The limits of rationality

I am not making the claim that people are all irrational all the time. I am saying that the model where people make decisions solely based on rationality has its limits. There are reasons for people making these inferences, even if they may not be good ones or even if we can't discern them.

Are people willing to pay for predictions of unpredictable outcomes (like tosses of a fair coin)? You bet. Slightly jaw dropping [ungated👍] paper by @NickPowdthavee et al (HT @AnnieDuke) https://t.co/DNqkj8qhkR pic.twitter.com/CkWD4mpb36

— Koenfucius (@koenfucius) December 24, 2018

If someone were to show me a "fair" coin which had been flipped five times and had each time come up heads, I would recognize a low probability event. If someone shows me a coin which came up ten times in a row, I begin to doubt the predicate claim that it is a "fair" coin. From a pure statistical view, I am being irrational, the coin is fair and it is just a low probability event. From a contextual view, doubts about the integrity of the experiment are, of course, perfectly rational.

From Would You Pay For Transparently Useless Advice? A Test of Boundaries of Beliefs in the Folly of Predictions by Nattavudh Powdthavee and Yohanes E. Riyanto. From the Abstract:

Standard economic models assume that the demand for expert predictions arises only under the conditions in which individuals are uncertain about the underlying process generating the data and there is a strong belief that past performances predict future performances. We set up the strongest possible test of these assumptions. In contrast to the theoretical suggestions made in the literature, people are willing to pay for predictions of truly random outcomes after witnessing only a short streak of accurate predictions live in the lab. We discuss potential explanations and implications of such irrational learning in the contexts of economics and finance.