The overconfident and optimistic price-setting newsvendor

Abstract

Overconfidence and optimism are behavioral biases known to impact newsvendor ordering decisions. We develop a model that accounts for both effects by applying a probability weighting function from Prospect Theory (PT). We apply the model to a price-setting newsvendor problem with reference effects. Contrary to previous work claiming that increased optimism leads a newsvendor to adopt a high margin and low volume strategy, we find that greater optimism typically results in lower margins and higher inventory, aligning with the more intuitive interpretation of optimism. In addition, we find that overconfidence and regret have similar impacts on both inventory levels and pricing.