Article | Management Science | May 2011

Overconfidence by Bayesian Rational Agents

by Eric J. Van den Steen

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 overestimate the precision and underweight in the opposite case. This causes overall an overestimation of the precision of the final estimate, which tends to increase as agents get more data.

Keywords: Decision Choices and Conditions; Forecasting and Prediction; Knowledge Acquisition; Risk Management; Prejudice and Bias;

Citation:

Van den Steen, Eric J. "Overconfidence by Bayesian Rational Agents." Management Science 57, no. 5 (May 2011): 884–896.