overconfidence bias

Syllable breakdown

Dictionary meaning

the tendency for people to overestimate the accuracy of their own knowledge, the precision of their forecasts, or the quality of their own abilities relative to objective performance, leading to excessive certainty about uncertain judgements; overconfidence is one of the most pervasive and consequential cognitive biases in financial markets, where it manifests as excessive trading — investors who believe their stock-picking ability is superior trade more frequently than passive strategies would justify, incurring transaction costs that erode returns — as underestimation of investment risk, and as overly narrow confidence intervals around predictions; research by Terrance Odean and Brad Barber showed that individual investors who trade most actively earn the lowest net returns, consistent with overconfidence driving excess trading; overconfidence also leads entrepreneurs to underestimate the probability of business failure, analysts to issue overly precise earnings forecasts, and merger executives to overestimate synergy benefits in acquisition decisions

Examples

• Overconfidence bias led the hedge fund manager to bet 40% of the portfolio on a single trade she was certain would succeed.
• Studies show that 80% of drivers rate themselves above average, a logical impossibility that illustrates overconfidence bias.