What are we weighting for? A mechanistic model for probability weighting
Ole Peters, Alexander Adamou, Mark Kirstein, and Yonatan Berman
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Submission date: 07. May. 2020
MSC-Numbers: 91B06, 91B30, 91B84
PACS-Numbers: 89.65.Gh, 05.45.Tp
Keywords and phrases: Ergodicity Economics, Prospect Theory, Probability Weighting, Decision Theory
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Link to arXiv: See the arXiv entry of this preprint.
Behavioural economics provides labels for patterns in human economic behaviour. Probability weighting is one such label. It expresses a mismatch between probabilities used in a formal model of a decision (i.e. model parameters) and probabilities inferred from real people's decisions (the same parameters estimated empirically). The inferred probabilities are called "decision weights." It is considered a robust experimental finding that decision weights are higher than probabilities for rare events, and (necessarily, through normalisation) lower than probabilities for common events. Typically this is presented as a cognitive bias, i.e. an error of judgement by the person. Here we point out that the same observation can be described differently: broadly speaking, probability weighting means that a decision maker has greater uncertainty about the world than the observer. We offer a plausible mechanism whereby such differences in uncertainty arise naturally: when a decision maker must estimate probabilities as frequencies in a time series while the observer knows them a priori. This suggests an alternative presentation of probability weighting as a principled response by a decision maker to uncertainties unaccounted for in an observer's model.