Mitigating free riding in social networks: The impact of underestimating others' ability in financial market

This study investigates overconfident traders who underestimate their contemporaries' information processing ability, and it examines the impact of these traders on the financial market within the framework of social networks. As a byproduct, we also explore the impact of traders who overestimate their own ability, which is another manifestation of overconfidence. We find that when information acquisition is endogenous, market outcomes are improved by the effects of both underestimation and overestimation biases. The underlying logic is that traders' overconfidence adds friction to free-riding on contemporaries' information, thereby mitigating the information crowding-out effect of social communication. The results are robust to the extension of endogenous network formation and varying information acquisition costs.