The Gambler's and Hot-Hand Fallacies: Theory and Applications

Matthew Rabin and Dimitri Vayanos

The Review of Economic Studies, 2010, vol. 77, issue 2, 730-778

Abstract: We develop a model of the gambler's fallacy--the mistaken belief that random sequences should exhibit systematic reversals. We show that an individual who holds this belief and observes a sequence of signals can exaggerate the magnitude of changes in an underlying state but underestimate their duration. When the state is constant, and so signals are i.i.d., the individual can predict that long streaks of similar signals will continue--a hot-hand fallacy. When signals are serially correlated, the individual typically under-reacts to short streaks, over-reacts to longer ones, and under-reacts to very long ones. Our model has implications for a number of puzzles in finance, e.g. the active-fund and fund-flow puzzles, and the presence of momentum and reversal in asset returns. Copyright , Wiley-Blackwell.

Date: 2010
References: Add references at CitEc
Citations: View citations in EconPapers (114)

Downloads: (external link)
http://hdl.handle.net/10.1111/j.1467-937X.2009.00582.x (application/pdf)
Access to full text is restricted to subscribers.

Related works:
Working Paper: The Gambler's and Hot-Hand Fallacies: Theory and Applications (2007)
Working Paper: The gambler's and hot-hand fallacies: theory and applications (2007)
Working Paper: The Gambler's and Hot-Hand Fallacies:Theory and Applications (2007)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:oup:restud:v:77:y:2010:i:2:p:730-778

Access Statistics for this article

The Review of Economic Studies is currently edited by Thomas Chaney, Xavier d’Haultfoeuille, Andrea Galeotti, Bård Harstad, Nir Jaimovich, Katrine Loken, Elias Papaioannou, Vincent Sterk and Noam Yuchtman

More articles in The Review of Economic Studies from Review of Economic Studies Ltd
Bibliographic data for series maintained by Oxford University Press ().