Abstract: The US Health and Retirement Study measures participants' recall fluency (RF), their ability to recall words from a list, a standard measure of memory in psychology. Controlling for multiple demographics and IQ, people with a higher RF are more optimistic about stock returns, the price of their homes, and their life expectancy. Consistent with the predictions of a standard memory model, we find that the beliefs of higher RF people about each domain are more sensitive: i) to cues, ii) to experiences in that domain, but also iii) to irrelevant experiences in other domains similar to the target one. These effects, in turn, carry to investment and retirement choices. Our findings buttress the importance of memory for economic behavior, with RF emerging as a relevant personal trait.

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Abstract: We present a model of "animal spirits" in which context and emotions affect macroeconomic beliefs by shaping which experiences people recall to simulate similar future aggregate states. We test this mechanism by priming Dutch National Bank Survey respondents to recall personal financial or health adversities before eliciting inflation and home price expectations. The treatment causes instability in beliefs and reasoning tied to the measured similarity of the primed experiences to different macro states. This similarity structure also accounts for heterogeneity in beliefs and reasoning based on a range of other personal experiences we measure. The model micro founds several features of macroeconomic beliefs, including narratives, and yields a "confidence multiplier": spending by some agents cues optimistic context for others, raising their spending.

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Abstract: Why do we see both advertising and powerful consumer habits for well-known and intrinsically similar brands? We offer an explanation based on the idea that, as in Bordalo et al. (2020), a consumer is more likely to demand a good if she recalls the pleasure it gave her in the past. In turn, the consumer is more likely to recall goods that are consumed more frequently and more similar to cues, subject to interference from other goods. Our model yields context-dependent brand habits where ads work as memory cues. It predicts that ads: i) are more effective for more habitual consumers and ii) exhibit spillovers, within and across products, that are stronger for more habitual consumers and for goods with more similar ads. Using data from NielsenIQ and Nielsen we find support for these predictions in 20 undifferentiated and highly advertised product categories. Memory offers new insights on how advertising affects market competition and consumer welfare.

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Abstract: A central question for understanding behaviour during the Covid-19 pandemic, at both the individual and collective levels, is how people perceive the health and economic risks they face. We conducted a survey of over 1,500 Americans from May 6 – 13, 2020, to understand these risk perceptions. Here we report some preliminary results. Our most striking finding is that perceived personal health risks associated with Covid-19 fall sharply with age.

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Abstract: US voters exaggerate the differences in attitudes held by Republicans and Democrats on a range of socioeconomic and political issues, and higher perceived polarization is associated with greater political engagement and affective polarization. In this paper, we examine the role of issue salience in driving beliefs about political attitudes. We find that a model of political stereotypes, where distortions are stronger for issues that are more salient to voters, captures important qualitative and quantitative features of the data. First, perceived partisan differences are larger on issues that individuals consider more important. To attach a causal interpretation to this link, we show that the end of the Cold War in 1991, which shifted US voters’ attention away from external threats, increased perceived, relative to actual, partisan differences on domestic issues. Second, issue salience increases the tendency to over-weigh extreme types. The increase in perceived polarization post 1991 was stronger for issues with more stereotypical partisan differences. Finally, the reverse pattern occurred after the terrorist attacks in 2001, when attention swung back towards external threats. We discuss other mechanisms, which may be at work but fail to match important features of the data. Our results highlight how beliefs about political groups can shift even when the underlying partisan differences change little, with important social and political consequences.

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Abstract: We examine how consumers' decisions are shaped by their past experiences. Using a large scale experiment that exogenously varied prices in all stores of a large retailer, we generate individual level variation in the history of prices faced by consumers for both durable and non-durable goods. We find that choices at given prices depend on the prices of similar goods the consumer experienced in the past: the consumer is more likely to buy at a given price if it is lower than prices seen previously. Several robust patterns help shed light on consumers' expectations and valuation processes: first, demand is inelastic for moderate departures from the (individual-specific) average past price but is highly elastic for large price movements. Second, demand is more inelastic for consumers who have experienced larger price volatility. The findings are in line with a model where consumers compare current prices to a price norm retrieved from memory and pay attention only when the difference is large or surprising. The norm is more flexible the higher the historical volatility, suggesting that both price stickiness and price flexibility can arise in equilibrium.

