Fluctuations in arousal reflect latent state transitions that facilitate behavioural optimization.

People are often faced with surprising events that defy expectations. Such events elicit transient activity in the locus coeruleus/norepinephrine system and elevation of peripheral arousal markers including pupil dilation and a late positive peak in stimulus evoked EEG response, the P300, but the function of these signals remains unclear. We propose that they reflect latent state transitions that dynamically control the mental context governing learning and perception. We tested and confirmed five preregistered predictions of this theory using EEG and pupil measurements collected from people performing a colour prediction and reproduction task. Task-induced latent state transitions elicited pupil dilation and amplified event-related potentials including the P3a component of the P300. These EEG and pupil measures related to behavioural signatures of latent state updating, including reduced bias and bidirectional adjustment of learning, both across trials and across individuals. Our findings support the theory that locus coeruleus/norepinephrine-linked arousal systems optimize behaviour by signalling environmental transitions to facilitate rapid adjustments of mental context.