Risk Aversion and Implicit Shortage Cost Explain the Anchoring and Insufficient Adjustment Bias in Human Newsvendors

Abstract

Anchoring and Insufficient Adjustment (AIA) bias has been observed in many newsvendor experiments, although a mathematical explanation for this behavior has previously eluded researchers. We show that risk aversion coupled with an implicit shortage cost, both of which are well-known components of newsvendor decisions, comprehensively explains this behavior. We construct combinations of a risk averse utility function and a shortage cost that explain the results from Schweitzer and Cachon (2000), the first and the most-cited study in newsvendor experiments.