Seminar

Inference from Streaks in Random Outcomes: Experimental Evidence on Beliefs in Regime-Shifting and the Law of Small Numbers

Elena Asparouhova (University of Utah)

January 28, 2008

Paul Woolley Research Initiative Seminar

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, Shleifer, and Vishny (1993) (BSV) and for beliefs in the "law of small numbers" as modeled in Rabin (2002). In our experiments, we show subjects randomly generated sequences of binary outcomes and ask them to provide probability assessments 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, 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 tend to favor the model in Rabin. To provide more insight on Rabin (and recent work by Burns and Corpus (2004)), we use two additional experimental treatments 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.