WP 2015-05 Information Characteristics and Errors in Expectations: Experimental Evidence

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Forthcoming – Journal of Financial and Quantitative Analysis

ABSTRACT: The behavioral biases documented in psychology are not always robust when tested in economic conditions. We design an experiment to test the hypothesis that, in violation of Bayes Rule, some people respond more forcefully to the strength of an information signal than to its weight. We provide real incentives to motivate effort, use naturally occurring information, and control for risk attitude. We find that the strength-weight bias affects expectations, but that its magnitude is significantly lower than originally reported. Controls for non-linear utility further reduce the strength-weight effect. Overall our results suggest that incentive compatibility and controls for risk attitude considerably affect inferences on errors in expectations.