Hindsight Bias, Risk Perception, and Investment Performance

Once they have observed information, hindsight biased agents fail to remember how ignorant they were initially, “they knew it all along.” We formulate a theoretical model of this bias, providing a foundation for empirical measures, and implying that hindsight biased agents conduct incorrect learning about volatility. In an experiment involving 67 students from Mannheim University, we find that hindsight bias reduces volatility estimates. In another experiment, involving 85 investment bankers in London and Frankfurt, we find that more biased agents have lower performance. These findings are robust to differences in location, information, overconfidence and experience. Many thanks for thoughtful comments to participants in the Toulouse and Amsterdam Universities seminars, the Warwick Conference on Behavioral Finance (2006) and the Munich Summer School on Economics and Psychology (2006), in particular Denis Hilton, Luis Garicano, Robin Hogarth, Florencio Lopez de Silanes, Thomas Mariotti, Paola Sapienza, Jean Tirole and Luigi Zingales.