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Belief in mean reversion and the law of small numbers

Author

Listed:
  • Noor, Jawwad

    (Department of Economics, Boston University)

  • Payro, Fernando

    (Universitat Autonoma de Barcelona and Barcelona School of Economics)

Abstract

Studies find that people systematically underestimate the likelihood of streaks in a random sequence. In a canonical coin-tossing environment, this paper shows that the evidence can be explained by a belief in mean reversion. Such beliefs are represented as if the bias of the coin is history-dependent and “self-correcting”. In a Bayesian inference setting, a belief in mean reversion ensures that the agent never rules out the true parameter.

Suggested Citation

  • Noor, Jawwad & Payro, Fernando, 0. "Belief in mean reversion and the law of small numbers," Theoretical Economics, Econometric Society.
    • Handle: RePEc:the:publsh:5996
    as

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    References listed on IDEAS

    as
    1. Daniel J. Benjamin & Matthew Rabin & Collin Raymond, 2016. "A Model of Nonbelief in the Law of Large Numbers," Journal of the European Economic Association, European Economic Association, vol. 14(2), pages 515-544.
    2. Rachel Croson & James Sundali, 2005. "The Gambler’s Fallacy and the Hot Hand: Empirical Data from Casinos," Journal of Risk and Uncertainty, Springer, vol. 30(3), pages 195-209, May.
    3. Terrell, Dek, 1994. "A Test of the Gambler's Fallacy: Evidence from Pari-mutuel Games," Journal of Risk and Uncertainty, Springer, vol. 8(3), pages 309-317, May.
    4. Larry G. Epstein, 2006. "An Axiomatic Model of Non-Bayesian Updating," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 73(2), pages 413-436.
    Full references (including those not matched with items on IDEAS)

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    Keywords

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    JEL classification:

    • D01 - Microeconomics - - General - - - Microeconomic Behavior: Underlying Principles
    • D9 - Microeconomics - - Micro-Based Behavioral Economics

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