Learning About Unstable, Publicly Unobservable Payoffs

Review of Financial Studies, Forthcoming

66 Pages Posted: 14 May 2012 Last revised: 22 Oct 2014

See all articles by Elise Payzan-LeNestour

Elise Payzan-LeNestour

University of New South Wales; Financial Research Network (FIRN)

Peter Bossaerts

University of Melbourne - Department of Finance

Date Written: June 10, 2014


Neoclassical finance assumes that investors are Bayesian. In many realistic situations, Bayesian learning is challenging. Here, we consider investment opportunities that change randomly, while payoffs are observable only when invested. In a stylized version of the task, we wondered whether performance would be affected if one were to follow reinforcement learning principles instead. The answer is a definite yes. When asked to perform our task, participants overwhelmingly learned in a Bayesian way. They stopped being Bayesians though when not nudged into paying attention to contingency shifts. This raises an issue for financial markets: who has the incentive to nudge investors?

Keywords: Instability, Payoff observability, Complexity, Learning, Multi-armed bandit problem, Neurofinance

JEL Classification: C91, D83, D87, G02, G11

Suggested Citation

Payzan-LeNestour, Elise and Bossaerts, Peter L., Learning About Unstable, Publicly Unobservable Payoffs (June 10, 2014). Review of Financial Studies, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2056927 or http://dx.doi.org/10.2139/ssrn.2056927

Elise Payzan-LeNestour (Contact Author)

University of New South Wales ( email )

Australian School of Business
Sydney, NSW 2052

HOME PAGE: http://www.elisepayzan.com/

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane

HOME PAGE: http://www.firn.org.au

Peter L. Bossaerts

University of Melbourne - Department of Finance ( email )

Faculty of Economics and Commerce
Department of Finance
Carlton, Victoria 3010

HOME PAGE: http://bmmlab.org

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