2. OVERCONFIDENCE BIAS
Overconfidence bias is a tendency to hold a false and misleading
assessment of our skills, intellect, or talent. In short, it’s an
egotistical belief that we’re better than we actually are. It can be a
dangerous bias and is very prolific in behavioral finance and capital
markets.
General Description
In finance and investing, overconfidence bias can result in excessive trading,
under-diversification, and taking excessive risks, among other pitfalls.
Recognizing and understanding overconfidence bias is crucial to making
better financial decisions and improving investment returns.
3. OVERCONFIDENCE BIAS
Technical Description
A technical description is a document that uses both visuals and text to inform a user of how
to use a product or complete a process. In the description, you can often find the name and
an overview of the product or process with key information about its functions and
components. You can also use these documents as a smaller piece of a larger document,
such as a project proposal plan. The description may be a few sentences or several pages
based on your audience and purpose.
4. PRACTICALAPPLICATION
Prediction overconfidnce :
Roger Clarke and Meir Statman demonstrated a classic example of prediction
overconfidence in 2000 surveyed on investors to guess the price range of the down jones
guesses .In the survey, few responses reasonably approximated the potential 1998 value
of the Dow, and no one estimated a correct confidence interval.
5. PRACTICALAPPLICATION
Certainty Overconfidence:
Certainty overconfidence is the perceived ability of the investors to actually pick the next
big stock with absolute certainty. These investors often believe that they have some kind
of acumen, which allows them to pick the next winner at a very early stage. Also,
sometimes investors fall prey to the notion that the quantity of information received
about an investment increases the quality of decision being made about it. The reality is
that even if investors have more information about a prospective investment opportunity,
it is unlikely to increase the efficiency of their decision making.
6. RESEARCH REVIEW
Title of research : “ Boys Will Be Boys Gender, Overconfidence, Common Stock
Investment.”
Author : Professors Brad Barber and Terrance Odean.
Year: 1991 to 1997
Description : The relationship between overconfidence as displayed by both men and
women and the impact of overconfidence on portfolio performance.
7. RESEARCH REVIEW
Rational investors only trade and purchase information when doing so increase their
expected duty.
On the other hand, overconfident investors can trade excessively as aresult they
believing that they process special knowledge that other don’t have.
Overconfident investors can underestimate their downside risks because they don’t
heed historical investment performance statistic.
Men will trade more and perform worse the women but both men and women would
have done better ,on average.
The stockmen chose to purchase underperformed those they chose to sell by 20 basis
points per month.
8. DIAGNOSTIC TESTING
PREDICTION OVERCONFIDENCE BIAS TEST
Question1: Give and high low estimates for the average weight of an adult male
sperm whale ( the largest of the toothed whales) in tones. Chose numbers far
enough apart to be 90 percent certain that the true answer lies somewhere in
between.
Answer : In actuality, the average weight of a male sperm whale is approximately 40
tons. Respondents specifying too restrictive a weight interval suspected to prediction
over confidence. A more inclusive response (20 to100 tones) is less symptomatic of
prediction overconfidence.
9. DIAGNOSTIC TESTING
PREDICTION OVERCONFIDENCE BIAS TEST
Question2: Give and high low estimates for the distance to the moon in miles. Choose
numbers far enough apart to be 90 percent certain that the true answer lies somewhere
in between.
Answer: The actual distance to the moon is 240000 miles. Again, respondent estimated
too narrow a range are likely to be susceptible to prediction overconfidence. Respondents
naming wider ranges (200000 to 500000 miles ) may not be susceptible of prediction
overconfidence.
10. CERTAINTY OVERCONFIDENCE BIAS TEST RESULTS ANALYSIS
DIAGNOSTIC TESTING
Prediction Overconfidence Bias Test Question 3: Relative to other drivers on the road, how
good a driver are you?
a. Below average
b. Average
C. Above average
d. Well above average
Analysis: The belief that one is an above – average deliver correlates positively with certainty
overconfidence susceptibility. Respondent describing themselves as average or below average
drivers are less likely to exhibit certainty overconfidence.
11. CERTAINTY OVERCONFIDENCE BIAS TEST RESULTS ANALYSIS
DIAGNOSTIC TESTING
How would you characterize your personal level of investment sophistication?
a. Unsophisticated
b. Somewhat sophisticated
c. Sophisticated
d. Very sophisticated
Analysis: Respondent describing themselves as sophisticates or highly sophisticated
investors are likelier than other to exhibit certainty overconfidence. If the respondent
chose “somewhat sophisticated “ or “unsophisticated “,susceptibility is les likely.
12. ADVICE
Overconfidence is one of the most detrimental biases that an investor can exhibit. Advice
presented here deals with overconfidence in an across-the-board, undifferentiated
manner. This advice is organized according to the specific behavior it addresses. All four
behaviors are “wealth hazards” resulting frequently from overconfidence.
1. Unfounded belief in own ability to identify companies as potential investments
2. Excessive trading
3. Underestimating downside risks
4. Portfolio under diversification
13. A FINAL WORD ON
OVERCONFIDENCE
The most common way in which overconfidence has been studied is by asking
people how confident they are of specific beliefs they hold or answers they
provide. The data show that confidence systematically exceeds accuracy, implying
people are more sure that they are correct than they deserve to be.
1. Illusion of control
2. Illusion of Knowledge
Investors should conscious about their overconfidence. Because confidence is
good, overconfidence are bear problem sometimes.
