Inference from Streaks in random outcomes: Experimental evidence on beliefs in regime shifting and the law of small numbers

Elena Asparouhova, Michael Hertzel, Michael Lemmon

Research output: Contribution to journalArticle

33 Citations (Scopus)

Abstract

Using data generated from laboratory experiments, we test and compare the empirical accuracy of two models that focus on judgment errors associated with processing information from random sequences. We test for regime-shifting beliefs of the type theorized in Barberis et al. (Barberis, N., A. Shleifer, R. Vishny. 1998. A model of investor sentiment. J. Financial Econom. 49(3) 307-343) and for beliefs in the "law of small numbers" as modeled in Rabin (Rabin, M. 2002. Inference by believers in the law of small numbers. Quart. J. Econom. 117(3) 775-816). In our experiments, we show subjects randomly generated sequences of binary outcomes and ask them to provide probability assessments of the direction of the next outcome. Inconsistent with regime-shifting beliefs, we find that subjects are not more likely to predict that the current streak will continue the longer the streak. Instead, consistent with Rabin (2002), subjects are more likely to expect a reversal following short streaks and continuation after long streaks. Results of a "test-of-fit" analysis based on structural estimation of each model also favor the model in Rabin. To provide more insight on Rabin, we use an additional experimental treatment to show that as the perception of the randomness of the outcome-generating process increases, subjects are more likely to predict reversals of current streaks.

Original languageEnglish (US)
Pages (from-to)1766-1782
Number of pages17
JournalManagement Science
Volume55
Issue number11
DOIs
StatePublished - Nov 2009

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Inference
Reversal
Investor sentiment
Information processing
Structural estimation
Probability assessment
Laboratory experiments
Experiment
Randomness

Keywords

  • Behavioral finance
  • Decision analysis
  • Experimental economics
  • Inference

ASJC Scopus subject areas

  • Strategy and Management
  • Management Science and Operations Research

Cite this

Inference from Streaks in random outcomes : Experimental evidence on beliefs in regime shifting and the law of small numbers. / Asparouhova, Elena; Hertzel, Michael; Lemmon, Michael.

In: Management Science, Vol. 55, No. 11, 11.2009, p. 1766-1782.

Research output: Contribution to journalArticle

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