Investment strategy and selection bias: An equilibrium perspective on overoptimism

Investors of new projects consider the returns of implemented projects delivering the same impression, and invest if the empirical mean return exceeds the cost.The steady states of such economies result in suboptimal investment decisions due to the selection bias in the sampling procedure and the dispersion of impressions across investors. Assuming better impressions are associated with higher returns, investors assessments of their projects are overoptimistic, and there is overinvestment as compared with the rational benchmark. The presence of rational investors aggravates the overoptimism bias of sampling investors, thereby illustrating a negative externality imposed by rational investors