From basketball games to financial markets, humans show a remarkably consistent pattern in how they misinterpret information: we tend to make too much of weak signals while failing to appreciate truly important news. This finding, supported by both experimental evidence and real-world data, offers new insights into human decision-making and market behavior.
Published in The Quarterly Journal of Economics | Estimated reading time: 4 minutes
Picture an NBA game where Steph Curry starts hot, sinking two three-pointers in the opening minutes. Fans get excited, and betting odds shift in the Warriors’ favor. Fast forward to the final seconds—the opposing team is up by two points with just 10 seconds remaining. History shows the Warriors now have less than a 10% chance of winning, yet betting markets fail to fully reflect this near-certainty.
This scenario illustrates a broader pattern discovered by researchers from UC Berkeley and University College London. Their comprehensive study reveals that humans consistently overreact to weak information while underreacting to strong signals—a pattern that holds true from sports betting to financial markets.
“There are all kinds of situations where I might know whether a piece of news is good or bad, but struggle to judge exactly how important it is,” explains Eben Lazarus, assistant professor at UC Berkeley’s Haas School of Business. “We saw this pattern everywhere we looked, which was surprising given the stakes involved in betting and financial markets.”
The research team conducted three controlled experiments and analyzed millions of real-world transactions to confirm their hypothesis. In one revealing experiment, they recruited 500 NBA fans to predict game outcomes based on sequences of plays. While participants understood that late-game baskets were more important than early ones, they still overvalued first-quarter scores by 60% while underweighting critical fourth-quarter plays by 33%.
The pattern extended well beyond sports. Analyzing over 4 million option prices from the Chicago Board Options Exchange, researchers found that markets overreact to daily news about companies when considering their long-term prospects, but underreact to crucial information just before option contracts expire.
Why do humans exhibit this consistent bias? The researchers suggest it stems from our tendency to default to middle-ground reactions when uncertain about how much weight to give new information. When we know something is “good” or “bad” news but aren’t sure exactly how important it is, we tend to treat all information as moderately significant—leading to overreaction to weak signals and underreaction to strong ones.
Key Terms Glossary
- Signal strength: The degree to which a piece of information should change our beliefs or predictions about an outcome
- Overinference: Giving too much weight to information when updating beliefs or making predictions
- Underinference: Failing to sufficiently update beliefs or predictions in response to important information
- Options market: A financial market where participants trade contracts based on their predictions of future asset prices
Quick Quiz
What pattern did researchers find in how people interpret information?
People tend to overreact to weak signals while underreacting to strong signals across various contexts.
Why does this pattern occur?
When people are unsure about how much weight to give information, they tend to default to treating all information as moderately significant.
How did researchers prove this pattern exists in sports betting?
They analyzed over 5 million betting transactions and found that markets overreact to early-game events but underreact to crucial late-game developments.
Can this knowledge be used to make better financial decisions?
While the pattern is consistent, the researchers caution that knowing about it doesn’t remove risk—you can still lose money betting against these market moves.
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