HEC Research Papers Series,
HEC Paris

Abstract: We argue that a precedent is important not only because it changes the relative frequency of a certain event, making it positive rather than zero, but also because it changes the way that relative frequencies are weighed. Specifically, agents assess probabilities of future events based on past occurrences, where not all of these occurrences are deemed equally relevant. More similar cases are weighed more heavily than less similar ones. Importantly, the similarity function is also learnt from experience by "second-order induction". The model can explain why a single precedent affects beliefs above and beyond its effect on relative frequencies, as well as why it is easier to establish reputation at the outset than to re-establish it after having lost it. Finally, we discuss more sophisticated forms of learning, by which similarity is defined not only on cases but also on attributes, and the importance of some attributes, learnt from the data by second-order induction, can also affect the perceived importance of other attributes.

Keywords: second-order induction; Higher-Order Induction

JEL-codes: A10

31 pages, July 1, 2017

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