Games And Economic Behavior: Overconfidence Essay

Question:

Discuss about the Games and Economic Behavior for Overconfidence.

Answer:

Introduction

Overconfidence is not just a fundamental psychological trait rather it can be considered as a well-established bias. In this case the subjective confidence of a person seems to be reliably higher than the objective accuracy of their judgements. However, there are other definitions of overconfidence as well. Author defines overconfidence as the overestimation of a person’s actual performance or over precision in depicting the unwarranted certainty regarding the accuracy of the beliefs of a person. The emergence of overconfidence and its impact over the decision making processes has widely been discussed. Extensive research works have been conducted on the basis of the impact of overconfidence in the context of financial, business or corporate decision making. More specifically overconfidence can be considered as the behavioural bias which is most willingly researched by the academicians who are working in the field of economics. In other words the “better than the average effect” which is simply the tendency of individuals to overestimate their expertise and capabilities relative to a reference group gives rise to direct likelihoods in the context of decision making. This assignment will solely focus on analysing three relevant journal articles which are broadly based on the impact of overconfidence on decision making. Primarily it will present summary of the three articles followed by a detailed analysis of those individual articles. Finally each of the articles will be compared and contrasted with respect to the other, for instance their similarities or difference will be discussed. Afterwards a discussion section will be there where the relevant understanding developed through reading these papers will be discussed and then certain recommendations will be provided.

Article Summary

This paper considers overconfidence as an effect which is named as “better than average effect” and this compels people to assume that believe that their skills and capabilities are over and above the average level. The paper will focus on developing an experimental paradigm through which a distinction could be made between the two potentially possible clarifications for the effect; these are specifically overconfidence and rational information processing (Merkle & Weber, 2011). In order to do so an experiment has been conducted. The participants of the experiment were asked to enumerate their relative position within the populace through stating their distribution of complete trust. However, the findings of the paper portray the fact that people holds specific beliefs regarding their capabilities in inexplicably different fields or genres which are sometimes inconsistent with the rational information processing. These people have depicted considerably high over-placement at both the individual level as well as the aggregate level. Henceforth, the paper comes into a concluding fact that overconfidence cannot only be regarded as a simple trait of overconfidence rather it is a result of a psychological bias (Merkle & Weber, 2011).

In the second paper emphasises over the impacts of overconfidence over the incentive contracts in the context of a moral hazard framework. It has been observed that the overconfidence of an agent can impose certain conflicting impacts on the equilibrium contract. On one side of the spectrum, an overconfident or optimistic agent may value the success-contingent payments disproportionately and hence prefers incentives which are high-powered (De la Rosa, 2011). On the other end of the spectrum, when the involved agent overestimates the degree to which his or her actions can affect the outcomes, whereas the low-powered incentives are adequate to persuade any given level of effort. On an added notion, when an agent is soberly overconfident, the effect stated latter dominates. This is because in such a case the agent bears less risk there are gains in efficiency gains which is stemming from the his or her overconfidence (De la Rosa, 2011). Again when the agent is extremely overconfident, the former effect will dominate and then the agent will get exposed to a great amount of risk. At that point of time any gains will be generated only through risk sharing under disagreement. The findings of the paper depicts that a rise in the level of overconfidence or optimism raises the implemented effort in equilibrium.

This paper is constructed on the basis of five experiments which strictly exhibit the fact that previous experience of possessing power certainly leads towards overconfident decision making. The study will make use of different instantiations of power that includes an episodic recall task (in experiments 1-3), a measure of power which is related to work (in experiment 4) and assigning of high and low power role (experiment 5) as well as the power produced overconfident decisions which gave rise to significant monetary loses on the part of the powerful (Fast et al., 2012). The findings of the paper clearly depict the fact that the presence of power plays an important role in generating these tendencies of decision making. Primarily, the sense of power not the mood influences the link between overconfidence and power (experiment 3). Secondarily, the linkage between the overconfidence and power was detached when power not accessible to the powerful as well as when the powerful was made to feel incompatible in their genre of power (Fast et al., 2012). These findings portrays that when the presence of objective power makes the people feel subjectively powerful then it gives rise to overconfident decision making.

Article Analysis- Analyse Each Article

As the first paper specifies that in a recent academic literature the notion of overconfidence has been challenged as this was only analysed in the domain of economics and psychology previously. They criticised the use of conventional methodology while explaining the better than average effect. The authors who raised the argument also showed the fact that in a simple signalling framework; the processing of rational information will lead to the results which were previously considered as the evidence of overconfidence (Merkle & Weber, 2011). Now in order to overcome the criticisms posed by these authors the current research work is based on a strategic guideline which will be able to indicate the existence of real overconfidence. This will be done through the improving the previous research methodology.

The researchers observed that there are many different sets of opinions which are able to providee the same result whenever they are aggregated. However, in this context the Bayesian posteriors and the actual overconfidence are typically same. Therefore in order to fetch more detailed beliefs of the participants regarding different domains which were previously associated with overconfidence, underconfidence and overoptimism the authors had designed two different experiments (Merkle & Weber, 2011). Along a quantile scale the self-evaluation were performed that elaborated the ability distribution compared with a peer group. In accordance with this scale the participants provided the estimates which in turn represent their subjective probability of falling into each of the skill quantile. This extended valuation of the test allowed the researchers to re-verify whether the results were in accordance with the rational information processing or not.

