Correlation Neglect in Belief Formation
AbstractMany information structures generate correlated rather than mutually independent signals, the news media being a prime example. This paper shows experimentally that in such context many people neglect these correlations in the updating process and treat correlated information as independent. In consequence, people’s beliefs are excessively sensitive to well-conncected information sources, implying a pattern of “overshooting” beliefs. Additionally, in an experimental asset market, correlation neglect not only drives overoptimism and overpessimism at the individual level, but also affects aggregate outcomes in a systematic manner. In particular, the excessive confidence swings caused by correlated signals give rise to predictable price bubbles and cashes. These findings are reminiscent of popular narratives according to which aggregate booms and busts might be driven by the spread of “stories”. Our results also lend direct support to recent models of boundedly rational social learning.
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Bibliographic InfoPaper provided by University of Bonn, Germany in its series Bonn Econ Discussion Papers with number bgse04_2013.
Date of creation: Apr 2013
Date of revision:
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Beliefs; Correlation Neglect; Experiments; Markets; Overshooting;
Other versions of this item:
- Benjamin Enke & Florian Zimmermann, 2013. "Correlation Neglect in Belief Formation," CESifo Working Paper Series 4483, CESifo Group Munich.
- Enke, Benjamin & Zimmermann, Florian, 2013. "Correlation Neglect in Belief Formation," IZA Discussion Papers 7372, Institute for the Study of Labor (IZA).
- Enke, Benjamin & Zimmermann, Florian, 2013. "Correlation Neglect in Belief Formation," Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order 79900, Verein für Socialpolitik / German Economic Association.
- C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
- D03 - Microeconomics - - General - - - Behavioral Microeconomics; Underlying Principles
- D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search, Learning, and Information
- D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
- D40 - Microeconomics - - Market Structure and Pricing - - - General
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-06-04 (All new papers)
- NEP-EXP-2013-06-04 (Experimental Economics)
- NEP-NEU-2013-06-04 (Neuroeconomics)
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