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The 'Ostrich Effect': Selective Attention to Information about Investments
Abstract
We develop a model of selective attention to information and apply it to investors' decisions about whether to obtain information about the value of their portfolio. In our model investors receive information about the aggregate level of the market and then decide whether to look up the value of their personal portfolio. Doing so not only provides additional information, but also increases the psychological impact of information on utility - an impact effect - and increases the speed of a utility reference point adjustment - a reference point updating effect. The main prediction of the model is that investors will check the value of their portfolios more frequently in rising markets but will "put their heads in the sand" when markets are flat or falling. We test and find support for this prediction with three Scandinavian data sets.
... We also analyze the time-series implications of investor attention for price and earnings momentum. A recent study by Karlsson, Loewenstein and Seppi (2005) documents an "ostrich effect"-investors pay more attention to stocks in rising markets, but "put their heads in the sand" in flat or falling markets. The ostrich effect motivates us to hypothesize that investors' underreaction to earnings news is stronger in down markets than in up markets, but overreaction-driven price momentum is weaker in down markets. ...
... The attention that investors allocate to stocks not only varies in the cross-section, but also over time. Karlsson, Loewenstein and Seppi (2005) analyze account activity in three Scandinavian data sets: the daily number of investor account look-ups at a large Norwegian financial service company, the daily number of online logins of a major Swedish bank, and the daily number of pension account look-ups by investors of the Swedish Pension Authority. In their study, they find that investors are more likely to look up their portfolios in up markets than in down markets. ...
... Investor attention also varies with the state of the stock markets. As discussed earlier, Karlsson, Loewenstein and Seppi (2005) find that investors pay more attention to stocks in up markets, but "put their heads in the sand" in down markets. In this section, we test the hypothesis that price momentum is more pronounced in up markets, while earnings momentum is stronger in down markets. ...
We examine the profitability of price and earnings momentum strate-gies. We find that price momentum profits are higher among high volume stocks and in up markets, while earnings momentum profits are higher among low volume stocks and in down markets. In the long run, price momentum profits are reversed, while earnings momentum profits are not. The dichotomy between price and earnings momentum is more pronounced when we orthogonalize one with respect to the other. To the extent that trading volume increases with investor attention and that investors tend to pay more attention to stocks in up markets, our results suggest a dual role for investor attention: while price underreaction to earnings news declines with investor attention, price continuation caused by investors' overreaction rises with attention.
... 3 Therefore , at an aggregate level this theory suggests that agents acquire information when the share-price index increases (that is, they buy the financial newspaper when they expect to see that the particular shares they hold are doing well), but prefer to ignore information when the share-price index decreases (that is, they do not buy the newspaper when they expect to learn from it that their shares are not doing well). We assume that expectations are correct on average, as the agent is exposed to some rumour about the general price level, but it is only after buying a newspaper that she will have precise information on her shares (see also Karlsson et al., 2004 for a similar justification). 4 ...
... In other words, she would buy the financial newspaper in times of high share prices and not buy it in times of low share prices. In this stream of the literature, Karlsson et al. (2004) present a model of belief manipulation. When facing a changing environment, agents choose between two psychological states: they can be either attentive and actively seek information, or inattentive and avoid information. ...
... There are two main differences between Karlsson et al. (2004) and the present paper. Firstly, we do not limit ourselves to investigating whether the data support the 'cognitive dissonance' (or 'ostrich behavior') hypothesis, but we also investigate competing hypotheses, according to which information is acquired in order to improve decision-making. ...
This paper deals with the determinants of agents' acquisition of information. Our econometric evidence shows that the general index of Italian share-prices and the series of Italy's financial newspaper sales are cointegrated, and the former series Granger-causes the latter, thereby giving support to the cognitive dissonance hypothesis: (non-professional) agents tend to buy the newspaper when share prices are high and not to buy it when share prices are low. Instead, we do not find support for the hypothesis that the agents acquire information in order to trade in the stock market: we find no relationship between quantities exchanged in the market and newspaper sales, nor between stock market volatility and newspaper sales.
... Galai and Sade ascribe the preference to an "ostrich effect" that drives investors away from securities that display market prices because display might expose paper losses. Karlsson, Loewenstein and Seppi (2005) found that Swedish investors tend to look up the value of their accounts on days when they know from general news that the stock market went up but refrain from looking on days when they know that the market went down. Karlsson et al (2005) wrote, "people clearly derive pleasure and pain directly from shifts in the value of their portfolios prior to consuming the actual underlying cash flows" (p. 1). ...
