Second-Best Considerations in Correcting Cognitive Biases

Abstract

Studies in psychology and behavioral economics have found that decision-making is replete with cognitive biases. Using stylized examples of time inconsistency, regret, and overconfidence, this paper demonstrates how biases may offset each other and lead to correct decisions. If only some biases are known, even correction of all known biases has ambiguous effects. With costly correction, the presence of some biases may be optimal. Further, if the correct decision is unknown, then the presence of biases does not imply that decision-making is suboptimal.

Keywords: second best, cognitive bias

JEL Classification: A12, D60