The Overconfidence Problem in Forecasting

A good article from Richard Thaler, a professor of economics and behavioral finance at the University of Chicago, published in this weekend’s New York Times.

BUSINESSES in nearly every industry were caught off guard by the Great Recession. Few leaders in business — or government, for that matter — seem to have even considered the possibility that an economic downturn of this magnitude could happen.

What was wrong with their thinking? These decision-makers may have been betrayed by a flaw that has been documented in hundreds of studies: overconfidence.

Most of us think that we are “better than average” in most things. We are also “miscalibrated,” meaning that our sense of the probability of events doesn’t line up with reality. When we say we are sure about a certain fact, for example, we may well be right only half the time.

To see how it works, try this little quiz: Give two estimates of the diameter of the moon in miles — a high and a low one, so that there is about a 10 percent chance that the moon is bigger than the upper estimate and a 10 percent chance that it is smaller than the lower one. It is easy to be 100 percent sure by making your low guess zero and your high guess a trillion, so don’t cheat. Write down your answers before reading further.

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