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We first describe the foundations of the theory of rational choice and then show the experimental evidence of invariable failure of the most basic rules of the theory. Our conclusion from these findings is that the normative and p...
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We first describe the foundations of the theory of rational choice and then show the experimental evidence of invariable failure of the most basic rules of the theory. Our conclusion from these findings is that the normative and positive analyses cannot be reconciled, and which one will be pursued is clearly dependent on how the role or the mission of economic analysis is defined. Moreover, we assert that the normative analysis has the appealing features of generality and uniformity. Modeling what is called imperfect or bounded rationality and what much more realistically describes the decision maker's actions is still far from reaching the same level of generality. Nevertheless, we suggest that construction of new theories of choice based on scientific, casual, or experimental observations that indicate systematic deviation from the rational man paradigm is necessary.
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This article introduces two tools aimed at improving our understanding of the relationship between human and artificial rationality and helping us identify agents that are false positives or negatives. The first is a framework tha...
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This article introduces two tools aimed at improving our understanding of the relationship between human and artificial rationality and helping us identify agents that are false positives or negatives. The first is a framework that systematically exposes where and how discrepancies between human and artificial rationalities can arise. The second is a test that utilises the insight gained from applying the framework in testing the ability of an artificial agent to represent human decision-making. To demonstrate the usefulness of the test, the article describes its application in testing the ability of a set of Individual Evolutionary Learning agents to represent human decision-making in a social psychology experiment, called the Voluntary Contributions Mechanism. In contrast to the results of a prior test that relied on a behaviour-based method, the results of this test show that the ability of these artificial agents to replicate the behaviour of their human counterparts is not a reliable indicator of their ability to represent their decision-making. The article then uses insight from the test to suggest how to improve the ability of Individual Evolutionary Learning agents to represent human decision-making in the Voluntary Contributions Mechanism.
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This paper offers two points on the impact of uncertainty and exchange rate shocks. (1) A conceptual model where behavioural frictions - rational inattentiveness and bounded expectations - interact with uncertainty, generating agg...
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This paper offers two points on the impact of uncertainty and exchange rate shocks. (1) A conceptual model where behavioural frictions - rational inattentiveness and bounded expectations - interact with uncertainty, generating aggregate fluctuations. Central banks can target these behavioural frictions to stabilise output and prices. (2) Empirical findings from a panel of advanced and emerging economies. Output and inflation slow in response to uncertainty shocks. Government bond yields moderate and exchange rates depreciate, suggesting within-country and between-country flight-to-safety respectively. Exchange rate appreciation shocks generate similar responses. The Malaysia-specific analysis finds divergent responses in employment and output, likely reflecting compositional effects in more productive tradable and less productive non-tradable sectors.
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Given free information and unlimited processing power, should decision algorithms use as much information as possible? A formal model of the decision-making environment is developed to address this question and provide conditions ...
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Given free information and unlimited processing power, should decision algorithms use as much information as possible? A formal model of the decision-making environment is developed to address this question and provide conditions under which informationally frugal algorithms, without any information or processing costs whatsoever, are optimal. One cause of compression that allows optimal algorithms to rationally ignore information is inverse movement of payoffs and probabilities (e.g., high payoffs occur with low probably and low payoffs occur with high probability). If inversely related payoffs and probabilities cancel out, then predictors that correlate with payoffs and consequently condition the probabilities associated with different payoffs will drop out of the expected-payoff objective function, severing the link between information and optimal action rules. Stochastic payoff processes in which rational ignoring occurs are referred to as compressed environments, because optimal action depends on a reduced-dimension subset of the environmental parameters. This paper considers benefits and limitations of economic models versus other methods for studying links between environmental structure and the real-world success of simple decision procedures. Different methods converge on the normative proposition of ecological rationality, as opposed to axiomatic rationality based on informational efficiency and internal consistency axioms, as a superior framework for comparing the effectiveness of decision strategies and prescribing decision algorithms in application.
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We analyze a market game where traders are heterogeneous with respect to their rationality level and have asymmetric information. The market mechanism results into a statistical equilibrium, where traders randomise among their ava...
