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Biased Learning Creates Overconfidence

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Abstract

The aim of this paper is to develop a multi-period economic model to interpret how the people become overconfident by a biased learning that people tend to attribute the success to their abilities and failures to other factors. The authors suppose that the informed trader does not know the distribution of the precision of his private signal and updates his belief on the distribution of the precision of his knowledge by Bayer’s rule. The informed trader can eventually recognize the value of the precision of his knowledge after an enough long time biased learning, but the value is overestimated which leads him to be overconfident. Furthermore, based on the definition on the luckier trader who succeeds the same times but has the larger variance of the knowledge, the authors find that the luckier the informed trader is, the more overconfident he will be; the smaller the biased learning factor is, the more overconfident the informed trader is. The authors also obtain a linear equilibrium which can explain some anomalies in financial markets, such as the high observed trading volume and excess volatility.

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Author information

Authors and Affiliations

  1. School of Software and Microelectronics, Peking University, Beijing, 100871, China

    Xuanming Ni

  2. Academy of Mathematics and Systems Science, Chinese Academy of Sciences, Beijing, 100190, China

    Chen Wu

  3. University of Chinese Academy of Sciences, Beijing, 100049, China

    Chen Wu

  4. Business School, Sun Yat-Sen University, Guangzhou, 510275, China

    Huimin Zhao

Authors
  1. Xuanming Ni
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  2. Chen Wu
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  3. Huimin Zhao
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Corresponding author

Correspondence to Huimin Zhao.

Additional information

This research was supported by the National Natural Science Foundation of China under Grant Nos. 71303265 and 71573289, and the Innovative Research Group Project of National Natural Science Foundation of China under Grant No. 71721001.

This paper was recommended for publication by Editor WANG Shouyang.

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Ni, X., Wu, C. & Zhao, H. Biased Learning Creates Overconfidence. J Syst Sci Complex 31, 1603–1617 (2018). https://doi.org/10.1007/s11424-018-7254-1

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  • DOI: https://doi.org/10.1007/s11424-018-7254-1

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