Even though inaccurate beliefs lead to costly mistakes, people interpret favorable feedback to be more informative; author casts a new light on the origins of overconfidence & the mechanisms that perpetuate it in the face of feedback

Belief-Based Utility and Signal Interpretation. Marta Kozakiewicz. February 23, 2021. https://marta-kozakiewicz.github.io/assets/kozakiewicz_jmp.pdf

Rolf Degen's take: https://twitter.com/DegenRolf/status/1378975549058646018

Abstract: People tend to overestimate their abilities and chances of success, even though inaccurate beliefs lead to costly mistakes. How can these beliefs persist in an environment with frequent feedback? I propose a new test of the hypothesis that people interpret favorable feedback to be more informative. Using experimental data, I provide the first causal evidence that the utility from beliefs affects one’s perception of signal informativeness. To establish causality, I adopt a matching estimator approach and construct a counterfactual outcome of a subject who observes the same signal, but the signal is not affecting his belief-based utility. I find a strong and significant effect: subjects interpret favorable signals to be more informative due to changes in belief-based utility. The results cast a new light on the origins of overconfidence and illuminate mechanisms that perpetuate it in the face of feedback.

Keywords: overconfidence, belief formation, learning, experiment

JEL classification: C91, D83