A briefer version of this paper with the same name has been published in

Research on people’s confidence in their general knowledge has to date produced two fairly stable effects, many inconsistent results, and no comprehensive theory. We propose such a comprehensive framework, the theory of probabilistic mental models (PMM theory). The theory (a) explains both the overconfidence effect (mean confidence is higher than percentage of answers correct) and the hard-easy effect (overconfidence increases with item difficulty) reported in the literature and (b) predicts conditions under which both effects appear, disappear, or invert. In addition, (c) it predicts a new phenomenon, the confidence-frequency effect, a systematic difference between a judgment of confidence in a single event (i.e., that any given answer is correct) and a judgment of the frequency of correct answers in the long run. Two experiments are reported that support PMM theory by confirming these predictions, and several apparent anomalies reported in the literature are explained and integrated into the present framework. Do people think they know more than they really do? In the last 15 years, cognitive psychologists have amassed a large and apparently damning body of experimental evidence on overconfidence in knowledge, evidence that is in turn part of an even larger and more damning literature on socalled cognitive biases. The cognitive bias research claims that people are naturally prone to making mistakes in reasoning and memory, including the mistake of overestimating their knowledge.

Theoretical models predict that overcon�dent investors trade excessively. We test this prediction by partitioning investors on gender. Psychological research demonstrates that, in areas such as �nance, men are more overcon�dent 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, nineteenth century American humorist It is dif�cult to reconcile the volume of trading observed in equity markets with the trading needs of rational investors. Rational investors make periodic contributions and withdrawals

In a duopoly model of informed speculation, we show that overconfidence may strictly dominate rationality since an overconfident trader may not only generate higher expected profit and utility than his rational opponent, but also higher than if he were also rational. This occurs because overconfidence acts like a commitment device in a standard Cournot duopoly. As a result, for some parameter values the Nash equilibrium of a two-fund game is a Prisoner's Dilemma in which both funds hire overconfident managers. Thus, overconfidence can persist and survive in the long run. 2 The rational expectations hypothesis implies that economic agents make decisions as though they know a correct probability distribution of the underlying uncertainty. According to the traditional view (Alchian (1950) and Friedman (1953)), the rational expectations hypothesis is empirically plausible because rational beliefs are better able to survive the market test than irrational beliefs. Yet, the empirical liter...

People tend to hold overly favorable views of their abilities in many social and intellectual domains. The authors suggest that this overestimation occurs, in part, because people who are unskilled in these domains suffer a dual burden: Not only do these people reach erroneous conclusions and make unfortunate choices, but their incompetence robs them of the metacognitive ability to realize it. Across 4 studies, the authors found that participants scoring in the bottom quartile on tests of humor, grammar, and logic grossly overestimated their test performance and ability. Although their test scores put them in the 12th percentile, they estimated themselves to be in the 62nd. Several analyses linked this miscalibration to deficits in metacognitive skill, or the capacity to distinguish accuracy from error. Paradoxically, improving the skills of participants, and thus increasing their metacognitive competence, helped them recognize the limitations of their abilities. It is one of the essential features of such incompetence that the person so afflicted is incapable of knowing that he is incompetent. To have such knowledge would already be to remedy a good portion of the offense. (Miller, 1993, p. 4) In 1995, McArthur Wheeler walked into two Pittsburgh banks

Automation is often problematic because people fail to rely upon it appropriately. Because people respond to technology socially, trust influences reliance on automation. In particular, trust guides reliance when complexity and unanticipated situations make a complete understanding of the automation impractical. This review considers trust from the organizational, sociological, interpersonal, psychological, and neurological perspectives. It considers how the context, automation characteristics, and cognitive processes affect the appropriateness of trust. The context in which the automation is used influences automation performance and provides a goal-oriented perspective to assess automation characteristics along a dimension of attributional abstraction. These characteristics can influence trust through analytic, analogical, and affective processes. The challenges of extrapolating the concept of trust in people to trust in automation are discussed. A conceptual model integrates research regarding trust in automation and describes the dynamics of trust, the role of context, and the influence of display characteristics. Actual or potential applications of this research include improved designs of systems that require people to manage imperfect automation.

Motivated by the behavior of asset prices, trading volume and price volatility during historical episodes of asset price bubbles, we present a continuous time equilibrium model where overconfidence generates disagreements among agents regarding asset fundamentals. With short-sale constraints, an asset owner has an option to sell the asset to other overconfident agents when they have more optimistic beliefs. As in Harrison and Kreps (1978), this re-sale option has a recursive structure, that is, a buyer of the asset gets the option to resell it. Agents pay prices that exceed their own valuation of future dividends because they believe that in the future they will find a buyer willing to pay even more. This causes a significant bubble component in asset prices even when small differences of beliefs are sufficient to generate a trade. In equilibrium, large bubbles are accompanied by large trading volume and high price volatility. Our model has an explicit solution, which allows for several comparative statics exercises. Our analysis shows that while Tobin’s tax can substantially reduce speculative trading when transaction costs are small, it has only a limited impact on the size of the bubble or on price volatility. We also give an example where the price of a subsidiary is larger than its parent firm. This paper was previously circulated under the title “Overconfidence, Short-Sale Constraints and Bubbles.”

This article discusses the history underlying the new literature, describes some of what has been learned thus far, and looks ahead towards making further progress

Abstract not found

We examine whether men and women of the same ability differ in their selection into a competitive environment. Participants in a laboratory experiment solve a real task, first under a non-competitive piece rate and then a competitive tournament incentive scheme. Although there are no gender differences in performance, men select the tournament twice as much as women when choosing their compensation scheme for the next performance. While seventy-three percent of the men select the tournament only thirty-five percent of the women make this choice. This gender gap in tournament entry is not explained by performance and factors such as risk and feedback aversion only play a negligible role. Instead the tournament-entry gap is driven by men being more overconfident and by gender differences in preferences for performing in a competition. The result is that women shy away from competition and men embrace it. * We thank Scott Kinross, who conducted all the experiments reported in this paper, for his excellent research assistance. We thank the editors and the referees who helped us improve the paper. We also