The overconfident newsvendor

Abstract

Previous experimental work has shown that individuals make suboptimal decisions in newsvendor problems. We argue that these decisions may be caused by overconfidence, and explore a theoretical (behavioral) model of overconfident newsvendors first presented in Ren and Croson () that is consistent with these observed results. Using classical analysis techniques, we show that overconfident newsvendors will over-order in low-profit situations and under-order in high-profit situations, exhibiting the ordering pattern observed in the field and in the lab. In this paper, we further demonstrate that order bias is linear in the level of overconfidence, and is increasing with the variance of the demand distribution. Order bias also has a U-shaped relationship with market profitability, and the costs of overconfidence are convex. We use the theory to develop new predictions which can be themselves tested in future work.

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