Base rate neglect for the wealth of populations
Base rate neglect has been shown to be a very robust bias in human information processing. It has also been show to be ecologically rational in some environments. However, when arguing about base rate neglect usually isolated individuals are considered. I complement these results by showing that in many scenarios of social learning a base rate neglect increases a population's wealth. I thereby strengthen the argument that the presence of base rate neglect could be evolutionary stable. I pick up a model of social learning that has been used to demonstrate the potential benefits of overconfidence. Individuals are confronted with a safe and a risky option. They receive a private signal about the risky option's outcome, they decide in an exogenously given sequence, and they observe decisions of preceding individuals. I first deviate from the original model by incorporating base rates that differ from fifty-fifty and show that under weighting this base rate can be for the wealth of a population. Then I analyse how the optimal base rate neglect reacts to changes in payoffs. I show that for large set of settings under weighting the base rate is still positive, but for a smaller subset it decreases wealth instead
References listed on IDEAS
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- Chamley,Christophe P., 2004. "Rational Herds," Cambridge Books, Cambridge University Press, number 9780521530927, October.
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- Antonio Bernardo & Ivo Welch, 2001. "On the Evolution of Overconfidence and Entrepreneurs," Yale School of Management Working Papers ysm211, Yale School of Management, revised 01 Nov 2003.
- Antonio E. Bernardo & Ivo Welch, 2001. "On the Evolution of Overconfidence and Entrepreneurs," Cowles Foundation Discussion Papers 1307, Cowles Foundation for Research in Economics, Yale University.
- Anderson, Lisa R & Holt, Charles A, 1997. "Information Cascades in the Laboratory," American Economic Review, American Economic Association, vol. 87(5), pages 847-862, December.
- Chamley,Christophe P., 2004. "Rational Herds," Cambridge Books, Cambridge University Press, number 9780521824019, October.
- Abhijit V. Banerjee, 1992. "A Simple Model of Herd Behavior," The Quarterly Journal of Economics, Oxford University Press, vol. 107(3), pages 797-817. Full references (including those not matched with items on IDEAS)
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