Optimistic Bias

Optimistic bias is a significant source of risk-taking. Generally people take risks because the odds are favourable, ie they accept some possibility of failure because the possibility of success is sufficient. To handle this bias there is a need for rational weighing of gains, losses and probabilities. Otherwise they over-estimate the benefits and under-estimate the cost (including potential for mistakes and miscalculations). Remember: people are overconfident of their ability to handle things and/or predict the future!!!! It is not easier to change direction with just a few facts that may contradict your point of view. It is a form of lethargy, ie an unwillingness to think about what has, or could, happen.

. Optimism is inherited, ie a preference for seeing the brighter side of everything. Generally, optimists are more cheerful and happy - therefore popular; more resilient; have a stronger immune system; better health, etc. Usually they are the inventors, entrepreneurs, leaders (political and military) who are seeking challenges and taking risks; they have been lucky; self-confident. An optimistic temperament encourages persistence in the face of obstacles

. Generally risk takers underestimate the odds they face and do not spend effort to find out what the odds are. For example, the chances of a small business surviving for 5 years in USA is 35%; yet individuals who start such businesses believe they have a 60+% chance of success, ie almost double the true value. But as the outcome of a start-up depends as much on their own efforts (like raising funds, handling stakeholders, etc) as their handling of competitors and changes in the marketplace. Remember: inadequate appreciation of the uncertainty of the environment inevitably results in decision-makers taking risks that they should avoid. In the marketplace, optimism is highly valued.

There can be collective blindness to risk and uncertainty as shown by the GFC that started in 2008

"...an unbiased appreciation of uncertainty is a cornerstone of rationality..."

Daniel Kahneman 2012

. Competition neglect = competitors' reactions are not part of the decision-making

. Hubris hypothesis = executives of an acquiring firm are simply less competent than they think they are. Many optimistic CEOs take excessive risks, like accruing large debts, overpaying for target firms, etc. Celebrity CEOs underperform non-celebrity CEOs

. Illusion of control = in explaining the past and predicting the future, we focus on the causal role of skill, and neglect the role of luck; we focus on what we know, neglecting what we do not know, making us very confident in our own beliefs

. Optimistic explanation style = contributes to resilience by defending one's self-image; it involves taking credit for successes but assuming little blame for failures; people have an exaggerated sense of their own importance; involves subjective confidence that is determined by the coherence of the story one has constructed, not by the quality and amount of information that supports it. One way to overcome this is to ask people to explore the outcome of a decision which proves to be a disaster, ie how would they handle this?, ie this legitimises doubt and reduces group think



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