoptimistic person estimates events beyond his control to be outstandingly positive.
Other sources such as Kyle and Wang (1997), Odean (1998), Hackbarth (2004) and Brettel and Kasch (2006) belong to the second group. They define overoptimism and overconfidence looking at the underlying development characteristics of growth and volatility. An overoptimistic person predicts that favorable events are more likely or more positive than they actually are. In investment decisions for example he overestimates a project’s future returns or growth rates. An overconfident person believes they have more precise knowledge about unknown events than they actually have. In investment decisions for example he underestimates the riskiness or volatility of the project’s future cash flows. Hackbarth refers to overoptimism as “growth perception bias” and to overconfidence as “risk perception bias”.
Summary of Chapters
1. INTRODUCTION: Outlines the shift from traditional rational economic theory to behavioral economics, highlighting the research focus on overconfidence and overoptimism.
2. LITERATURE REVIEW: Categorizes and synthesizes academic research regarding the characteristics and economic impacts of overoptimism and overconfidence in both personal and professional environments.
3. MEASUREMENT METHODS: Evaluates various empirical approaches used to identify and quantify estimation biases, distinguishing between qualitative, subjective, and action-based methodologies.
4. EMPIRICAL EVIDENCE: Presents an empirical study analyzing the connection between bias levels and individual characteristics such as gender, industry, company life cycle, and professional success.
5. CONCLUSION: Summarizes key findings and proposes future research directions regarding the persistence and impact of cognitive biases in organizational and economic decision-making.
Keywords
Behavioral Economics, Overoptimism, Overconfidence, Growth Perception Bias, Risk Perception Bias, Better-than-average Effect, Illusion of Control, Investment Valuation, Corporate Financing, Economic Behavior, Decision Making, Cognitive Bias, Self-serving Bias, Behavioral Finance, Empirical Evidence.
Frequently Asked Questions
What is the core focus of this thesis?
This work explores the behavioral economic traits of overoptimism and overconfidence, examining how these cognitive biases influence decision-making and economic outcomes.
What are the primary themes discussed?
The paper covers the theoretical classification of biases, their impact on corporate finance and investment, methodologies for measuring them, and their correlation with professional and personal characteristics.
What is the main goal of the research?
The thesis aims to provide a comprehensive framework for understanding how these biases operate, evaluate the reliability of current measurement methods, and empirically test their influence on business-related decisions.
Which methodologies are employed?
The study utilizes a literature review to synthesize theoretical models and conducts an empirical survey (n=38) among graduates to test hypotheses regarding bias correlations with demographics and industry choices.
What topics are covered in the main section of the paper?
The main section details definitions, the inherent structures of these biases, their impact on private and professional decision-making (specifically hierarchy, performance, valuation, and financing), and their effect on company value.
Which keywords best characterize this work?
The work is characterized by terms such as Behavioral Economics, Growth/Risk Perception Bias, Better-than-average Effect, and Corporate Financing.
How does the author distinguish between overoptimism and overconfidence?
The author defines overoptimism primarily as a "growth perception bias" and overconfidence as a "risk perception bias," noting that while related, they involve different estimation parameters.
What did the empirical analysis regarding company life cycle reveal?
The empirical findings suggested that students planning to work for established players exhibited higher biasedness, which paradoxically contradicted the initial hypothesis that entrepreneurs would be the most biased group.
- Citation du texte
- Andreas Müller (Auteur), 2007, Impact of overoptimism and overconfidence on economic behavior: Literature review, measurement methods and empirical evidence, Munich, GRIN Verlag, https://www.grin.com/document/82940
