Must Read Paper On Overconfidence
Via the indispensable Tyler Cowen, a new paper from Johnson and Fowler explores whether overconfidence is, in fact, adaptive. They show that it it is under some very reasonable assumptions. They model competition for resources as a two-player game and then analyze the evolutionary dynamics of populations playing this game.
The basic result is that overconfidence is beneficial in proportion to two factors: (1) the size of the payoff relative to the cost to play and (2) uncertainty about competitor capabilities. There are two optimal strategies for a population, overconfidence (which minimizes unclaimed resources) and underconfidence (which minimizes conflict costs). Unbiased self-perception is always dominated by these strategies. However, an overconfident person can successfully invade an underconfident population while the reverse is not true. So overconfidence is the stable solution.
The direct implication is that resources get destroyed. It is optimal for an individual to be overconfident, but then he ends up fighting with other overconfident individuals, which imposes costs. If you think about it for a minute, this is a pretty important fundamental problem. All of the big societal decisions we face have potentially big payoffs (or avoidance of costs), but it’s really unclear who has the best expertise to make a recommendation. So we get a bunch of “experts” telling us they are absolutely right.
Note that if it is public knowledge how “good” someone is, the “overconfidence premium” goes to zero. This is why forcing experts to make public predictions is so important. Then you can figure out how good they really are.