Base rate neglect for the wealth of populations

Diemo Urbig

No 266, Computing in Economics and Finance 2006 from Society for Computational Economics

Abstract: Base rate neglect has been shown to be a very robust bias in human information processing. It has also been show to be ecologically rational in some environments. However, when arguing about base rate neglect usually isolated individuals are considered. I complement these results by showing that in many scenarios of social learning a base rate neglect increases a population's wealth. I thereby strengthen the argument that the presence of base rate neglect could be evolutionary stable. I pick up a model of social learning that has been used to demonstrate the potential benefits of overconfidence. Individuals are confronted with a safe and a risky option. They receive a private signal about the risky option's outcome, they decide in an exogenously given sequence, and they observe decisions of preceding individuals. I first deviate from the original model by incorporating base rates that differ from fifty-fifty and show that under weighting this base rate can be for the wealth of a population. Then I analyse how the optimal base rate neglect reacts to changes in payoffs. I show that for large set of settings under weighting the base rate is still positive, but for a smaller subset it decreases wealth instead

Keywords: cognitive biases; base rate neglect; social learning; ecological rationality (search for similar items in EconPapers)
JEL-codes: D7 D83 (search for similar items in EconPapers)
Date: 2006-07-04
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