Overconfident Competing Newsvendors

Abstract

Overconfidence is one of the most consistent, powerful, and widespread cognitive biases affecting decision making in situations characterized by random outcomes. In this paper, we study the effects and implications of overconfidence in a competitive newsvendor setting. In this context, overconfidence is defined as a cognitive bias in which decision makers behave as though the outcome of an uncertain event is less risky than it really is. This bias unequivocally leads to a lower expected profit for a newsvendor that does not compete on inventory availability. Nevertheless, it can be a positive force for competing newsvendors. Indeed, we find that when the product’s profit margin is high, overconfidence can lead to a first-best outcome. In a similar vein, we also show that the more biased of two competing newsvendors is not necessarily destined to a smaller expected profit than its less biased competitor. This paper was accepted by Manel Baucells, decision analysis.