Abstract: An extensive literature suggests that choice sets influence decisions, in possible contradiction with standard assumptions of rationality. The paper explores these phenomena in the context of Salience Theory. The decision-maker's attention is drawn to each option's salient attributes, which in turn depend on the available alternatives. Context effects ensue when changes in the choice set cause shifts in the salience of attributes. The model accounts for several effects observed with small choice sets, such as the decoy and compromise effects. It clarifies under what conditions such effects occur, and these predictions are tested experimentally. For large choice sets, preferences become more stable.

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Abstract: We present a theory of choice in which attention to the features of options is determined by the decision maker’s categorization of the current problem in a set of problems she solved in the past. Categorization depends on goal-relevant and contextual problem-level features. The model yields heterogeneity in attention and choice in a given problem based on different past experiences, choice rigidity when categorization does not change despite new data, and choice instability when changes in irrelevant context cause re-categorization. We show that heterogeneous and unstable mental representations unify major biases in judgments and decision making.

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Abstract: We embed diagnostic expectations in a workhorse neoclassical model with heteroge- neous firms and risky debt. A realistic degree of overreaction estimated from US firms' earnings forecasts generates realistic credit cycles. Good times produce economic and financial fragility, predicting future disappointment of expectations, low bond returns, and investment declines. To generate the size of spread increases observed during 2007-9, the model requires only moderate negative shocks. Diagnostic expectations offer a realistic, parsimonious way to produce financial reversals in business cycle models.

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Abstract: For standard statistical problems, we provide new evidence documenting i) multi-modality and ii) instability in probability estimates, including from irrelevant changes in problem description. The evidence motivates a model in which, when solving a problem, people represent each hypothesis by attending to its salient features while neglecting other, potentially more relevant, ones. Only the statistics associated with salient features are used. The model unifies biases in judgments about i.i.d. draws, such as the Gambler's Fallacy and insensitivity to sample size, with biases in inference such as under- and overreaction and insensitivity to the weight of evidence. The model makes predictions for how changes in the salience of specific features jointly shapes known biases and measured attention to features, but also create entirely new biases. We test and confirm these predictions experimentally. Salience-driven attention to features emerges as a unifying framework for biases conventionally explained using a variety of stable heuristics or distortions of the Bayes rule.

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Abstract: How do people form beliefs about novel risks, with which they have little or no experience? Motivated by survey data on beliefs about Covid we collected in 2020, we build a model based on the psychology of selective memory. When a person thinks about an event, different experiences compete for retrieval, and retrieved experiences are used to simulate the event based on how similar they are to it. The model predicts that different experiences interfere with each other in recall and that non domain-specific experiences can bias beliefs based on their similarity to the assessed event. We test these predictions using data from our Covid survey and from a primed-recall experiment about cyberattack risk. In line with our theory of similarity-based retrieval and simulation, experiences and their measured similarity to the cued event help account for experience effects, priming effects, and the interaction of the two in shaping beliefs.

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Abstract: We address the joint hypothesis problem in cross-sectional asset pricing by using measured analyst expectations of earnings growth. We construct a firm-level measure of Expectations Based Returns (EBRs) that uses analyst forecast errors and revisions and shuts down any cross-sectional differences in required returns. We obtain three results. First, variation in EBRs accounts for a large chunk of cross-sectional return spreads in value, investment, size, and momentum factors. Second, time variation in these spreads is predictable, and proxied by predictable time variation in EBRs. This result holds even controlling for scaled price variables, which may capture time varying required return differentials. Third, firm characteristics typically viewed as capturing risk predict disappointment of expectations (and of EBRs). Overall, return spreads typically attributed to exotic risk factors are explained by predictable movements in non-rational expectations of firms’ earnings growth.

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Abstract: We construct an index of long-term expected earnings growth for S&P 500 firms and show that it has remarkable power to jointly predict future errors in expectations and stock returns, in both the aggregate market and the cross section. The evidence supports a mechanism whereby good news causes investors to become too optimistic about long-term earnings growth. This leads to inflated stock prices and, as beliefs are systematically disappointed, subsequent low returns in the aggregate market. Overreaction of long-term expectations helps resolve major asset-pricing puzzles without time-series or cross-sectional variation in required returns.