The results obtained from the test depicted that there exists substantial amount of overconfidence in the belief distribution of the participants of the experiment (Merkle & Weber, 2011). Most of the people found that their probability of falling in the high quantile in higher. Moreover, interestingly, the unskilled exhibits depicted overconfidence. However, the research work also found the fact that the theoretical criticisms as posed by the previous researchers have only certain practical values regarding overconfidence research.

The standard model of principle-agent has been used widely to determine the incentive structure in different organisations. It thoroughly provides a detailed overview of the forces that give form to the incentive contracts on basis of the assumption of full rationality (De la Rosa, 2011). There are many instances that people are often overconfident about their future prospects and ability. This is the behavioural characteristic that seems important regarding the agency problem. The paper aims to enumerate the impact of overconfidence of the agents in a moral hazard model, significantly its influence over the equilibrium contract.

Overconfidence of agents may give rise to conflicting results within the equilibrium contract. On one hand, if the agent is overconfident, a lower amount of compensation is sufficient to bring any level of effort rather compared to the effort which is cost-effective. This is referred to as “Incentive Effect of overconfidence”; it thrusts the equilibrium contract towards low-powered incentives. In the other end, when the salesman is overconfident confident enough he or she will certainly overestimate the probability of the sale, at this point of time he or she will find a high commissioned contract of incentive more lucrative than a realistic agent would (De la Rosa, 2011). This is because the owner will believe that she will have to pay the commission more frequently. At that point it will seem that hiring a person with high powered incentive and lower base salary is more attractive, this is termed as the Wager Effect of overconfidence. Interestingly the findings of the paper depicts that overconfidence of the agents can be beneficial if measures in terms of efficiency (De la Rosa, 2011).

The third paper is solely concerned about the fact that though overconfidence among the powerful have always remained a widely discussed issue, lesser focus in given over the psychological and sociological factors which gives rise to the overconfidence. The research work will try to examine this relationship between the sociological and psychological factors with the occurrence of overconfidence. This will not only focus on the factors that give rise to overconfidence but also explore when it is more likely to take place (Fast et al., 2012). The substitute explanations of the existence of overconfidence within the powerful will also be examined in this research. It may be a case that the overconfident individuals are more attracted towards power and are more likely to achieve a high-powered position. If this is the case then promoting only those who does not have a tendency towards overconfidence would certainly help to resolve the problem. On the other hand, when a person has pre-existing experience of possessing power it may give rise to overconfidence which will in turn make it difficult to tame relationship between overconfidence and power (Fast et al., 2012). This paper has broadly examined why when and how the emergence of power will lead to overconfidence. In order to do so the researchers have conducted five baseline experiments and these experiments were so designed that the findings of an experiment substantiates the findings of the other experiment. The experiments conducted revealed the fact that psychologically experiencing power can lead to the overconfident decision making.

Article Comparison

The key similarity between all the three articles is that all of them are based on the emergence of overconfidence and its impact on decision making process. All the researchers have tried to establish the fact that overconfidence is not only a psychological trait; rather there are certain other factors as well which gives rise to this overconfidence. It is also a matter of fact that all the articles analysed in the assignment clearly depict that overconfidence may lead to wrong decision making. If this decision is regarding the economy or the financial aspects of an organisation it may harm the core interests of the firm adversely. On the contrary sometimes overconfident decision may also benefit the organisation as well.

However, from the primary viewpoint there are huge dissimilarities among the research works. The first article traces out the key reason behind the emergence of overconfidence, while the second one approaches on overconfidence through the traditional principle agent framework. The third, article also explains overconfidence in the light of pre-existing experience of possessing power. This means that the third article states if a person has experience of possessing power he or she will be more likely to be overconfident. Hence it can be said that although the research works stated above are concentrated on the same factor, each of them has tried to approach it from different perspectives.

Discussion

After analysing and reviewing all the articles it can be clearly said that all of them are based on rational assumptions. The findings are quite plausible which are obtained on the basis of the calculations and analysis. Hence it is quite evident that these research works are very well written and based on logically established calculations. However, as all of the articles are based on overconfidence, on a recommendation note it can be said that people should not always base their decisions under the influence of overconfidence. Though it may sound contradictory but it is necessary to mention that sometimes overconfident decisions may also sound beneficial for the decision maker, though it is quite rare.

Works Cited

De la Rosa, L.E., 2011. Overconfidence and moral hazard. Games and Economic Behavior, 73(2), pp.429-51.

Fast, N.J., Sivanathan, N., Mayer, N.D. & Galinsky, A.D.., 2012. Power and overconfident decision-making. Organizational behavior and human decision processes, 117(2), pp.249-60.

Merkle, C. & Weber, M.., 2011. True overconfidence: The inability of rational information processing to account for apparent overconfidence. Organizational Behavior and Human Decision Processes, 116(2), pp.262-71.

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