#  Abstract: Base-Rate Neglect: Foundations and Implications 

 



 We explore the implications of a model in which people underweight the use of their prior beliefs when updating based on new information. Our model is an extension, clarification, and “completion” of previous formalizations of base-rate neglect. Although base-rate neglect can cause beliefs to overreact to new information, beliefs are too moderate on average, and a person may even weaken her beliefs in a hypothesis following supportive evidence. Under a natural interpretation of how base-rate neglect plays out in dynamic settings, a person’s beliefs will reflect the most recent signals and not converge to certainty even given abundant information. We also demonstrate that BRN can generate effects similar to other well- known biases such as the hot-hand fallacy, prediction momentum, and adaptive expectations. We examine implications of the model in settings of individual forecasting and information gathering, as well studying how rational firms would engage in persuasion and reputation- building for BRN investors and consumers. We also explore many of the features, such as intrinsic framing effects, that make BRN difficult to formulaically incorporate into economic analysis, but which also have important implications.