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Abstract: In many economic decisions, people estimate probabilities, such as the likelihood that a risk materializes or that a job applicant will be a productive employee, by retrieving experiences from memory. We model this process based on two established regularities of selective recall: similarity and interference. We show that the similarity structure of a hypothesis and the way it is described (not just its objective probability) shape the recall of experiences and thus probability assessments. The model accounts for and reconciles a variety of empirical findings, such as overestimation of unlikely events when these are cued versus neglect of non-cued ones, the availability heuristic, the representativeness heuristic, conjunction and disjunction fallacies, and over- versus underreaction to information in different situations. The model yields several new predictions, for which we find strong experimental support.

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Abstract: We review the fast-growing work on salience and economic behavior. Psychological research shows that salient stimuli attract human attention bottom up due to their high contrast with surroundings, their surprising nature relative to recalled experiences, or their prominence. The Bordalo, Gennaioli & Shleifer (2012, 2013b, 2020) models of salience show how bottom-up attention can distort economic choice by distracting decision makers from their immediate goals or from relevant choice attributes. This approach unifies probability weighting, menu effects, reference points, and framing as distinct manifestations of bottom-up attention. We highlight new predictions and discuss open conceptual questions, as well as potential applications in finance, industrial organization, advertising, and politics.

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Abstract: We introduce diagnostic expectations into a standard setting of price formation in which investors learn about the fundamental value of an asset and trade it. We study the interaction of diagnostic expectations with learning from prices and speculation (buying for resale). With diagnostic (but not with rational) expectations, these mechanisms lead to price paths exhibiting three phases: initial underreaction, then overshooting (the bubble), and finally a crash. With learning from prices, the model generates price extrapolation as a by-product of beliefs about fundamentals, lasting only as the bubble builds up. When investors speculate, even mild diagnostic distortions generate substantial bubbles.

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Abstract: We introduce diagnostic expectations into a standard setting of price formation in which investors learn about the fundamental value of an asset and trade it. We study the interaction of diagnostic expectations with learning from prices and speculation (buying for resale). With diagnostic (but not with rational) expectations, these mechanisms lead to price paths exhibiting three phases: initial underreaction, then overshooting (the bubble), and finally a crash. With learning from prices, the model generates price extrapolation as a by-product of beliefs about fundamentals, lasting only as the bubble builds up. When investors speculate, even mild diagnostic distortions generate substantial bubbles.

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Abstract: We explore the idea that judgment by representativeness reflects the workings of memory. In our model, the probability of a hypothesis conditional on data increases in the ease with which instances of that hypothesis are retrieved when cued with the data. Retrieval is driven by a measure of similarity which exhibits contextual interference: a data/cue is less likely to retrieve instances of a hypothesis that occurs frequently in other data. As a result, probability assessments are context dependent. In a new laboratory experiment, participants are shown two groups of images with different distributions of colors and other features. In line with the model’s predictions, we find that (a) decreasing the frequency of a given color in one group significantly increases the recalled frequency of that color in the other group; and (b) cueing different features for the same set of images entails different probabilistic assessments, even if the features are normatively irrelevant. A calibration of the model yields a good quantitative fit with the data, highlighting the central role of contextual interference.

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Abstract: We study the rationality of individual and consensus forecasts of macroeconomic and financial variables using the methodology of Coibion and Gorodnichenko (2015), who examine predictability of forecast errors from forecast revisions. We find that individual forecasters typically overreact to news, while consensus forecasts underreact relative to full-information rational expectations. We reconcile these findings within a diagnostic expectations version of a dispersed information learning model. Structural estimation indicates that departures from Bayesian updating in the form of diagnostic overreaction capture important variation in forecast biases across different series, yielding a belief distortion parameter similar to estimates obtained in other settings.

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Abstract: Building on a textbook description of associative memory (Kahana 2012), we present a model of choice in which a choice option cues recall of similar past experiences. Memory shapes valuation and decisions in two ways. First, recalled experiences form a norm, which serves as an initial anchor for valuation. Second, salient quality and price surprises relative to the norm lead to large adjustments in valuation. The model unifies many well-documented choice puzzles, including the attribution and projection biases, inattention to hidden attributes, background contrast effects, and context-dependent willingness to pay. Unifying these puzzles on the basis of selective memory and attention to surprise yields multiple new predictions.

