Rational Laymen versus Over-Confident Experts:Who Survives in the Long Run?

In this paper we study the equilibrium in a heterogeneous economy with twogroups of investors. Over-confident experts incorrectly assume that their signalfor the drift of the dividend process is correlated with the true drift, butinterpret the signal otherwise perfectly. Rational laymen avoid the experts’error, but their signal is noisier than that received by the experts. We investigatewhich of these two problems is more severe by computing long-runequilibrium consumption shares for the two groups. Our results indicate thatover-confidence might be a more serious problem than limited informationprocessing capability.