Risk, Overconfidence and Production in a Competitive Equilibrium

David Just, Ying Cao and David Zilberman

No 49161, 2009 Annual Meeting, July 26-28, 2009, Milwaukee, Wisconsin from Agricultural and Applied Economics Association

Abstract: Previous studies have found underestimation of risk, or overconfidence, to be pervasive. In this paper, we model overconfidence as a reduction in perceived variance. We generalize the analysis of Sandmo and examine the effects of competition on firms displaying overconfidence. Cases for both competitive equilibrium and imperfect competition are investigated. We show that overconfidence may strictly dominate rationality in a competitive market by leading risk averse producers to invest greater amounts and produce more. This leads to a higher average profit, and greater variance of profits, leaving the producer a greater probability of surviving competitive pressures. Despite the greater variance of profits, if enough producers underestimate their risk, they should collectively drive more rational decision makers from the market. Our results suggest that overconfidence may be as important a determinant of market behavior as diminishing marginal utility of wealth.

Keywords: Production Economics; Risk and Uncertainty (search for similar items in EconPapers)
Pages: 30
Date: 2009
New Economics Papers: this item is included in nep-bec and nep-mic
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Persistent link: https://EconPapers.repec.org/RePEc:ags:aaea09:49161

DOI: 10.22004/ag.econ.49161

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