Bias Arbitrage

Abstract

The production of law - including the choice of a law's subject matter, the timing of its enactment and the manner in which it is publicized and perceived by the public - is significantly driven by an extra-legal market in which politicians and private parties compete over the opportunity to engage in bias arbitrage. Bias arbitrage is the extraction of private benefits through actions that identify and mitigate discrepancies between objective risks and the public's perception of the same risks.

Politicians arbitrage these discrepancies by enacting laws that address the misperceived risk and contain a 'placebo effect' - a counter-bias that attempts to offset the pre-existing misperception. If successful, politicians are able to take credit for the change in the perceived risk, while social welfare is enhanced by the elimination of deadweight loss caused by the risk misperception.

However, politicians must compete with private parties such as insurers, experts and the media, who can engage in bias arbitrage using extra-legal means. This article analyses methods in which parties engage in bias arbitrage and the effect of interaction between potential bias arbitrageurs on the production of law.

JEL Classification: D21, D72, D84, G22, K40