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We analyze a market game where traders are heterogeneous with respect to their rationality level and have asymmetric information. The market mechanism results into a statistical equilibrium, where traders randomise among their available actions due to their limited rationality. We provide a necessary and sufficient condition for convergence of statistical to strategic equilibria of market games, when traders become more informed and increasingly more rational.
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Fuzzy relations have been widely applied in decision making process. However, the application process requires people to have a high level of ability to compute and infer information. As people usually have limited ability of comp...
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Fuzzy relations have been widely applied in decision making process. However, the application process requires people to have a high level of ability to compute and infer information. As people usually have limited ability of computing and inferring, the fuzzy relation needs to be adapted to fit the abilities of people. The bounded rationality theory holding the view that people have limited rationality in terms of computing and inferring meets such a requirement, so we try to combine the fuzzy relation with the bounded rationality theory in this study. To do this, first of all, we investigate four properties of fuzzy relations (i.e. reflexivity, symmetry, transitivity and reciprocity) within the bounded rationality context and find that these properties are not compatible with the bounded rationality theory. Afterwards, we study a new property called the bounded rational reciprocity of fuzzy relations, to make it possible to combine a fuzzy relation with the bounded rationality theory. Based on the bounded rational reciprocity, the bounded rational reciprocal preference relation is then introduced. A rationality visualization technique is proposed to intuitively display the rationality of experts. Finally, a bounded rationality net-flow-based ranking method is presented to solve real decision-making problems with bounded rational reciprocal preference relations, and a numerical example with comparative analysis is given to demonstrate the advantages of the proposed methods.
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We propose a rule of decision-making, the sequential procedure guided by routes, and show that three influential boundedly rational choice models can be equivalently understood as special cases of this rule. In addition, the seque...
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We propose a rule of decision-making, the sequential procedure guided by routes, and show that three influential boundedly rational choice models can be equivalently understood as special cases of this rule. In addition, the sequential procedure guided by routes is instrumental in showing that the three models are intimately related. We show that choice with a status quo bias is a refinement of rationalizability by game trees, which, in turn, is also a refinement of sequential rationalizability. Thus, we provide a sharp taxonomy of these choice models, and show that they all can be understood as choice by sequential procedures.
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There is an extensive literature claiming that it is often difficult to make use of arbitrage opportunities in financial markets. This paper provides a new reason why existing arbitrage opportunities might not be seized. We consid...
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There is an extensive literature claiming that it is often difficult to make use of arbitrage opportunities in financial markets. This paper provides a new reason why existing arbitrage opportunities might not be seized. We consider a world with short-lived securities, no short-selling constraints and no transaction costs. We show that to exploit all existing arbitrage opportunities, traders should pay attention to all financial markets simultaneously. The paper gives a general result stating that failure to do so will leave some arbitrage opportunities unexploited with probability one. (c) 2006 Elsevier B.V. All rights reserved.
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Management theory has been heavily influenced by Simon's concept of bounded rationality, so much so that bounded rationality has become a first principle in many modern theories of management and organization. But this influence h...
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Management theory has been heavily influenced by Simon's concept of bounded rationality, so much so that bounded rationality has become a first principle in many modern theories of management and organization. But this influence has come at a price. It has devolved into a view of managers as "small brains" myopically trapped in local environments. We take issue with small-brained management theory, and argue that the time is ripe to refashion the microfoundations of managerial cognition into a "big-brained" alternative.
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In economics in situations where there is uncertainty one has to attribute some attitude to handling this uncertainty to individuals. The original idea was to assume that "people do not make systematic mistakes" for which Muth coi...
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In economics in situations where there is uncertainty one has to attribute some attitude to handling this uncertainty to individuals. The original idea was to assume that "people do not make systematic mistakes" for which Muth coined the term "rational expectations". This was replaced by a much more formal vision which suggested that people fully understand how the economy evolves. In this paper I will argue that the foundations of the "rational expectations" hypothesis which has underpinned most recent modern macroeconomic models, which have, in turn, been used for policymaking, are unsound. From a philosophical point of view the idea that agents can not only forecast the evolution of their environment but also their own evolution seems unjustified. If agents do manage to coordinate on specific expectations these may not be rational and can be self fulfilling. From an econometric point of view, when there are changes in the evolution of the economy, it is not rational to satisfy the hypothesis. Furthermore the empirical and experimental evidence suggests that we should abandon this route.
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