Probabilistic cost efficiency and bounded rationality in the newsvendor model

Abstract

In this paper we establish a link between probabilistic cost efficiency and bounded rationality in the newsvendor model. This establishes a framework where bounded rationality can be examined rigorously by statistical methods. The paper offers a relatively deep theoretical analysis of underorders/overorders in the newsvendor model. The theory is supported by empirical findings from our analysis of empirical data from laboratory experiments. In particular, we observe that underorders are systematically larger than overorders, an issue that our theoretical model explains. From statistical tests we conclude that all variability in our data can be explained by probabilistic cost efficiency and risk aversion.