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Complexity and Misspecification

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  • Drew Fudenberg
  • Florian Mudekereza

Abstract

We propose a tractable unified framework to study the evolution and interaction of model-misspecification concerns and complexity aversion in repeated decision problems. This aims to capture environments where decision makers worry that their models are misspecified while also disliking overly complex models. We find that pathological cycles caused by endogenous concerns for misspecification can be eliminated by penalizing complex models and show that such preferences for simplicity tend to favor safety, which can enhance welfare in the long run. We use our framework to provide new microfoundations for pervasive empirical phenomena such as "scale heterogeneity" in discrete-choice analysis, "probability neglect" in behavioral economics, and "home bias" in international finance.

Suggested Citation

  • Drew Fudenberg & Florian Mudekereza, 2026. "Complexity and Misspecification," Papers 2602.15674, arXiv.org.
    • Handle: RePEc:arx:papers:2602.15674
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    File URL: http://arxiv.org/pdf/2602.15674
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