Outlier Blindness: A Neurobiological Foundation for Neglect of Financial Risk

Abstract

How do people record information about the outcomes they observe in their environment? Building on a well-established neuroscientific framework, we propose a model in which people are hampered in their perception of outcomes that they expect to seldom encounter. We provide experimental evidence for such ‘outlier blindness’ and discuss how it provides a microfoundation for neglected tail risk by investors in financial markets.

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

JEL Classification: C91, D87, G41