Operations, Information and Decisions Papers

Document Type

Journal Article

Date of this Version

6-2005

Publication Source

Management Science

Volume

51

Issue

6

Start Page

932

Last Page

947

DOI

10.1287/mnsc.1050.0386

Abstract

Many decision makers operate in dynamic environments in which markets, competitors, and technology change regularly. The ability to detect and respond to these regime shifts is critical for economic success. We conduct three experiments to test how effective individuals are at detecting such regime shifts. Specifically, we investigate when individuals are most likely to underreact to change and when they are most likely to overreact to it. We develop a system-neglect hypothesis: Individuals react primarily to the signals they observe and secondarily to the environmental system that produced the signal. The experiments, two involving probability estimation and one involving prediction, reveal a behavioral pattern consistent with our system-neglect hypothesis: Underreaction is most common in unstable environments with precise signals, and overreaction is most common in stable environments with noisy signals. We test this pattern formally in a statistical comparison of the Bayesian model with a parametric specification of the system-neglect model.

Keywords

regime shift, belief revision, subjective probability, change points, underreaction, overreaction

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Date Posted: 27 November 2017

This document has been peer reviewed.