'Outlier Blindness': Efficient Coding Generates an Inability to Represent Extreme Values

Abstract

How do people perceive extreme values? Building on a well-established theory from neuroscience, we hypothesize that economic agents are inherently hampered in the way they perceive extreme values because the human brain is organized to devote neural activity to representing the most probable values at the expense of the improbable ones. We find support for this hypothesis in a series of controlled laboratory experiments.

Keywords: Tail risk, Instability, Imprecise perception, Efficient coding, Adaptation, Decision making under uncertainty, Behavioral finance, Neuroeconomics, Experiments

JEL Classification: C91, D87