Overconfident Entrepeneurs Can Break Information Cascades
An article by Antonio E. Bernardo and Ivo Welch titled “On the Evolution of Overconfidence and Entrepreneurs” details the behaviors of entrepreneurs in groups, and how that affects the groups actions. As discussed in class information cascades can form off very little actual information. Everyone in a group can often rationally ignore their own personal information if the rest of the group is providing sufficient outside information, even if it’s very small. The example given in class was that where there are two jars: one that has 2 red balls and a blue ball, and one that has 2 blue balls and a red ball. A random jar is chosen and the group lines up and takes turns picking balls out of that jar. Upon picking up a ball the person announces a guess to everybody whether the jar was the mainly red or mainly blue jar, but the actual ball that was picked out remains private information. The idea is that the first person guesses that the jar contains mostly the ball color they chose, and the next person does the same. Then the following people will guess their own color if it’s 50/50 which jar it is, otherwise they pick what everybody else picked. If the first two people picked the same color, rational people will guess what they guessed and ignore their own color. This can lead to every member of the group choosing an incorrect decision, as no new information is being injected into the system.
The article discusses how there tends to exist a percentage of people who can be labeled “entrepreneurs” who are overconfident in their own personal information. This leads to the entrepreneurs requiring a larger amount of outside information in order to follow the group. Since these entrepreneurs often don’t follow the herd, they can often be hurt individually by making the wrong choice. However, these entrepreneurs provide new information to the group which can sometimes break incorrect information cascades, which greatly benefits the group. The article states that the benefit to the group from entrepreneurs in their model can be up to two orders of magnitude higher than cost that the entrepreneurs personally incur for choosing a sub-optimal strategy. Thus it makes sense that from a group perspective overconfident individuals exist, despite overconfidence being on an individual level a seemingly detrimental trait. It is entirely possible that as populations evolved, a certain low percentage of overconfident individuals were selected for due to the benefit they provide to the group. It is important to mention, however, that too many overconfident individuals just causes not as many people to rely on group information, which will hurt the group at a certain point. Thus a balance of entrepreneurs to non-overconfident individuals is required for a successful group. The author’s found the Pareto-preferred amount of entrepreneurs in a group to be 1-2% for their model. There were a lot of assumptions made and variables set to obtain this number, so it is best to take a look at the article to see the math behind it. Anyways, what this article shows is that if you have a friend who always seems overconfident almost to a fault, just remember that though it seems like a negative trait, that overconfidence could actually unintentionally be helping out everyone else in the long run.
Source: http://onlinelibrary.wiley.com/doi/10.1111/j.1430-9134.2001.00301.x/pdf