We Should Totally Open a Restaurant: How Optimism and Overconfidence Affect Beliefs

25 Pages Posted: 7 Nov 2013 Last revised: 23 Nov 2015

See all articles by Stephanie Heger

Stephanie Heger

Washington University in St. Louis - Department of Economics

Nicholas W. Papageorge

Johns Hopkins University Department of Economics

Date Written: November 23, 2013

Abstract

Overestimating the probability of high-payoff outcomes is a widely-documented phenomenon that can affect decision-making in numerous domains, including finance, management, and entrepreneurship. In this paper, we design an experiment to distinguish between two often-confounded beliefs biases, optimism and overconfidence, both of which can explain why individuals over-estimate the probability of high-payoff outcomes. Optimism occurs when individuals, independent of their own performance, over-estimate the probability of outcomes they prefer. Overconfidence occurs when individuals believe they perform better than they actually do. We find that optimism and overconfidence are positively correlated at the individual level and that both optimism and overconfidence help to explain why individuals over-estimate high-payoff outcomes. Our findings challenge previous work that focuses solely on overconfidence to explain behavior. The reason is that ignoring the role of optimism results in an upwardly biased estimate of the role of overconfidence. To illustrate the magnitude of the problem, we show that 30% of our observations are misclassified as under- or over-confident if optimism is omitted from the analysis.

Keywords: Experiments, subjective beliefs, overconfidence, optimism, entrepreneurship

JEL Classification: C91, D03, D84, L26

Suggested Citation

Heger, Stephanie and Papageorge, Nicholas W., We Should Totally Open a Restaurant: How Optimism and Overconfidence Affect Beliefs (November 23, 2013). Available at SSRN: https://ssrn.com/abstract=2348410 or http://dx.doi.org/10.2139/ssrn.2348410

Stephanie Heger (Contact Author)

Washington University in St. Louis - Department of Economics ( email )

One Brookings Drive
St. Louis, MO 63130
United States

Nicholas W. Papageorge

Johns Hopkins University Department of Economics ( email )

3400 Charles Street
Baltimore, MD 21218-2685
United States

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
129
Abstract Views
973
rank
235,838
PlumX Metrics