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Correlation Neglect in Belief Formation

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  • Benjamin Enke

    ()

  • Florian Zimmermann

    ()

Abstract

Many 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 Info

Paper provided by University of Bonn, Germany in its series Bonn Econ Discussion Papers with number bgse04_2013.

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Length: 35
Date of creation: Apr 2013
Date of revision:
Handle: RePEc:bon:bonedp:bgse04_2013

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Web page: http://www.bgse.uni-bonn.de

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Keywords: Beliefs; Correlation Neglect; Experiments; Markets; Overshooting;

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References

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Cited by:
  1. Bormann, Sven-Kristjan, 2013. "Sentiment indices on financial markets: What do they measure?," Economics Discussion Papers 2013-58, Kiel Institute for the World Economy.
  2. Pietro Ortoleva & Erik Snowberg, 2013. "Overconfidence in Political Behavior," NBER Working Papers 19250, National Bureau of Economic Research, Inc.

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