Overconfidence

Overconfidence is the most prevalent judgment bias. Several studies find that overconfidence can lead to suboptimal decisions on the part of investors, managers, or politicians. This chapter explains which effects are usually summarized as overconfidence, shows how to measure these effects, and discusses several factors affecting the degree of overconfidence of people. Furthermore, the chapter explains how overconfidence is modeled in finance and that the main assumptions, which assume that investors are miscalibrated by underestimating stock variances or by overestimating the precision of their knowledge, are a reasonable modeling assumption. Applications of overconfidence in the theoretical and empirical finance literature are also described