A Model of Reference-Dependent Belief Updating
62 Pages Posted: 4 Dec 2016
Date Written: November 03, 2016
We propose a model of instrumental belief choice under loss aversion. When new information arrives, an agent is prompted to abandon her prior. However, potential posteriors may induce her to take actions that generate a lower utility in some states than actions induced by her prior. These losses loom larger than gains in other states in which potential posteriors lead to larger utility than the prior. In choosing her belief, the agent optimally trades off these psychological gains and losses against the belief's objective performance. Consistent with empirical evidence, belief updating in this model is conservative and can be asymmetric, so that bad news is updated more conservatively than good news. These updating biases generate prior-dependent information preferences, such that agents may avoid information when being unconfident but are information seeking otherwise. Because belief updating depends on the decision problem in which new information is going to be used, the model allows us to explore how these predictions change with either individual preferences or the choice context.
Keywords: belief choice, non-Bayesian updating, reference dependence, loss aversion, regret, conservatism, signal valence, information preferences, overconfidence
JEL Classification: D030, D810, D830, D840, G020
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