Question

Define optimism bias and overconfidence bias in finance. What is the difference between the two? Have you ever encountered these cognitive biases from your personal finance experience or work experience? Can you share with us?

Answer 1

Optimism bias is a bias which will be reflecting that investors are highly optimistic about their investment and they are not rational about the company so they will be holding onto the losing assets in expectation and optimism that these assets are going to recover and these assets are going to provide them with profits but in reality those assets are are continuously going down and eroding the value of the portfolio of the investor and it would be leading to a loss of return for the investor because he is highly optimistic.

Overconfidence bias in finance means that the investor have placed very high Reliance on his own ability and he will be believing that his views are better than rest of others so even if he is proved wrong in various decision making regarding investment decision he will still be believing upon his investment cases because he believes that he is a better decision maker and he has a better potential than others in the market so it will be leading to bad decision making due to overconfidence of investor upon himself and his investments.

Optimism buyers will mean that investor would be holding onto losing asset where as overconfidence bias will mean that investors will be taking risky bets and he will be trying to prove others view wrong. Optimism buyers will still be trying to predict some probable outcome whereas overconfidence bias will be leading the investor to predict some kind of unexpected rate of return from market.

I've personally encountered optimism bias as I had invested in the shares of Tesla at 370 before the stock was split and I thought of company going private and I kept it on the basis of the announcement of Elon Musk and I was holding the share till it went to 200 and I had to book loss because there was almost erosion of my 50% of the wealth and I was optimistic about my rate of return but I had to book loss due to ultimate need of money.