Subjective probabilities: psychological evidence and economic applications

Abbigail J. Chiodo, Massimo Guidolin, Michael Owyang and Makoto Shimoji

No 2003-009, Working Papers from Federal Reserve Bank of St. Louis

Abstract: Real-life decision makers are often forced to estimate the likelihood of uncertain future events. Usually, economists assume that agents behave as though they are fully rational, employing statistical rules to assess probabilities, and that they maximize expected utility. Psychological studies, however, have shown that people tend not to adhere to these rationality postulates. We review three rules of thumb taken from the psychology literature that people have been shown to rely on when assessing the likelihood of uncertain events. We construct a simple model of belief formation that incorporates these rules and present one formal and two illustrative applications in which these psychological phenomena cause deviations from anticipated economic outcomes.

Keywords: Economic conditions; prediction (search for similar items in EconPapers)
Date: 2003
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Published in Federal Reserve Bank of St. Louis Review, January/February 2004, 86(1), pp. 33-47

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DOI: 10.20955/wp.2003.009

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