Mental Models and Endogenous Learning

Abstract

This paper experimentally studies how people learn about their environment when their subjective understanding of the environment, their mental model, is misspecified. We use people's tendency to hold optimistic beliefs about their abilities to generate a significant amount of model misspecification and investigate the implications of overconfidence as a misspecified mental model on learning about own ability and a fundamental. Consistent with the theoretical predictions, overconfident subjects develop pessimistic beliefs about the fundamental and take growingly suboptimal actions. Inconsistent with the theoretical prediction, endogenous feedback does not exacerbate the extent of suboptimal behavior. Investigating how subjects learn about their own ability reveals that abundant feedback "weakens" misspecified mental models. The "weakening" of mental models is more pronounced with endogenous feedback and explains why endogenous feedback may not exacerbate the extent of suboptimal behavior.