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Outlier blindness: A neurobiological foundation for neglect of financial risk

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  • Payzan-LeNestour, Elise
  • Woodford, Michael

Abstract

How do people record information about the outcomes they observe in their environment? Building on a well-established neuroscientific framework, we propose a model in which people are hampered in their perception of outcomes that they expect to seldom encounter. We provide experimental evidence for such “outlier blindness” and discuss how it provides a microfoundation for neglected tail risk by investors in financial markets.

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  • Payzan-LeNestour, Elise & Woodford, Michael, 2022. "Outlier blindness: A neurobiological foundation for neglect of financial risk," Journal of Financial Economics, Elsevier, vol. 143(3), pages 1316-1343.
    • Handle: RePEc:eee:jfinec:v:143:y:2022:i:3:p:1316-1343
    DOI: 10.1016/j.jfineco.2021.06.019
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    Cited by:

    1. John R. Graham, 2022. "Presidential Address: Corporate Finance and Reality," Journal of Finance, American Finance Association, vol. 77(4), pages 1975-2049, August.
    2. Payzan-LeNestour, Elise & Pradier, Lionnel & Putniņš, Tālis J., 2023. "Biased risk perceptions: Evidence from the laboratory and financial markets," Journal of Banking & Finance, Elsevier, vol. 154(C).
    3. Hertel, Johanna & Igan, Deniz & Smith, John, 2023. "On the dynamics of the responses in Frydman and Jin (2022): Nullius in verba," MPRA Paper 117788, University Library of Munich, Germany.
    4. Sean, Duffy & John, Smith, 2023. "Stochastic choice and imperfect judgments of line lengths: What is hiding in the noise?," MPRA Paper 116382, University Library of Munich, Germany.

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    More about this item

    Keywords

    Tail risk; Imprecise perception; Efficient coding; Adaptation; Decision making under uncertainty; Behavioral finance; Neuroeconomics; Experiments;
    All these keywords.

    JEL classification:

    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
    • D87 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Neuroeconomics
    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets

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