Belief Formation Under Signal Correlation

47 Pages Posted: 9 Aug 2018 Last revised: 19 Jan 2024

See all articles by Tanjim Hossain

Tanjim Hossain

University of Toronto

Ryo Okui

University of Tokyo - Graduate School of Economics

Date Written: January 17, 2024

Abstract

This paper demonstrates the importance of considering incorrect perceptions of variance in characterizing people’s belief formation rules when they suffer from correlation neglect. Using laboratory experiments, we elicit posterior beliefs regarding the realization of a random variable where some signals that a subject receives are correlated. Subjects in our experiments consistently neglect correlation and also misperceive signal variance when updating their beliefs. We present behavioral models that illustrate how people who suffer from both biases overvalue strongly correlated signals and undervalue weakly correlated signals relative to Bayesian predictions. Additional experiments provide strong support for such a nuanced impact of correlation neglect on belief updating rules. The estimated model parameters are consistent with subjects showing high levels of correlation neglect and undersensitivity to increases in the true variance. Moreover, we find significant heterogeneity across subjects, with a majority exhibiting correlation neglect combined with variance misperception.

Keywords: Information processing, non-Bayesian updating, correlation neglect, variance misperception, belief elicitation.

JEL Classification: C91, D81, D83, D84

Suggested Citation

Hossain, Tanjim and Okui, Ryo, Belief Formation Under Signal Correlation (January 17, 2024). Available at SSRN: https://ssrn.com/abstract=3218152 or http://dx.doi.org/10.2139/ssrn.3218152

Tanjim Hossain

University of Toronto ( email )

105 St George Street
Toronto, Ontario M5S 3G8
Canada

Ryo Okui (Contact Author)

University of Tokyo - Graduate School of Economics ( email )

Tokyo
Japan

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