"Economics of Self-Feeding Fear"

Abstract

A model of self-feeding fear is presented. Suppose that an economic agent is (1-ƒÃ)~100% certain that uncertainty she faces is characterized by a particular probability measure, but that she has a fear that, with ƒÃ~100% chance, her conviction is completely wrong and she is left perfectly ignorant about the true measure in the present as well as in the future. We call this situation ƒÃ-contamination of confidence. In this situation, if the economic agent follows Bayesian procedure or its variant, which is considered as rational in the theory of economics, her confidence erodes after having new observation.