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American Economic Review: Vol. 102 No. 6 (October 2012)
AER Volume. 102, Issue 6 | 
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Modeling the Change of Paradigm: Non-Bayesian Reactions to Unexpected News
Article Citation
Ortoleva, Pietro. 2012. "Modeling the Change of Paradigm: Non-Bayesian Reactions to Unexpected News."
American Economic Review,
102(6): 2410-36.
DOI: 10.1257/aer.102.6.2410
DOI: 10.1257/aer.102.6.2410
Abstract
Bayes' rule has two well-known limitations: 1) it does not model the
reaction to zero-probability events; 2) a sizable empirical evidence documents systematic violations of it. We characterize axiomatically an alternative updating rule, the Hypothesis Testing model. According
to it, the agent follows Bayes' rule if she receives information to which she assigned a probability above a threshold. Otherwise, she looks at a prior over priors, updates it using Bayes' rule for second-order
priors, and chooses the prior to which the updated prior over priors assigns the highest likelihood. We also present an application to equilibrium refinement in game theory. (JEL D11, D81, D83)
Article Full-Text Access
Full-text Article
Authors
Ortoleva, Pietro (CA Institute of Technology)
JEL Classifications
D11: Consumer Economics: Theory
D81: Criteria for Decision-Making under Risk and Uncertainty
D83: Search; Learning; Information and Knowledge; Communication; Belief
D81: Criteria for Decision-Making under Risk and Uncertainty
D83: Search; Learning; Information and Knowledge; Communication; Belief
