COWLES FOUNDATION FOR RESEARCH IN ECONOMICS
AT YALE UNIVERSITY

Box 208281
New Haven, CT 06520-8281

COWLES FOUNDATION DISCUSSION PAPER NO. 1307

On the Evolution of Overconfidence and Entrepreneurs

Antonio E. Bernardo and Ivo Welch

June 2001

This paper explains why seemingly irrational overconfident behavior can persist. Information aggregation is poor in groups in which most individuals herd. By ignoring the herd, the actions of overconfident individuals ("entrepreneurs") convey their private information. However, entrepreneurs make mistakes and thus die more frequently. The socially optimal proportion of entrepreneurs trades off the positive information externality against high attrition rates of entrepreneurs, and depends on the size of the group, on the degree of overconfidence, and on the accuracy of individuals’ private information. The stationary distribution trades off the fitness of the group against the fitness of overconfident individuals.

Keywords: Evolution, overconfidence, behavioral economics

JEL Classification: D7, L2