Tag Archives: Overconfidence

The fallacy of the one-sided bet (for example, risk, God, torture, and lottery tickets)

This entry by Eliezer struck me as an example of what I call the fallacy of the one-sided bet.  As a researcher and teacher in decision analysis, I’ve noticed that this form of argument has a lot of appeal as a source of paradoxes.  The key error is the framing of a situation as a no-lose (or no-win) scenario, formulating the problem in such a way so that tradeoffs are not apparent.  Some examples:

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Small Business Overconfidence

The August Journal of Economic Psychology says that across 18 countries "subjective, and often biased, perceptions have a crucial impact on new business creation." For example, the strongest predictor of who starts a new business is "whether the person believes herself to have the sufficient skills, knowledge and ability to start a business."  But for those who do start a business, the higher such confidence, the lower their "approximate survival chances." Furthermore, "some countries exhibit relatively high rates of start-up activity because their inhabitants are more (over)confident than in other countries."

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Don’t trust your lying eyes…

This blog has already welcomed many posts on lying, how to detect it, and how poor we are at doing so. A New Scientist story provides yet another twist in the tale.

I interviewed the political broadcaster Robin Day, asking him about his favourite film. In the first segment he told me the truth, describing how he adored Some Like It Hot. In a second he lied, telling me how he loved Gone With the Wind when, in reality, he hated it. We asked viewers to watch the two clips and vote on which they thought was the truth. Almost 30,000 people telephoned, and the votes were evenly split between the two interviews.

So far, as expected. We aren’t good at detecting lies. However:

On the same day, we broadcast the two interviews on national radio and published the transcripts in The Daily Telegraph newspaper. An impressive 73 per cent of the radio listeners identified the falsehood and 64 per cent of the newspaper readers did.

Why should this be? It seems that body language and facial expressions give little guide to people’s sincerity. The most reliable signs of lying seem to be in the words we use.

So don’t look into people’s eyes, seek signs of nervousness, or judge their sincerity by their handshake. Ignore the evidence of your misleading eyes. Turn away, and focus only on what is being said.

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Bias-awareness bias, or was 9/11/01 a “black swan”

The bias I’m talking about here–I’m not quite sure what to call it–is the readiness to assume bias where possibly none exists.  Or, more generally, the overestimation of the magnitude of a bias, or the attribution to bias of a phenomenon that can be explained more directly.  I’m thinking specifically of Eliezer’s entry on hindsight bias where he wrote:

Hindsight bias is when people who know the answer vastly overestimate its predictability or obviousness, compared to the estimates of subjects who must guess without advance knowledge. . . . Shortly after September 11th 2001, I [Eliezer] thought to myself, and now someone will turn up minor intelligence warnings of something-or-other, and then the hindsight will begin. Yes, I’m sure they had some minor warnings of an al Qaeda plot, but they probably also had minor warnings of mafia activity, nuclear material for sale, and an invasion from Mars.

This doesn’t seem quite right to me:  I’d think the FBI and CIA would have the resources to investigate warnings of an al Quaeda plot, mafia activity, and nuclear material for sale (and I think they know enough to ignore warnings of invasions from Mars).  As Alex puts it here,

What about this specific threat, Osama Bin Laden? Well, he did have a past prior for trying to blow up the World Trade Center, didn’t he? I don’t think his past failure would have made it less likely for him to try again, do you?

The comments at that link are also relevant to this discussion.  Anyway, my key point here is that people do make mistakes–people even make mistakes that could’ve been realized ahead of time if proper procedure had been followed.  In these cases, the concept of "hindsight bias" can be used inappropriately as a blanket to cover up all failures.

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Acquisitions Signal CEO Dominance

CEOs may try to acquire other companies in order to signal dominance within their firm.  At least this is my interpretation of this article in the Sept. Journal of Economics and Business:

Logistic regression and Australian data … suggest that both CEO overconfidence and CEO dominance are important in explaining the decision to acquire another firm. When compared to existing US studies, the evidence on CEO overconfidence is robust across two different financial and corporate governance systems. Our results also indicate that CEO dominance is at least as significant as CEO overconfidence in the decision to undertake an acquisition.

Humans constantly struggle to achieve and signal dominance over each other.  Since in equilibrium more dominant CEOs are in fact better able to push through an acquisition, doing so is a credible way to signal that you do in fact dominate decision making in your firm.   And since signals must always "overdo" it to be credible, this may explain why acquisitions appear to be "overconfident."

