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Subjective probabilities: psychological evidence and economic applications

  • Abbigail Chiodo
  • Massimo Guidolin
  • Michael T. Owyang
  • Makoto Shimoji

Real-life decision makers are often forced to estimate the likelihood of uncertain future events. Usually, economists assume that agents behave as though they are fully rational, employing statistical rules to assess probabilities, and that they maximize expected utility. Psychological studies, however, have shown that people tend not to adhere to these rationality postulates. We review three rules of thumb taken from the psychology literature that people have been shown to rely on when assessing the likelihood of uncertain events. We construct a simple model of belief formation that incorporates these rules and present one formal and two illustrative applications in which these psychological phenomena cause deviations from anticipated economic outcomes.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2003-009.

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Date of creation: 2003
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Publication status: Published in Federal Reserve Bank of St. Louis Review, January/February 2004, 86(1), pp. 33-47
Handle: RePEc:fip:fedlwp:2003-009
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