The Rationality of Behavioral Biases

11 Pages Posted: 3 Jan 2018 Last revised: 9 Mar 2018

Leon Yang Chu

University of Southern California - Marshall school of Business

Date Written: December 29, 2017


Ignoring supposedly irrelevant information can be a strictly dominated decision approach, and thus irrational. The resulting unbiased decision can be improved upon by shrinking the decision toward an arbitrarily chosen reference point. By doing so, the decision-maker incurs a bias, but reduces the variance of the decision, which raises his expected utility. This dominance result highlights the difference between probability theory and statistical inference. The finding further suggests that when the decision-maker faces considerable uncertainty, his behavior should exhibit biases from an evolutionary standpoint. Examination of the known features of the anchoring effect provides additional support for this view.

Keywords: Decision Making under Uncertainty, Behavior Economics, Anchoring Effect, Decision Theory, James-Stein Shrinkage

JEL Classification: B20, C10, C11, D03, D81

Suggested Citation

Chu, Leon Yang, The Rationality of Behavioral Biases (December 29, 2017). Available at SSRN: or

Leon Yang Chu (Contact Author)

University of Southern California - Marshall school of Business ( email )

Marshall School of Business
BRI 401, 3670 Trousdale Parkway
Los Angeles, CA 90089
United States

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