Talking the talk, not walking the walk: The co-evolution of overconfidence and loss aversion

Perhaps the two most prominent human cognitive "biases" are unjustified self-belief, termed overconfidence, and loss aversion, a special form of reference dependence whereby an outcome is less attractive if perceived as a loss. As evolution tends to make adaptations that enhance fitness, the puzzle is why these biases arise, especially as they tend to offset each other. Specifically, overconfidence promotes risk-taking, such as starting a business, whilst loss aversion curbs it. Is evolution just burying its own mistakes? We propose an alternative reconciliation of the evolutionary basis of these seemingly conflicting biases. Following Robert Trivers, overconfidence arises to positively influence the behavior of others. The downside is that if acted on, overconfidence leads to mistaken decisions. Our point is that loss aversion limits how far these evaluation errors are implemented. Importantly, loss aversion corrects decision errors due to overconfidence more effectively than does augmented risk aversion.