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

Abstract

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

Keywords: Neuroeconomics, Tail Risk, Efficient Coding, Adaptation, Decision-Making Under Uncertainty

JEL Classification: C91, D87