Edited by Victor J. Tremblay, Elizabeth Schroeder and Carol Horton Tremblay
Underestimation of risk as well as overestimation of mean outcomes has been widely documented in both experimental and field settings. These biases in perception are commonly referred to (either jointly or in isolation) as overconfidence. Several researchers have examined the implications of overconfident decision makers in the context of firms attempting to maximize profit in isolation. We review this literature and then extend this analysis to determine the impact of competitive market forces on overconfident firms. We generalize the analysis of Sandmo, who examined the impact of risk on competitive markets, extending his results to firms displaying overconfidence. We explore the case of imperfect competition, showing that overconfident firms may strictly dominate firms displaying perfect perception in a competitive market. Overconfident producers invest greater amounts and produce more than those with accurate perception. Under risk aversion, modest overconfidence leads to a higher average profit and greater variance of profits, leaving the producer a greater probability of surviving downward competitive pressures. Despite the greater variance of profits, if enough producers underestimate their risk, they should collectively drive decision makers with more accurate perceptions from the market. For this reason, overconfidence may be as important a determinant of market behavior as diminishing marginal utility of wealth or loss aversion.
You are not authenticated to view the full text of this chapter or article.
Elgaronline requires a subscription or purchase to access the full text of books or journals. Please login through your library system or with your personal username and password on the homepage.
Non-subscribers can freely search the site, view abstracts/ extracts and download selected front matter and introductory chapters for personal use.
Your library may not have purchased all subject areas. If you are authenticated and think you should have access to this title, please contact your librarian.