Overconfidence

Question 1

What is miscalibration?

Answer 1

• times when an event is supposed to happen actually happens
• systematic deviation from perfect calibration
• unwarranted belief in correctness of one’s answer
• evidence of overconfidence

People think they are better than the average

Question 2

What is illusion of control?

Answer 2

Exaggeration of the degree that they can control their own fate, and misperceive games of chance and games of skill

Question 3

What is optimism?

Answer 3

• Most people’s beliefs are biased in the direction of optimism
• Optimists also underestimate the likelihood of bad things happening to them over which they have no control

Question 4

What are the factors which impact the accuracy-confidence relationship? 4

Answer 4

• complexity of a task:as tasks get easier, overconfidence is reduced
• amount of feedback:failure to learn from experience causes overconfidence
• motivation level of participant
• skills of the participant:overconfidence in tasks people have expertise in

Question 5

What are the views on overconfidence in trading? 3

Answer 5

• men are more confident than women so they trade more frequently than women but they earn less
• trading volume increases:overconfidence generates trading. Those who trade more fare worse than those who trade less
• overconfident traders hold under diversified portfolios. Riskier portfolios though they have the same degree of risk aversion

Question 6

What is the theoretical evidence of overconfidence? 3

Answer 6

• odeon (1999):investors receive noisy/imperfect info that they think is more precise than it actually is. Also finds that stocks individuals sell outperform the stocks they buy (individual investors trade too much)
• Statman et al(2006): higher confidence leads to higher trading volume is high past returns are a good proxy for overconfidence
• Kim and Nofsinger(2002): Asian cultures are more prone to overconfidence

But these empirical studies using proxies of overconfidence is subject to the shortcoming that overconfidence isn’t actually observed

Question 7

What is overconfidence? 3

Answer 7

• arises from not knowing the limits of one’s own knowledge/abilities
• is the overestimation of the accuracy and precision of one’s knowledge
• is the overestimation if one’s skills ore abilities