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American Economic Journal: Microeconomics: Vol. 6 No. 1 (February 2014)

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Overconfidence and Diversification

Article Citation

Heller, Yuval. 2014. "Overconfidence and Diversification." American Economic Journal: Microeconomics, 6(1): 134-53.

DOI: 10.1257/mic.6.1.134

Abstract

Experimental evidence suggests that people tend to be overconfident in the sense that they overestimate the accuracy of their private information. In this paper, we show that risk-averse principals might prefer overconfident agents in various strategic interactions because these agents help diversify the aggregate risk. This may help understanding why successful analysts and entrepreneurs tend to be overconfident. In addition, a different interpretation of the model presents a novel evolutionary foundation for overconfidence, and explains various stylized facts about this bias.

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Authors

Heller, Yuval (U Oxford)

JEL Classifications

D81: Criteria for Decision-Making under Risk and Uncertainty
D82: Asymmetric and Private Information; Mechanism Design

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