Belief Digitization in Economic Prediction

Abstract

Economic choices depend on our predictions of the future. Yet, at times predictions are not based on all relevant information, but instead on the single most likely possibility, which is treated as though certainly the case—that is, digitally. Two sets of studies test whether this digitization bias would occur in higher-stakes economic contexts. When making predictions about the future asset prices, participants ignored conditional probability information given relatively unlikely events and relied entirely on conditional probabilities given the more likely events. This effect was found for both financial aggregates and individual stocks, for binary predictions about the direction and continuous predictions about expected values, and even when the “unlikely” event explicitly had a probability as high as 30%; further, it was not moderated by investing experience. Implications for behavioral finance are discussed.


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