Optimism bias

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Optimism bias is the demonstrated systematic tendency for people to be over-optimistic about the outcome of planned actions. This includes over-estimating the likelihood of positive events and under-estimating the likelihood of negative events. It is one of several kinds of positive illusion to which people are generally susceptible.

Experimental demonstration

Armor and Taylor review a number of studies that have found optimism bias in different kinds of judgement. These include:

• Second-year MBA students overestimated the number of job offers they would receive and their starting salary.
• Students overestimated the scores they would achieve on exams.
• Almost all the newlyweds in a US study expected their marriage to last a lifetime, even while aware of the divorce statistics.
• Professional financial analysts consistently overestimated corporate earnings.
• Most smokers believe they are less at risk of developing smoking-related diseases than others who smoke.

Students in one study rated themselves as much less likely than their peers (students of the same sex at the same college) to experience negative life events such as developing a drinking problem, having a heart attack, being fired from a job or divorcing a few years after getting married.

Optimism bias does not apply universally. For example, people overestimate their chances of experiencing very low-frequency events, including negative events.

Effects of overconfidence

Example: Increased risk taking and insufficient preventive care

Optimistic overconfidence bias can induce people to underinvest in primary and preventative care and other risk reducing behaviors, like abstinence from smoking.

Example: Credit card borrowing and penalty rates and fees

Overconfidence causes many individuals to grossly underestimate their odds of making a payment late. Statistically, many people are quite likely to make at least one or more payments late due to the normal range of difficulties and delays in day-to-day life. Overconfidence bias causes these individuals to grossly underestimate the odds of this happening, and therefore to accept grossly punitive fees and rates (for example an interest rate of nearly 30 %) as a result of otherwise minor transgressions like a late payment. Other companies now have extended on this approach, by increasing interest rates to punitive rates for any late payment even if it is to another creditor. Overconfidence bias makes these terms more acceptable to borrowers than if they were accurately calibrated.

Overconfidence bias also causes many individuals to substantially underestimate the probability of having serious financial or liquidity problems - for example from a sudden job loss or severe illness. This can cause individuals to take on excessive debt under the expectation that they will do "better than average" in the future and be readily able to pay it off.

Overconfidence, locus of control and depression

Overconfidence bias may cause many individuals to overestimate their degree of control as well as their odds of success. This may be protective against depression - since Seligman and Maier's model of depression includes a sense of learned helplessness and loss of predictability and control. Depressives tend to be more accurate, and less overconfident in their assessments of the probabilities of good and bad events occurring to others but they tend to overestimate the probability of bad events happening to them. This has caused some researchers to consider that overconfidence bias may be adaptive and/or protective in some situations.

Optimism bias and planning

Main article: Planning fallacy

Optimism bias arises in relation to estimates of costs and benefits and duration of tasks. It must be accounted for explicitly in appraisals, if these are to be realistic. Optimism bias typically results in cost overruns, benefit shortfalls, and delays, when plans are implemented.

The UK government explicitly acknowledges that optimism bias is a problem in planning and budgeting and has developed measures for how to deal with optimism bias in government (HM Treasury 2003 ). The UK Department for Transport requires project planners to use so-called "optimism bias uplifts" for large transport projects in order to arrive at accurate budgets for planned ventures (Flyvbjerg and Cowi 2004).

In a debate in Harvard Business Review, between Daniel Kahneman, Dan Lovallo, and Bent Flyvbjerg, Flyvbjerg (2003) – while acknowledging the existence of optimism bias – pointed out that what appears to be optimism bias may on closer examination be strategic misrepresentation. Planners may deliberately underestimate costs and overestimate benefits in order to get their projects approved, especially when projects are large and when organizational and political pressures are high. Kahneman and Lovallo (2003) maintained that optimism bias is the main problem.

Mechanisms

A brain-imaging study found that, when imagining negative future events, signals in the amygdala, an emotion centre of the brain, are weaker than when remembering past negative events. This weakened consideration of possible negative outcomes is one possible mechanism for optimism bias.

See also

List of cognitive biases Cost-benefit analysis Cost overrun Cost underestimation Benefit shortfall Planning fallacy Reference class forecasting Rosy retrospection References Further reading Flyvbjerg, Bent, 2003. "Delusions of Success: Comment on Dan Lovallo and Daniel Kahneman." Harvard Business Review, December Issue, pp. 121-122. Flyvbjerg, Bent, "From Nobel Prize to Project Management: Getting Risks Right." Project Management Journal, vol. 37, no. 3, August 2006, pp. 5-15. Flyvbjerg, Bent and Cowi, Procedures for Dealing with Optimism Bias in Transport Planning: Guidance Document (London: UK Department for Transport, June 2004). 61 pp. Flyvbjerg, Bent, Mette K. Skamris Holm, and Søren L. Buhl, "Underestimating Costs in Public Works Projects: Error or Lie?" Journal of the American Planning Association, vol. 68, no. 3, Summer 2002, pp. 279-295. HM Treasury, Supplementary Green Book Guidance: Optimism Bias (London: HM Treasury, 2003). Kahneman, Daniel and Dan Lovallo, 2003. "Response to Bent Flyvbjerg." Harvard Business Review, December Issue, p. 122. Lovallo, Dan and Daniel Kahneman, 2003. "Delusions of Success: How Optimism Undermines Executives' Decisions," Harvard Business Review, July Issue, pp. 56-63. Matlin, Margaret W. "Pollyanna Principle" in Pohl, Rüdiger (2004). Cognitive Illusions: a handbook on fallacies and biases in thinking, judgement and memory. Psychology Press. ISBN 978-1-84169-351-4. Lev Virine and Michael Trumper. Project Decisions: The Art and Science, Vienna, VA: Management Concepts, 2008. ISBN 978-1567262179