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Correlation Neglect in Belief Formation

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  • Enke, Benjamin
  • Zimmermann, Florian

Abstract

A frequent feature of information structures is that they generate signals which are not mutually independent, but rather rely on a common set of underlying information. Using a simple experimental design, we show that in such contexts many people neglect correlations in the updating process, leading to systematically "overshooting" beliefs. This finding lends direct support to recent models of boundedly rational learning in social networks. In an experimental market setting, correlation neglect not only drives overoptimism and overpessimism at the individual level, but also affects aggregate outcomes in a systematic manner. In particular, the excessive confidence swings produced by correlated information structures translate into predictable price bubbles and crashes. Finally, we show the robustness of correlation neglect in a naturally occurring informational environment, in which subjects predict GDP growth on the basis of real news reports.

Suggested Citation

  • Enke, Benjamin & Zimmermann, Florian, 2013. "Correlation Neglect in Belief Formation," Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order 79900, Verein für Socialpolitik / German Economic Association.
  • Handle: RePEc:zbw:vfsc13:79900
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    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. On the counting heuristic
      by chris in Stumbling and Mumbling on 2016-11-01 18:27:45

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    1. Alejandro Martínez-Marquina & Muriel Niederle & Emanuel Vespa, 2017. "Probabilistic States versus Multiple Certainties: The Obstacle of Uncertainty in Contingent Reasoning," NBER Working Papers 24030, National Bureau of Economic Research, Inc.
    2. Elgin, Ceyhun & Yucel, Emekcan, 2014. "Determinants of the weight for leisure in preferences," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy (IfW), vol. 8, pages 1-26.
    3. Levy, Gilat & Razin, Ronny, 2017. "The coevolution of segregation, polarized beliefs and discrimination: the case of private versus state education," LSE Research Online Documents on Economics 68532, London School of Economics and Political Science, LSE Library.
    4. Dmitry Taubinsky & Alex Rees-Jones, 2016. "Attention Variation and Welfare: Theory and Evidence from a Tax Salience Experiment," NBER Working Papers 22545, National Bureau of Economic Research, Inc.
    5. Nuzzo, Simone & Morone, Andrea, 2017. "Asset markets in the lab: A literature review," Journal of Behavioral and Experimental Finance, Elsevier, vol. 13(C), pages 42-50.
    6. Bayona, Anna & Brandts, Jordi & Vives, Xavier, 2016. "Supply Function Competition, Private Information, and Market Power: A Laboratory Study," CEPR Discussion Papers 11378, C.E.P.R. Discussion Papers.
    7. Alice Hsiaw & Ing-Haw Cheng, 2016. "Distrust in Experts and the Origins of Disagreement," Working Papers 110R2, Brandeis University, Department of Economics and International Businesss School, revised Jan 2017.
    8. Eyster, Erik & Rabin, Matthew & Weizsäcker, Georg, 2015. "An Experiment on Social Mislearning," CEPR Discussion Papers 11020, C.E.P.R. Discussion Papers.
    9. Alice Hsiaw & Ing-Haw Cheng, 2016. "Distrust in Experts and the Origins of Disagreement," Working Papers 110, Brandeis University, Department of Economics and International Businesss School.
    10. Rasmus Tangsgaard Varneskov & Pierre Perron, 2011. "Combining Long Memory and Level Shifts in Modeling and Forecasting the Volatility of Asset Returns," CREATES Research Papers 2011-26, Department of Economics and Business Economics, Aarhus University.
    11. Pietro Ortoleva & Erik Snowberg, 2015. "Overconfidence in Political Behavior," American Economic Review, American Economic Association, pages 504-535.
    12. Krishna Dasaratha & Kevin He, 2017. "Network Structure and Naive Sequential Learning," Papers 1703.02105, arXiv.org, revised Dec 2017.
    13. Pietro Ortoleva & Erik Snowberg, 2015. "Overconfidence in Political Behavior," American Economic Review, American Economic Association, pages 504-535.
    14. Andrew Ellis & Michele Piccione, 2017. "Correlation Misperception in Choice," American Economic Review, American Economic Association, pages 1264-1292.
    15. Xavier Gabaix, 2017. "Behavioral Inattention," NBER Working Papers 24096, National Bureau of Economic Research, Inc.
    16. Christine L. Exley & Judd B. Kessler, 2017. "The Better is the Enemy of the Good," Harvard Business School Working Papers 18-017, Harvard Business School.
    17. Brandts, Jordi & Giritligil, Ayça Ebru & Weber, Roberto A., 2015. "An experimental study of persuasion bias and social influence in networks," European Economic Review, Elsevier, pages 214-229.
    18. Brandts, Jordi & Giritligil, Ayça Ebru & Weber, Roberto A., 2015. "An experimental study of persuasion bias and social influence in networks," European Economic Review, Elsevier, pages 214-229.
    19. Barron, Kai, 2016. "Belief updating: Does the 'good-news, bad-news' asymmetry extend to purely financial domains?," Discussion Papers, Research Unit: Economics of Change SP II 2016-309, Social Science Research Center Berlin (WZB).
    20. Epstein, Larry G. & Halevy, Yoram, 2017. "Ambiguous Correlation," Microeconomics.ca working papers yoram_halevy-2017-2, Vancouver School of Economics, revised 09 Jan 2018.
    21. Luca Gambetti & Dimitris Korobilis & John D. Tsoukalas & Francesco Zanetti, 2017. "The Effect of News Shocks and Monetary Policy," BCAM Working Papers 1705, Birkbeck Centre for Applied Macroeconomics.
    22. Martin Geiger & Richard Hule, 2017. "The role of correlation in two-asset games: Some experimental evidence," Working Papers 2017-19, Faculty of Economics and Statistics, University of Innsbruck.
    23. Bohren, Aislinn & Hauser, Daniel, 2017. "Bounded Rationality And Learning: A Framework and A Robustness Result," CEPR Discussion Papers 12036, C.E.P.R. Discussion Papers.

    More about this item

    JEL classification:

    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles
    • D40 - Microeconomics - - Market Structure, Pricing, and Design - - - General

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