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Abstract: We revisit La Porta’s finding that returns on stocks with the most optimistic analyst long-term earnings growth forecasts are lower than those on stocks with the most pessimistic forecasts. We document the joint dynamics of fundamentals, expectations, and returns of these portfolios, and explain the facts using a model of belief formation based on the representativeness heuristic. Analysts forecast fundamentals from observed earnings growth, but overreact to news by exaggerating the probability of states that have become more likely. We find support for the model’s predictions. A quantitative estimation of the model accounts for the key patterns in the data.

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Abstract: We conduct laboratory experiments that explore how gender ste- reotypes shape beliefs about ability of oneself and others in differ- ent categories of knowledge. The data reveal two patterns. First, men’s and women’s beliefs about both oneself and others exceed observed ability on average, particularly in difficult tasks. Second, overestimation of ability by both men and women varies across cate- gories. To understand these patterns, we develop a model that sepa- rates gender stereotypes from misestimation of ability related to the difficulty of the task. We find that stereotypes contribute to gender gaps in self-confidence, assessments of others, and behavior in a cooperative game.

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Abstract: We present a model of credit cycles arising from diagnostic expectations—a belief formation mechanism based on Kahneman and Tversky’s representativeness heuristic. Diagnostic expectations overweight future outcomes that become more likely in light of incoming data. The expectations formation rule is forward looking and depends on the underlying stochastic process, and thus is immune to the Lucas critique. Diagnostic expectations reconcile extrapolation and neglect of risk in a unified framework. In our model, credit spreads are excessively volatile, overreact to news, and are subject to predictable reversals. These dynamics can account for several features of credit cycles and macroeconomic volatility.

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Abstract: We present a model of stereotypes based on Kahneman and Tversky’s representativeness heuristic. A decision maker assesses a target group by over-weighting its representative types, defined as the types that occur more frequently in that group than in a baseline reference group. Stereotypes formed this way contain a ‘‘kernel of truth’’: they are rooted in true differences between groups. Because stereotypes focus on differences, they cause belief distortions, particularly when groups are similar. Stereotypes are also context dependent: beliefs about a group depend on the characteristics of the reference group. In line with our predictions, beliefs in the lab about abstract groups and beliefs in the field about political groups are context dependent and distorted in the direction of representative types.

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Abstract: We present a model of market competition in which consumers' attention is drawn to the products' most salient attributes. Firms compete for consumer attention via their choices of quality and price. Strategic positioning of a product affects how all other products are perceived. With this attention externality, depending on the cost of producing quality some markets exhibit "commoditized" price salient equilibria, while others exhibit "de-commoditized" quality salient equilibria. When the costs of quality change, innovation can lead to radical shifts in markets, as in the case of decommoditization of the coffee market by Starbucks. In the context of financial innovation, the model generates the phenomenon of reaching for yield.

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Abstract: We present a model of judicial decision making in which the judge overweights the salient facts of the case. The context of the judicial decision, which is comparative by nature, shapes which aspects of the case stand out and draw the judge’s attention. By focusing judicial attention on such salient aspects of the case, legally irrelevant information can affect judicial decisions. Our model accounts for a range of recent experimental evidence that bears on the psychology of judicial decisions, including anchoring effects in the setting of damages, decoy effects in choice of legal remedies, and framing effects in the decision to litigate. The model also offers a new approach to positive analysis of damage awards in torts.

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Abstract: We present a theory of context-dependent choice in which a consumer’s attention is drawn to salient attributes of goods, such as quality or price. An attribute is salient for a good when it stands out among the good’s attributes relative to that attribute’s average level in the choice set (or, more broadly, the choice context). Consumers attach disproportionately high weight to salient attributes, and their choices are tilted toward goods with higher quality/price ratios. The model accounts for a variety of disparate evidence, including decoy effects and context-dependent willingness to pay. It also suggests a novel theory of misleading sales.

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Abstract: We present a theory of choice among lotteries in which the decision maker’s attention is drawn to (precisely defined) salient payoffs. This leads the decision maker to a context-dependent representation of lotteries in which true probabilities are replaced by decision weights distorted in favor of salient payoffs. By specifying decision weights as a function of payoffs, our model provides a novel and unified account of many empirical phenomena, including frequent risk-seeking behavior, invariance failures such as the Allais paradox, and preference reversals. It also yields new predictions, including some that distinguish it from prospect theory, which we test.

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