... Karlsson, Loewenstein and Seppi (2005) found that Swedish investors tend to look up the value of their accounts on days when they know from general news that the stock market went up but refrain from looking on days when they know that the market went down. Karlsson et al (2005) wrote, "people clearly derive pleasure and pain directly from shifts in the value of their portfolios prior to consuming the actual underlying cash flows" (p. 1). Barberis, Huang and Santos (2001) presented a model where changes in the utility of investors depend on changes in the value of their investments, not only the utility of consuming from them, and Benartzi and Thaler (1995) discussed the effect of the frequency of observing change in the value of stocks on the willingness to invest in them. ...
Assets are economically liquid when they can be sold quickly with no loss relative to their fair market value. Assets are "mentally liquid" when they offer investors options to obscure losses relative to reference prices and options to avoid their realization. Purchase prices are common references prices but other prices, such as the maximum price reached during the preceding 12 months, might serve as reference price. The price of a 20-year $1,000 Treasury bond purchased for $1,000 a year ago might have declined to $900 because interest rates increased during the year. That bond is almost perfectly economically liquid; investors can sell it for $900 less a small commission. But the mental liquidity of the bond is impaired if investors are unable to avoid observation of paper losses relative to the purchase price or if they feel compelled to postpone the sale of the bond so as to avoid the realization of losses. Still, the bond is more highly mentally liquid than a stock since bondholders have the option to wait till maturity date and avoid the realization of losses while stockholders do not have that option. Investors like gains and hate losses so they love investments that combine the prospect of gains with protection from losses. The purpose of this article is to describe some of these investments, highlighting the features designed to obscure losses or avoid their realization. These securities include bonds, money market funds, stable value funds and indexed annuities.
... We also analyze the time-series implications of investor attention for price and earnings momentum. A recent study by Karlsson, Loewenstein and Seppi (2005) documents an "ostrich effect" − investors pay more attention to stocks in rising markets, but "put their heads in the sand" in flat or falling markets. The ostrich effect motivates us to hypothesize that the underreaction-driven earnings momentum should be stronger in down markets than in up markets, but the overreaction-driven price momentum should be weaker in down markets. ...
... The attention that investors allocate to stocks not only varies in the cross-section, but also over time. Karlsson, Loewenstein, and Seppi (2005) analyze account activities in three Scandinavian data sets: the daily numbers of investor account look-ups at a large Norwegian financial service company, online logins of a major Swedish bank, and pension account look-ups by investors of the Swedish Pension Authority. They find that investors are more likely to look up their portfolios in up markets than in down markets. ...
We examine the role of investor attention in explaining the profitability of price and earnings momentum strategies. Using trading volume and market state to measure cross-sectional and time-series variations of investor attention, we find that price momentum profits are higher among high volume stocks and in up markets, but that earnings momentum profits are higher among low volume stocks and in down markets. In the long run, price momentum profits reverse but earnings momentum profits do not. These results suggest that price underreaction to earnings news weakens with investor attention, but price continuation caused by investors' overreaction strengthens with attention.
... The ostrich effect, defined by Karlsson et al (2005), is the tendency of investors to observe their portfolio more often during strong performances than weak. The authors suggest agents prefer to receive positive information about their financial holdings than negative information, and do so by selectively avoiding negative information. ...
... By including both cases, if anything, we bias the outcomes in favor of the maximizing hypothesis. 2 Bodner and Prelec (2002) have a model dedicated to this type of self-signaling. The model underlies the Karlsson et al. (2005) and Galai and Sade (2006) theory of the ostrich effect, discussed later in this paper. 3 To distinguish our ostrich effect from Karlsson et al.: in their scenario an agent knows the market performance but has a choice whether to observe his own investments. ...
Specific behavioral tendencies cause investors to deviate from optimal investing. We investigate three such tendencies in a simplified stock market. Subjects rarely follow the fully profit-maximizing strategy, most commonly by ignoring information and continuing to hold on to a stock regardless of its performance. The results support the predictions of the status quo bias, but not the ostrich effect or the disposition effect. These deviations cost subjects a substantial portion of their potential earnings.
