Working Paper: CEPR ID: DP7263
Authors: Hamid Sabourian; Anne Sibert
Abstract: Confirmation bias refers to cognitive errors that bias one towards one's own prior beliefs. A vast empirical literature documents its existence and psychologists identify it as one of the most problematic aspects of human reasoning. In this paper, we present three related scenarios where rational behaviour leads to outcomes that are observationally equivalent to different types of conformation bias. As an application, the model provides an explanation for how the reward structure in the financial services industry led to the seemingly irrational behaviour of bankers and other employees of financial institutions prior to the financial crisis of that erupted in the summer of 2007.
Keywords: belief persistence; confirmation bias; financial crisis; overconfidence; signalling
JEL Codes: D81; D82; D83; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Incentive structure (M52) | Distorted behaviour among bankers (G21) |
| Distorted behaviour among bankers (G21) | Confirmation bias (G41) |
| Desire to appear competent (D83) | Decision-making (D87) |
| Decision-making (D87) | Actions that align with confirmation bias (D91) |
| Incentive structure (M52) | Confirmation bias (G41) |