Payoff-Based Belief Distortion

Heterogeneous beliefs often arise among people who have the same information but different personally experienced payoffs. To explain this phenomenon, this paper proposes a mechanism in which experienced payoffs distort beliefs: gains lead an agent to relatively underweight negative new signals and thus to become overoptimistic, whereas losses do the opposite. I experimentally test this mechanism and find behaviour consistent with its predictions. The experiment created a setting where payoffs carried no informational value for Bayesian updating, and thus offered a strong test for the effect of payoffs on beliefs. The findings were robust, and distinct from alternative mechanisms in important ways.