Information-Constrained Dynamic Models of Choice Behavior

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This project will explore models of the cognitive processes underlying human choice behavior in economic contexts. The models to be explored allow for departures from fully-informed optimal choice. Rather than positing that behavior is simply "irrational," they will explain departures from optimal decision-making as resulting from the (generally pre-conscious) use of choice algorithms that are well-suited to mostly achieving decision makers' objectives. The choice algoritms also would not require greater information-processing capacity. If successful, the research will have broad implications for the development of economic theory by showing how research findings in other disciplines, such as psychology, vision science and neuroscience, can be integrated into economic analysis. It should also have broad implications for the design of economic policies, if accurate perception of the incentives of policies changes individuals' behavior.The project will explore the ability of the proposed theory to explain anomalies of economic choice in a variety of contexts. Applications to be considered include processing errors as a source of randomness in observed choices; delays in the adjustment of behavior to changing market conditions and differential degrees of delay in the response to differing types of news; excess volatility of asset prices as a result of inattentiveness on the part of some traders to current market conditions; "focusing illusions" in which certain attributes of alternatives are disproportionately influential in determining choice; context effects in consumer choice, such as those that allow manipulation of purchasing behavior by the addition of additional alternatives to the set with which consumers are presented; and aspects of choice with regard to risky outcomes that are inconsistent with the theory of expected utility maximization. The approach to be pursued differs from previous treatments of these aspects of behavior by seeking a more unified explanation for them, and providing functional explanations for such patterns of behavior rather than merely documenting "biases." The theory to beexplored imposes additional constraints on the theory of "rational inattention" (Sims, 2003, 2010). Particular attention will be given to the dynamic processes of decision-making as a result of accumulation of successive pieces of evidence, each of which is only slightly informative as to best course of action, and to the optimal selection of attention to different aspects of the choice situation in the course of such a dynamic process. The constraints on information processing that are proposed are ones that are common features of descriptive (non-normative) models of cognitive processes involved in both perceptual judgments and value-based decisionmaking. The empirical observations on which these are based include not only the frequencies with which particular choices or judgments are made in particular decision problems, but other measurements that provide evidence about the cognitive processes giving rise to these choices, such as reaction times and measures of neural activation. The proposed research will compare the predictions of normative models based on information constraints with experimental evidence of the kind used to test descriptive models of decision making.