The Evolution of Confidence Caught between Euphoria and Despair

This paper provides – by means of an experiment- a consistent explanation for the timing and occurrence of radical changes in confidence: if a sequence of past gains (losses) is interrupted by a loss (gain), then agent‟s beliefs change instantly, radically and significantly different from the predictions of Bayesian theory. In addition, the paper reveals that the shorter the time spans to a reference period (e.g. bonus) the more people on average overestimate their likelihood of success. The paper brings about three innovations: (1) it provides empirical evidence on a multiple stage game with sequences of gains and losses, (2) it measures confidence and action explicitly and separately (3) it makes an explicit and measurable distinction between the two minds of agents (see Seligman, 1990). Policy recommendations are to moderate and regulate market forces.