Overconfidence and Informational Cascades∗

This paper combines behavioral economics and social learning. Overconfident agents overweigh their private information relative to the public information revealed by the decisions of others. Therefore, when following a herd, they broadcast more of the information available to them. However, overconfidence trades the additional information revealed by overconfident decisions against more information that is being suppressed by rational decisions. This paper shows that the presence of overconfident agents intensifies the free-rider problem of rational agents, since, even if overconfident agents have very limited information, by making it public, they trigger an uninformative everlasting cascade stage, that otherwise need not start. With the help of numerical simulations, this paper shows that having overconfident agents cannot break the poor information flow intrinsic to erroneous uniform behavior. Journal of Economic Literature Classification Numbers: D82, D83 ∗I acknowledge helpful discussions of Andrew Caplin, Stefano DellaVigna, Kfir Eliaz, Douglas Gale, David Hirshleifer, Botond Koszegi, Yaw Nyarko, Ben Polak, Matthew Rabin and Andrew Schotter. This paper has benefited from suggestions by the participants of seminars at several universities. †Department of Economics, University of California, Berkeley, Evans Hall #3880, Berkeley, CA 94720-3880 (E-mail: [email protected]; URL: www.socrates.berkeley.edu/~kariv).