Deciphering the Noise: The Welfare Costs of Noisy Behavior

Theoretical work on stochastic choice mainly focuses on the sources of choice ran- domness, and less on its economic consequences. We attempt to close this gap by developing a method of extracting information about the monetary costs of noise from structural estimates of preferences and choice randomness. Our method is based on allowing a degree of noise in choices in order to rationalize them by a given structural model. To illustrate the approach, we consider risky binary choices made by a sample of the general Danish population in an artefactual eld experiment. The estimated welfare costs are small in terms of everyday economic activity, but they are consider- able in terms of the actual stakes of the choice environment. Higher welfare costs are associated with higher age, lower education, and lower income.