This paper is an updated version of a previous working paper, “Capital Budgeting in the Presence of Managerial Overconfidence and Optimism, ” by the same authors. Financial support by the Rodney L. White Center for Financial Research is gratefully acknowledged. The authors would like to thank Andrew Abel,

Innovation makes demands on training when it changes the knowledge and skill requirements in companies. This need to develop the expertise and knowledge of employees is an emerging concern in management studies. The theory of cognitive science can be of use here to understand how the knowledge of the relevant formalisms transfers from training to real world settings. It has been shown that graphical systems of logic can help bridge the gap between learning a formalism and it's application (Cox, Stenning and Oberlander, 1994) . Statistical process control is seen as one innovation in management that generates training needs. A substantial range of empirical studies has demonstrated the effectiveness of graphical techniques for teaching probability and the theory of stochastic processes (Ichikawa, 1989; Hong and O'Neill, 1992; Cheng, 1994). Other work illustrates the cogency of using computers as an exploratory learning environment (Cox and Cumming, 1990; Papert, 1980). In this study, I ...

This article presents three experiments that examine the relation between order effects and frequency learning, with the following results. First, when frequencies of occurrence are presented as sequences of real events, base rates can be learned and used with a high degree of accuracy. However, conditional probabilities for multiple sequentially presented evidence items cannot be completely learned, due to the distortion of a recency order effect for actual decisions. Second, there is also a recency order effect for belief evaluations, which cannot be eliminated even if base rates are used correctly. Third, base rates learned in one environment can be transferred to another environment, but the transfer soon diminishes due to learning in the new environment. However, belief evaluations are not transferred from one to another environment. The existing models of frequency learning cannot explain the order effect for actual decisions because they do not consider sequential information. The existing models of belief updating can explain both types of order effects, but they do not have any mechanisms for frequency learning. To account for the complete spectrum of frequency learning and order effects, we outline our initial effort in developing a unified model that integrates frequency learning and order effects. Belief updating and frequency learning are two ubiquitous phenomena. Suppose that a disease R can be diagnosed by test A and test B. When a physician

Theoretical models predict that overconfident investors trade excessively. We test this prediction by partitioning investors on gender. Psychological research demonstrates that, in areas such as finance, men are more overconfident than women. Thus, theory predicts that men will trade more excessively than women. Using account data for over 35,000 households from a large discount brokerage, we analyze the common stock investments of men and women from February 1991 through January 1997. We document that men trade 45 percent more than women. Trading reduces men’s net returns by 2.65 percentage points a year as opposed to 1.72 percentage points for women. It's not what a man don't know that makes him a fool, but what he does know that ain't so. Josh Billings, 19 th century American humorist It is difficult to reconcile the volume of trading observed in equity markets with the trading needs of rational investors. Rational investors make periodic contributions and withdrawals from their investment portfolios, rebalance their portfolios, and trade to minimize their taxes. Those possessed of superior information may trade speculatively,

Miscalibration is a form of overconfidence examined in both psychology and economics. Although it is often analyzed in lab experiments, there is scant evidence about the effects of miscalibration in practice. We test whether top corporate executives are miscalibrated, and study the determinants of their miscalibration. We study a unique panel of over 11,600 probability distributions provided by top financial executives and spanning nearly a decade of stock market expectations. Our results show that financial executives are severely miscalibrated: realized market returns are within the executives ’ 80 % confidence intervals only 33 % of the time. We show that miscalibration improves following poor market performance periods because forecasters extrapolate past returns when forming their lower forecast bound (“worst case scenario”), while they do not update the upper bound (“best case scenario”) as much. Finally, we link stock market miscalibration to miscalibration about own-firm project forecasts and increased corporate investment.

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We evaluate Dijksterhuis, Bos, van der Leij, & van Baaren (2009), Psychological Science, on the benefit of unconscious thinking in predicting the outcomes of soccer matches. We conclude that the evidence that unconscious thinking helps experts to make better predictions is tenuous both from theoretical and statistical perspectives.

A question of increasing interest to researchers in a variety of fields is whether the biases found in judgment and decision making research remain present in contexts in which experienced participants face strong economic incentives. To investigate this question, we analyze the decision making of National Football League teams during their annual player draft. This is a domain in which monetary stakes are exceedingly high and the opportunities for learning are rich. It is also a domain in which multiple psychological factors suggest teams may overvalue the chance to pick early in the draft. Using archival data on draft-day trades, player performance and compensation, we compare the market value of draft picks with the surplus value to teams provided by the drafted players. We find that top draft picks are significantly overvalued in a manner that is inconsistent with rational expectations and efficient markets and consistent with psychological research.

Overprecision is the most robust type of overconfidence. We present a new method that significantly reduces this bias and offers insight into its underlying cause. In three experiments, overprecision was significantly reduced by forcing participants to consider all possible outcomes of an event. Each participant was presented with the entire range of possible outcomes divided into intervals, and estimated each interval’s likelihood of including the true answer. The superiority of this Subjective Probability Interval Estimate (SPIES) method is robust to range widths and interval grain sizes. Its carryover effects are observed even in subsequent estimates made using the conventional, 90 % confidence interval method: judges who first made SPIES judgments considered a broader range of values in subsequent conventional interval estimates as well.

The anchoring-and-adjustment heuristic (Tversky & Kahneman, 1974) predicts elicitation of an initial estimate will prompt subsequent minimum and maximum estimates to lie close to the initial estimate, resulting in narrow ranges and overconfidence. Evidence for this, however, is mixed; while Heywood-Smith, Welsh & Begg (2008) observed narrower subsequent ranges, Block and Harper (1991) report ranges became wider. One suggestion has been that this reflects a difference between expert and novice reactions to elicitation tasks. The present study investigated whether the interplay between expertise and number preferences leads to the paradoxical effects of an initial estimate. Participants with high expertise make precise estimates whereas participants with less expertise prefer rounded numbers, which could, potentially, reduce the impact of anchors. We confirm that expertise affects the precision of estimates and observe results indicative of the theorized effect – an interaction between expertise and elicitation method on range widths.