Predicting the improbable
Excerpt (Via Voxeu)
Japan’s trio of tsunami, earthquake, and nuclear disaster has left the world stunned. As this column points out, even the experts were shocked. But while these events were highly unlikely, they were still possible. This column uses evidence from the Danish lottery to show that people tend to adjust their expectations of future events based on only small pockets of recent experience, often at their cost.
Conclusion (Via Voxeu)
Using data from the particularly clear-cut case of lotto gambling, this study shows that laypeople tend to draw strong conclusions based on few observations, and that biases are common and systematic when predicting improbable events. In a more general perspective, such biases may induce public opinion and the media to call for dramatic swings in policy in response to highly improbable events. Politicians are then under pressure to yield to popular demands for drastic regulation. However, regulators would be well-advised to be aware of the common tendency to over-infer regularities from rare events and to carefully investigate whether observed data indeed warrants a dramatic swing in policy.