Averting economic collapse and the solipsism bias

We study the behavior of experimental subjects who have to make a sequence of risky investment decisions in the presence of network externalities. Subjects follow a simple heuristic—investing after positive experiences and reducing their propensity to invest after a failure. This result contrasts with the theoretical findings of Jeitschko and Taylor [Jeitschko, T.D., Taylor, C., 2001. Local discouragement and global collapse: A theory of coordination avalanches. Amer. Econ. Rev. 91 (1), 208–224] in which even agents who have only good experiences eventually stop investing because they account for the fact that others with worse experiences will quit. This can trigger sudden economic collapse—a coordination avalanche—even in the most efficient Bayesian equilibrium. In the experiment, subjects follow their own experiences and disregard the possible bad experiences of others—thus exhibiting behavior that we term “solipsism bias.” Solipsism results in sustained investment activity and thus averts complete collapse. © 2005 Elsevier Inc. All rights reserved. JEL classification: C7; C9; D8; E0; G0