Behavioral Finance

This article is a few weeks old, but I want to link to it anyway because I am fascinated by behavioral economics/finance.

According to behavioral-finance theorists, overconfidence is one of a host of well-documented cognitive biases—systematic errors in the way people process information (see "Troubling Thoughts," at the end of this article). Shefrin likes to warm his students to the subject of overconfidence by asking them to rate themselves as drivers. "Typically, 40 percent say they're above average, 50 percent average, and 10 percent below average," he says. "Few people are willing to admit to being below average."

Two other pioneers, Richard H. Thaler and Robert J. Shiller, advanced the integration of economics and psychology by solving puzzles of economic behavior (Thaler)—why people adjust so poorly to a decline in wages, for example, or are reluctant to take a high deductible in insurance—and revealing the excessive volatility of the stock market (Shiller). Indeed, although much research has been conducted in the lab, devoted to experiments and problems that illuminate the effects of cognitive biases, behavioral finance relies heavily on real-world data. Shiller and others, for example, have compared historical dividend values and stock prices; Odean and others have found evidence of irrational behavior in the actual account records of thousands of individual investors.

Anyone who understands how the brain works should question themselves when they have such high confidence. That is why it helps, like I said previously, to be a little paranoid.