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1 Introduction
The overweening conceit which the greater part of men have of their abilities is an ancient evil remarked by the philosophers and moralists of all ages [...]. The chance of gain is by every man more or less overvalued and the chance of loss by most men undervalued and by scarce any man valued more than it is worth (Adam Smith, 1776).
"According to popular belief, people tend to think that they are invulnerable. They expect others to be victims of misfortune, not themselves" ([29] Weinstein, 1980, p. 806). This hopeful outlook on life implies "a judgement error" which Weinstein called unrealistic optimism (UO) or optimistic bias[1] . As back as 1776 [22] Smith (1937) was convinced that most people displayed such a trait.
Optimistic biases are robust and widespread. Since much psychological evidence shows that subjects do not have rational expectations, but rather that they are unrealistically optimistic, it would be surprising if economic and managerial decision-making were immune to the bias.
These positive illusions create distortions which may be the most important source of efficiency loss in the economic system and, as yet, their policy implications have been ignored. Consider the role of government in facilitating credit to start-up companies and incentivising entrepreneurship in order to foster economic growth and employment. What if in doing so it is (unknowingly) acting against entrepreneurs' best financial interests, and generating large welfare losses? Also consider bankruptcy laws - in most countries they are designed to increase the life span of struggling firms and, in doing so, they may simply be increasing the chances that entrepreneurs will follow a road to ruin. [14] Kahneman (2011, p. 259) shares these concerns.
This paper challenges the neo-classical economic approach (which assumes that individuals are fully rational), shows evidence of very likely irrationality in the markets for loans in Portugal and Spain, and discusses the implications in terms of private and public policy making.
In Section 2 we start by analysing the meaning of UO and how it should be measured. We then provide evidence that UO is a robust and widespread psychological phenomenon. Finally, since the policy implications of such trait may be far from negligible, a clear understanding of when optimistic biases are more likely to...