Unrealistic optimism: what it is and how to deal with it

Abstract

Purpose Unrealistic optimism is a well‐documented psychological phenomenon. The purpose of this paper is to discuss the meaning of being “unrealistically optimistic”. This bias has important implications in many economic and managerial contexts and the authors present evidence of it. Although the policy and welfare implications of such a widespread phenomenon are vast, they have been largely neglected by policy makers. The authors propose conservative paternalistic measures. Design/methodology/approach Critical review of existing literature on Unrealistic Optimism. Analyses of some relevant variables of the mortgage and corporate credit markets in Portugal and Spain. Findings The authors point to evidence and argue that Unrealistic Optimism may well have been at play in the recent behaviour of mortgage and corporate credit markets in Portugal and Spain. Practical implications Because ignoring such biases may simply lead borrowers and financial institutions down a real road to ruin, it is important to discuss paternalistic policies that may mitigate them. The paper therefore presents a conservative approach to paternalistic measures that policy makers should consider adopting. Originality/value The paper shows the link between irrational behaviour and mortgage and corporate credit markets in Portugal and Spain and suggests paternalistic policies that should be encouraged.

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