Overconfidence, subjective perception and pricing behavior

Benigno, Pierpaolo; Karantounias, Anastasios G. (2019). Overconfidence, subjective perception and pricing behavior. Journal of economic behavior & organization, 164, pp. 107-132. Elsevier 10.1016/j.jebo.2019.05.029

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We study the implications of overconfidence for price setting in a monopolistic competition setup with incomplete information. Our price-setters overestimate their abilities to infer aggregate shocks from private signals. The fraction of uninformed firms is endogenous; firms can obtain information by paying a fixed cost. We find two results: i) overconfident firms are less inclined to acquire information relative to the rational benchmark; ii) prices might exhibit excess volatility driven by non-fundamental noise. We explore the empirical predictions of our model for idiosyncratic price volatility.

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