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Self‐fulfilling regression and statistical discrimination

This paper provides a simple model which explains that statistical discrimination can arise in a purely self‐fulfilling manner. The story is as follows. (i) At the point of hiring, employers cannot observe workers’ productivities but can observe only their signals, such as test scores, and under perfect competition they pay for expected labor productivity conditional on signal observation, based on their belief about return to signal. (ii) Given the employers’ belief, workers choose an effort level, which affects the joint probability distribution over productivity–signal pairs. (iii) In equilibrium, the employers’ belief proves to be statistically consistent. We show that there may be multiple equilibria, and that equilibrium selection has nothing to do with economic fundamentals.