Overconfidence by Bayesian Rational Agents

23 Pages Posted: 18 Nov 2010

See all articles by Eric Van den Steen

Eric Van den Steen

Harvard Business School - Strategy Unit

Date Written: November 17, 2010

Abstract

This paper derives two mechanisms through which Bayesian-rational individuals with differing priors will tend to be relatively overconfident about their estimates and predictions, in the sense of overestimating the precision of these estimates. The intuition behind one mechanism is slightly ironic: in trying to update optimally, Bayesian agents overweight information of which they over-estimate the precision and underweight in the opposite case. This causes overall an over-estimation of the precision of the final estimate, which tends to increase as agents get more data.

Suggested Citation

van den Steen, Eric, Overconfidence by Bayesian Rational Agents (November 17, 2010). Harvard Business School Strategy Unit Working Paper No. 11-049. Available at SSRN: https://ssrn.com/abstract=1710683 or http://dx.doi.org/10.2139/ssrn.1710683

Eric Van den Steen (Contact Author)

Harvard Business School - Strategy Unit ( email )

Harvard Business School
Soldiers Field Road
Boston, MA 02163
United States

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