Predicting Relative Performance in Economic Competition

Abstract

Recent research in psychology has challenged the notion of a systematic “better-than-average” bias in predicted relative performance. Extending this research, we show that in an incentive-compatible experimental competition with widespread variation in abilities, those who are better than average tend to overestimate their actual performance, while those who are worse than average tend to underestimate their actual performance. We then demonstrate that this symmetric miscalibration at both sides of the relative performance distribution can facilitate optimal choices of costly insurance to mitigate performance-based risks. In contrast to the findings of prior research, we find that, after taking this insurance into account, participants are no worse off when economic risks are based on relative performance than when risks are assigned randomly in a similarly structured control setting.

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