The Rationality of Decision Biases

12 Pages Posted: 3 Jan 2018 Last revised: 31 Jul 2018

Leon Yang Chu

University of Southern California - Marshall school of Business

Date Written: June 30, 2018

Abstract

Biases may lead to smaller variability, which raises the decision-maker's expected concave utility. As a result, seeking unbiased estimators can be a strictly dominated decision approach. Moreover, by aggregating unrelated tasks and leveraging supposedly irrelevant information, the decision-maker may improve the unbiased decision by shrinking it toward an arbitrarily chosen reference point. This revelation highlights the difference between probability theory and statistical inference. Moreover, it leads to novel testable hypotheses for estimation problems when the knowledge is primarily gained through experience and observation. Built upon the findings of anchoring effects in behavioral economics, we further illustrate that compared to economic models based on probability theory, economic models based on statistical inference better reconcile the gap between rational theories and descriptive behavior.

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

JEL Classification: B20, C10, C11, D01, D81

Suggested Citation

Chu, Leon Yang, The Rationality of Decision Biases (June 30, 2018). Available at SSRN: https://ssrn.com/abstract=3094490 or http://dx.doi.org/10.2139/ssrn.3094490

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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