Abstract
Probability matching, also known as the "matching law" or Herrnstein's Law, has long puzzled economists and psychologists because of its apparent inconsistency with basic self-interest. We conduct an experiment with real monetary payoffs in which each participant plays a computer game to guess the outcome of a binary lottery. In addition to finding strong evidence for probability matching, we document different tendencies towards randomization in different payoff environments-as predicted by models of the evolutionary origin of probability matching-after controlling for a wide range of demographic and socioeconomic variables. We also find several individual differences in the tendency to maximize or randomize, correlated with wealth and other socioeconomic factors. In particular, subjects who have taken probability and statistics classes and those who self-reported finding a pattern in the game are found to have randomized more, contrary to the common wisdom that those with better understanding of probabilistic reasoning are more likely to be rational economic maximizers. Our results provide experimental evidence that individuals-even those with experience in probability and investing-engage in randomized behavior and probability matching, underscoring the role of the environment as a driver of behavioral anomalies.
Highlights
Our results provide experimental validation for the predictions of Brennan and Lo [50], as well as additional evidence that individuals engage in randomized behavior and probability matching, even those with prior experience in probability and investing
Probability matching—the tendency of the relative frequency of guesses of the outcomes of a sequence of independent random events to match the underlying probability distribution of events—can be explained when the uncertainty in environment is systematic across all individuals, an example demonstrating that natural selection is able to yield behaviors that may be individually sub-optimal but are optimal for the population
We have used a simple lottery game to test the occurrence of probability matching behavior in financial decision-making
Summary
Most economic theories are based on the premise that individuals maximize their self-interest and correctly incorporate the structure of their environment into their decisions. This framework has led to numerous advances, including expected utility theory [1], game theory [1, 2], rational expectations [3], the efficient markets hypothesis [4, 5], and option pricing theory [6, 7]. The influence of this paradigm goes far beyond academia; it underlies current macroeconomic and monetary policy making, becoming an integral component of the rules and regulations that govern financial markets today [8, 9]. The funders had no role in study design, data collection and analysis, decision to publish, or preparation of the manuscript
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