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Modeling the Change of Paradigm: Non-Bayesian Reactions to Unexpected News

Ortoleva, Pietro (2012) Modeling the Change of Paradigm: Non-Bayesian Reactions to Unexpected News. American Economic Review, 102 (6). pp. 2410-2436. ISSN 0002-8282.

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Bayes' rule has two well-known limitations: 1) it does not model the reaction to zero-probability events; 2) a sizable empirical evidence documents systematic violations of it. We characterize axiomatically an alternative updating rule, the Hypothesis Testing model. According to it, the agent follows Bayes' rule if she receives information to which she assigned a probability above a threshold. Otherwise, she looks at a prior over priors, updates it using Bayes' rule for second-order priors, and chooses the prior to which the updated prior over priors assigns the highest likelihood. We also present an application to equilibrium refinement in game theory.

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Additional Information:© 2012 American Economic Association. I thank two anonymous referees, Kim Border, Mark Dean, Federico Echenique, Larry Epstein, Paolo Ghirardato, Andrea Mattozzi, Asen Kochov, Jawwad Noor, Efe Ok, Leonardo Pejsachowicz, Ariel Rubinstein, Gil Riella, Marciano Siniscalchi, Leeat Yariv, the participants at seminars at ASU, Boston University, Caltech, Collegio Carlo Alberto, New York University, USC, and at ESSET 2010, RUD 2010, SWET 2010, and AEA Meetings 2011 for useful comments and discussions.
Subject Keywords:JEL Classifications: D11: Consumer Economics: Theory D81: Criteria for Decision-Making under Risk and Uncertainty D83: Search; Learning; Information and Knowledge; Communication; Belief
Issue or Number:6
Classification Code:JEL: D11, D81, D83
Record Number:CaltechAUTHORS:20121126-103347996
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Official Citation:Ortoleva, Pietro. 2012. "Modeling the Change of Paradigm: Non-Bayesian Reactions to Unexpected News." American Economic Review, 102(6): 2410-36.
Usage Policy:No commercial reproduction, distribution, display or performance rights in this work are provided.
ID Code:35633
Deposited By: Jason Perez
Deposited On:26 Nov 2012 19:37
Last Modified:03 Oct 2019 04:30

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