Complexity and Misspecification

Drew Fudenberg and Florian Mudekereza

Papers from arXiv.org

Abstract: We propose a tractable unified framework to study the evolution and interaction of model-misspecification concerns and complexity aversion in repeated decision problems. This aims to capture environments where decision makers worry that their models are misspecified while also disliking overly complex models. We find that pathological cycles caused by endogenous concerns for misspecification can be eliminated by penalizing complex models and show that such preferences for simplicity tend to favor safety, which can enhance welfare in the long run. We use our framework to provide new microfoundations for pervasive empirical phenomena such as "scale heterogeneity" in discrete-choice analysis, "probability neglect" in behavioral economics, and "home bias" in international finance.

Date: 2026-02
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