Optimism and Overconfidence
People often expect better outcomes for themselves than for comparable others and rate their abilities above average. These expectations can encourage them to take risks they would judge differently using outside evidence.
THE IDEA
Optimism and Overconfidence
Before the start of Thaler’s class in managerial decision making, students fill out an anonymous survey on the course website. One of the questions is “In which decile do you expect to fall in the distribution of grades in this class?” Students can check the top 10 percent, the second 10 percent, and so forth. Since these are MBA students, they are presumably well aware that in any distribution, half the population will be in the top 50 percent and half in the bottom. And only 10 percent of the class can, in fact, end up in the top decile.
Nevertheless, the results of this survey reveal a high degree of unrealistic optimism about performance in the class. Typically less than 5 percent of the class expects their performance to be below the median (the 50th percentile) and more than half the class expects to perform in one of the top two deciles. Invariably, the largest group of students put themselves in the second decile. We think this is most likely explained by modesty. They really think they will end up in the top decile but are too modest to say so.
MBA students are not the only ones overconfident about their abilities. The “above-average” effect is pervasive. In some studies, 90 percent of drivers say they are above average behind the wheel. And nearly everyone thinks they have an above-average sense of humor, including some people who are rarely seen smiling. (That is because they know what is funny!) This applies to professors, too. One study found that about 94 percent of professors at a large university believed they were better than the average professor, and there is every reason to think that such overconfidence applies to professors in general.8 (Yes, we admit to this particular failing.)
People are unrealistically optimistic even when the stakes are high. The authors cite a US divorce estimate of about 40 to 50 percent, while noting that the precise number is hard to nail down. But around the time of the ceremony, almost all couples have been found to believe that there is approximately a zero percent chance that their marriage will end in divorce—even those who have already been divorced9 — Figure unavailable in the source files. (Second marriage, Samuel Johnson once quipped, “is the triumph of hope over experience.”) A similar point applies to entrepreneurs: the source cites a business failure rate of at least 50 percent, without specifying a time horizon here. In one survey of people starting new businesses (typically small businesses, such as contracting firms, restaurants, or salons), respondents were asked two questions: (a) What do you think is the chance of success for a typical business like yours? (b) What is your chance of success? The most common answers to these questions were 50 percent and 90 percent, respectively, and many said 100 percent in response to the second question.10
Unrealistic optimism can explain a lot of individual risk-taking, especially in the domain of risks to life and health. Asked to envision their future, students typically say that they are far less likely than their classmates to be fired from a job, to have a heart attack or get cancer, to be divorced after a few years of marriage, or to have a drinking problem. Older people underestimate the likelihood that they will be in a car accident or suffer major diseases. Smokers are aware of the statistical risks and often even exaggerate them, but most believe that they are less likely to be diagnosed with lung cancer and heart disease than most nonsmokers. Lotteries are successful partly because of unrealistic optimism.11
Unrealistic optimism is a pervasive feature of human life; it characterizes most people in most social categories. When they overestimate their personal immunity to harm, people may fail to take sensible preventive steps. During the pandemic of 2020 and 2021, some people failed to take precautions, including mask-wearing, because of optimism about their personal risks. If people are running risks because of unrealistic optimism, they might be able to benefit from a nudge. One possibility is to remind people of a relevant bad event, which may temper their optimism.
When to use it
An investor evaluating a startup should actively question highly optimistic projections and seek disconfirming evidence against their own enthusiasm.
A healthcare professional can educate patients about statistical risks to counter their tendency to underestimate personal health threats.
A policy maker designing public health campaigns should recognize that standard risk statistics may not change behavior, as people tend to believe they are less at risk than others.
FROM THEORY TO EVERYDAY LIFE
In practice
Grade Expectations in MBA Class
MBA students predict their performance. Less than 5% expect to be below the median, and over half expect to be in the top two deciles, despite the impossibility for everyone to be in the top 20%. The largest group chose the second decile, which the author attributes to a veil of modesty covering true overconfidence.
Entrepreneurial Success Rates
In the survey described by the authors, new business owners most often estimated a 50% chance of success for a similar business and a 90% chance for their own; many gave themselves 100%. The source also cites a failure rate of at least 50%, though this excerpt gives no time horizon for that estimate.
Driving Ability
In some studies cited by the authors, approximately 90% of drivers rated themselves above average. Such a large share raises questions about overconfidence, although the comparison depends on what drivers mean by average and which aspects of driving they assess.
Marriage Success Predictions
The authors describe studies in which almost all newly married couples, including previously divorced people, put their chance of divorce near 0%. They contrast that confidence with a cited US divorce estimate of 40-50%; the excerpt does not establish a current rate.
A MOMENT TO REFLECT
Put it to work.
How might your current projects or goals be affected by unrealistic optimism? Consider a specific goal and how your estimation of its probability of success compares to known base rates.
In what domain of your life (e.g., health, finance, relationships) do you most frequently overestimate positive outcomes, and what steps could you take to get a more accurate view?
If you are advising someone on a risky decision, how can you help them calibrate their optimism without crushing their motivation?
Often confused with
CONTINUE THE CONVERSATION
Source texts
- Nudge The Final Edition (Richard H. Thaler Cass R. Sunstein)