Overinference from Weak Signals and Underinference from Strong Signals

67 Pages Posted: 30 Dec 2022 Last revised: 13 May 2023

See all articles by Ned Augenblick

Ned Augenblick

University of California, Berkeley - Economic Analysis & Policy Group

Eben Lazarus

University of California, Berkeley - Haas School of Business - Finance Group

Michael Thaler

University College London - Drayton House

Date Written: March 21, 2023

Abstract

We study how overreaction and underreaction to signals depend on their informativeness. While a large literature has studied belief updating in response to highly informative signals, people in important real-world settings are often faced with a steady stream of weak signals. We use a tightly controlled experiment and new empirical evidence from betting and financial markets to demonstrate that updating behavior differs meaningfully by signal strength: across domains, our consistent and robust finding is overreaction to weak signals and underreaction to strong signals. Both sets of results align well with a simple theory of cognitive imprecision about signal informativeness. Our framework and findings can help harmonize apparently contradictory results from the experimental and empirical literatures.

JEL Classification: C91, D83, D91, G14, G41

Suggested Citation

Augenblick, Ned and Lazarus, Eben and Thaler, Michael, Overinference from Weak Signals and Underinference from Strong Signals (March 21, 2023). MIT Sloan Research Paper No. 6830-22, Available at SSRN: https://ssrn.com/abstract=4315007 or http://dx.doi.org/10.2139/ssrn.4315007

Ned Augenblick

University of California, Berkeley - Economic Analysis & Policy Group ( email )

Berkeley, CA 94720
United States

Eben Lazarus (Contact Author)

University of California, Berkeley - Haas School of Business - Finance Group ( email )

Haas School of Business
545 Student Services Building
Berkeley, CA 94720
United States

HOME PAGE: http://ebenlazarus.github.io

Michael Thaler

University College London - Drayton House ( email )

30 Gordon Street
London, WC1H 0QB
United Kingdom

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