Consumer Overconfidence and the Choice of Cell Phone Plans

I use an original and rich data set from a cell phone service provider from Europe to estimate the degree of consumer overconfidence and its impact on welfare in the market for cell phone services. The menu of tariffs offered by the cellular service provider includes both two-part and three-part tariffs which are optimal under different levels of voice minute usage. The observed customer plan choice and voice minute consumption allow me to estimate the degree of overconfidence about future usage. To separately identify overconfidence from uncertainty and to account for consumer self selection into cell phone plans, I build a two-stage structural model where a consumer makes his plan choice based on his beliefs about future demand, while the voice minute consumption decision is based on the realization of his demand. The structural model also allows me to estimate the variance of the optimization error which arises from customers not perfectly monitoring their voice minute usage. I estimate that 76 percent of consumers underestimate the variance of their future demand for voice minutes, and, on average, a customer underestimates it by 23 percent. Furthermore, the optimization error term is precisely estimated and accounts for 17 percent of variation in observed voice minute usage not accounted by observable customers' characteristics. I also find that elimination of overconfidence and optimization error leads to 3.06 percent increase in total welfare.