Does Correlation Matter in Probability Matching? A Laboratory Investigation
82 Pages Posted: 18 Jan 2023 Last revised: 20 Feb 2024
Probability Matching, a classical violation of expected utility maximization, refers to people's tendency to randomize, or even match their choice frequency to the outcome probability, when choosing over binary lotteries that differ only in their probabilities. Why? I present an experiment designed to distinguish between several broad classes of explanations: (1) models of Correlation-Invariant Stochastic Choice --- randomizing due to factors orthogonal to the correlation between lotteries, such as non-standard preferences or errors, and (2) models of Correlation-Sensitive Stochastic Choice --- deliberately randomizing due to misperceived hedging opportunities, especially when lotteries are negatively correlated. My experimental design differentiates between their testable predictions by varying the correlation between lottery outcomes. The findings indicate that the first class, despite being home to most existing theories, has limited explanatory power. Using additional treatment, I rule out Similarity Heuristics as an alternative explanation competing with the second class. The results indicate that a vast majority of individuals deliberately randomize due to misperceived hedging opportunities.
Keywords: Probability matching; Stochastic Choice; Convex preferences; Misperceived hedging opportunity; Similarity Heuristics.
JEL Classification: D81, D91, C91
Suggested Citation: Suggested Citation