Perceiving Prospects Properly
American Economic Review
vol. 106,
no. 7, July 2016
(pp. 1601-31)
(Complimentary)
Abstract
When an agent chooses between prospects, noise in information processing generates an effect akin to the winner's curse. Statistically unbiased perception systematically overvalues the chosen action because it fails to account for the possibility that noise is responsible for making the preferred action appear to be optimal. The optimal perception pattern exhibits a key feature of prospect theory, namely, overweighting of small probability events (and corresponding underweighting of high probability events). This bias arises to correct for the winner's curse effect.Citation
Steiner, Jakub, and Colin Stewart. 2016. "Perceiving Prospects Properly." American Economic Review, 106 (7): 1601-31. DOI: 10.1257/aer.20141141Additional Materials
JEL Classification
- D11 Consumer Economics: Theory
- D81 Criteria for Decision-Making under Risk and Uncertainty
- D82 Asymmetric and Private Information; Mechanism Design
- D83 Search; Learning; Information and Knowledge; Communication; Belief; Unawareness