The overconfidence effect is observed when people’s subjective confidence in their own ability is greater than their objective (actual) performance (Pallier et al., 2002). It is frequently measured by having experimental participants answer general knowledge test questions. They are then asked to rate how confident they are in their answers on a scale. Overconfidence is measured by calculating the score for a person’s average confidence rating relative to the actual proportion of questions answered correctly. (See also optimism bias.)

A big range of issues have been attributed to overconfidence more generally, including the high rates of entrepreneurs who enter a market despite the low chances of success (Moore & Healy, 2008). Among investors, overconfidence has been associated with excessive risk-taking (e.g. Hirshleifer & Luo, 2001),  concentrated portfolios  (e.g. Odean, 1998) and overtrading (e.g. Grinblatt & Keloharju, 2009).

The planning fallacy is another example of overconfidence, where people underestimate the length of time it will take them to complete a task, often ignoring past experience (Buehler et al., 1994).

 

Buehler, R., Griffin, D., & Ross, M. (1994). Exploring the “planning fallacy”: Why people underestimate their task completion times. Journal of Personality and Social Psychology, 67(3), 366-381.

Grinblatt, M., & Keloharju, M. (2009). Sensation seeking, overconfidence, and trading activity. Journal of Finance, 64(2), 549-578.

Hirshleifer, D., & Luo, G. Y. (2001). On the survival of overconfident traders in a competitive securities market. Journal of Financial Markets, 4(1), 73-84.

Moore, D. A., & Healy, P. J. (2008). The trouble with overconfidence. Psychological Review, 115(2), 502-517.

Odean, T. (1998). Volume, volatility, price, and profit when all traders are above average. Journal of Finance, 53(6), 1887-1934.

Pallier, G., Wilkinson, R., Danthiir, V., Kleitman, S., Knezevic, G., Stankov, L., & Roberts, R. D. (2002). The role of individual differences in the accuracy of confidence judgments. Journal of General Psychology, 129(3), 257-299.