Btw, I’ve been wondering: what fraction of a CEO pay is for the value he adds to key decisions, versus the value he adds by being an impressive person for employees to look up to, outsiders to meet, admire, feel comfortable with, and so on? 

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Beware the Inside View

Instead of watching fireworks on July 4, I did 1500 piece jigsaw puzzle of fireworks, my first jigsaw in at least ten years.  Several times I had the strong impression that I had carefully eliminated every possible place a piece could go, or every possible piece that could go in a place.  I was very tempted to conclude that many pieces were missing, or that the box had extra pieces from another puzzle.  This wasn’t impossible – the puzzle was an open box a relative had done before.  And the alternative seemed humiliating. 

But I allowed a very different part of my mind, using different considerations, to overrule this judgment; so many extra or missing pieces seemed unlikely.  And in the end there was only one missing and no extra pieces.  I recall a similar experience when I was learning to program.  I would carefully check my program and find no errors, and then when my program wouldn’t run I was tempted to suspect compiler or hardware errors.  Of course the problem was almost always my fault.   

Most, perhaps all, ways to overcome bias seem like this.  In the language of Kahneman and Lovallo’s classic ’93 paper, we allow an outside view to overrule an inside view.  From their paper:

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Gullible Then Skeptical

A friend, Ute Shaw, asks why we seem too eager to believe the first opinion we hear on a subject, and then seem too skeptical about further contrary opinions we hear.   Some possibilities:

  1. We like to appear knowledgeable by having opinions on many topics, and changing our opinion would undermine that appearance.
  2. To show loyalty to our group, we adopt their opinions.  Changing opinions would suggested changed loyalties.
  3. To quickly assimilate cultural knowledge, humans are programmed to accept the first opinion they hear.  A topic on which contrary opinions are also expressed  tends to contain less cultural knowledge. 
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How should unproven findings be publicized?

A year or so ago I heard about a couple of papers by Satoshi Kanazawa on "Engineers have more sons, nurses have more daughters" and "Beautiful parents have more daughters."  The titles surprised me, because in my acquaintance with such data, I’d seen very little evidence of sex ratios at birth varying much at all, certainly not by 26% as was claimed in one of these papers.  I looked into it and indeed it turned out that the findings could be explained as statistical artifacts–the key errors were, in one of the studies, controlling for intermediate outcomes and, in the other study, reporting only one of multiple potential hypothesis tests.  At the time, I felt that a key weakness of the research was that it did not include collaboration with statisticians, experimental psychologists, or others who are aware of these issues.

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Death Risk Biases

A recent Journal of Risk and Uncertainty paper confirms very standard results; low risk people overestimate their risks, high risk people underestimate their risks, overall people underestimate risk, and men are worse than women:

Individuals’ perception of their own road-traffic and overall mortality risks are examined in this paper. Perceived risk is compared with the objective risk of the respondents’ peers, i.e. their own gender and age group, and the results suggest that individuals’ risk perception of their own risk is biased. For road-traffic risk we obtain similar results to what have been found previously in the literature, overassessment and underassessment among low- and high-risk groups, respectively. For overall risk we find that all risk groups underestimate their risk. The results also indicate that men’s risk bias is larger than women’s.

We could fill up this blog just with abstracts of papers like this, but what would be the point? 

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Adam Smith on Overconfidence

The over-weening conceit which the greater part of men have of their own abilities, is an ancient evil remarked by the philosophers and moralists of all ages. Their absurd presumption in their own good fortune, has been less taken notice of. It is, however, if possible, still more universal. There is no man living who, when in tolerable health and spirits, has not some share of it. The chance of gain is by every man more or less over-valued, and the chance of loss is by most men under-valued, and by scarce any man, who is in tolerable health and spirits, valued more than it is worth. …

The contempt of risk and the presumptuous hope of success, are in no period of life more active than at the age at which young people chuse their professions. How little the fear of misfortune is then capable of balancing the hope of good luck, appears still more evidently in the readiness of the common people to enlist as soldiers, or to go to sea, than in the eagerness of those of better fashion to enter into what are called the liberal professions.

Adam Smith, An Inquiry Into the Nature and Causes of the Wealth of Nations, Book I, Chapter 10, paragraphs 29 and 32.  (Hat tip to Econtalk.)

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