... Non-professional investors tend to buy newspapers when stock prices are high and not buy them when they are low: if prices are low, there is dissonance between owning the stock and seeing its quotation drop, and to overcome this dissonance the investor ignores the information by not buying the newspaper, while if the prices rise the investor buys the paper because he is expecting good news about his stocks 13. Conversely, the data do not support the theory that investors buy information for use in stock market trading: there is no relationship between newspaper sales and either stock trading numbers (rational models would suggest that investors buy information to 12 According toRabin and Schrag (1999)the risk that those reporting information may suffer from confirmatory bias affects the way in which the recipient uses the information concerned;Carrillo and Mariotti (2000)argue that investors may decide not to acquire all the information available because they are afraid that they may have to revise their convictions and thus their future behavior;Akerlof and Dickens (1982), Köszegi (2000) and Yariv (2002) state that agents with utility functions dependent on their beliefs may prefer less information to more when the latter might cast doubt on those beliefs; Karlsson, Loewenstein, andSeppi (2004)suggest a model in which agents switch to " ostrich " mode, ceasing to gather further information, when the context is not favourable. 13 This inaction when stock prices are low also appears in Karlsson, Loewenstein, andSeppi (2004), who note that investors tend to check their portfolios more often when stock prices are rising than when they are falling. ...
... Conversely, the data do not support the theory that investors buy information for use in stock market trading: there is no relationship between newspaper sales and either stock trading numbers (rational models would suggest that investors buy information to 12 According toRabin and Schrag (1999)the risk that those reporting information may suffer from confirmatory bias affects the way in which the recipient uses the information concerned;Carrillo and Mariotti (2000)argue that investors may decide not to acquire all the information available because they are afraid that they may have to revise their convictions and thus their future behavior;Akerlof and Dickens (1982), Köszegi (2000) and Yariv (2002) state that agents with utility functions dependent on their beliefs may prefer less information to more when the latter might cast doubt on those beliefs; Karlsson, Loewenstein, andSeppi (2004)suggest a model in which agents switch to " ostrich " mode, ceasing to gather further information, when the context is not favourable. 13 This inaction when stock prices are low also appears in Karlsson, Loewenstein, andSeppi (2004), who note that investors tend to check their portfolios more often when stock prices are rising than when they are falling. improve their trading activities or the composition of their portfolios, and this might lead to an increase in trading levels), or the volatility of the stock market (rational models also predict that the proportion of informed individuals rises with price noise, because the more noise increases the less informative the price system is, and thus the value of information to traders rises). ...
Our paper offers evidence that printed media can affect stock prices by covering public news (nonevents) even without resorting to spin or emphasis. However, the price reaction is limited to small caps, suggesting that small investors still obtain public information mainly through newspapers. The absence of spin or emphasis is the core element that differentiates our study from existing evidence, making it unique, to the best of our knowledge, in the financial literature on the media and asset pricing.
... This negative relationship suggests that uninformed investors tend to act more in the market in an uptrend (optimism). This result contradicts the findings of Chau et al. (2016); Karlsson et al. (2011);Stambaugh et al. (2012). However, it is in keeping with the result of Yu and Yuan (2011) for the US market, and Piccoli et al. (2018), for the Brazilian market, who reported that the higher the sentiment of investors (optimism), the more they tend to act in the financial market to induce an inverse relationship between risk and return. ...
This study, based on Ahmed’s (2017) work for the US market, examines whether the prices of shares traded on the stock market of a developing country, such as Brazil, can also be influenced by noise traders who make their decisions based on irrelevant information. Using data from the Brazilian stock market between Jan/2003 and Sep/2018 we show that irrelevant firm characteristics are associated with variations in capital gains overhang (CGO), a proxy for the disposition effect bias. Our results are quite similar to those found by Ahmed (2017) for the US. However, the two markets show different results for the relationship between CGO and market liquidity and systematic risk for the entire sample period. Also, we find that there is an inverse relationship between investor sentiment and CGO at times of market upward movement. Overall, the influence of variables considered irrelevant was confirmed in robustness checks. These results may imply that noise traders evaluate stocks and companies based on their irrelevant characteristics, and this behavior, which is not compensated for by rational investors, temporarily influences the market by generating price distortions like the disposition effect.
... The knowledge flow is significant for SMEs because of their short production cycles [66], limited resources, lower R&D budgets, and lack of organizational flexibility [67]. Many industrial SMEs specialize in converting raw materials for one stage of processing. ...
This study aimed to identify sources of external knowledge in small- and medium-sized enterprises (SMEs). Additionally, it aimed to determine how external knowledge flow affects the different types of SMEs’ innovation capabilities (product, process, organizational, and marketing innovation capability). A quantitative approach was adopted to achieve the objectives. A questionnaire survey was used to collect study data from 83 random SME managers/owners in Saudi Arabia. The data were analyzed using regression analysis and descriptive statistics. The findings of the study showed that customers were the main source of external knowledge in SMEs. The results of the regression analysis also demonstrated that external knowledge flow has a significant effect on SMEs’ innovation capabilities. External knowledge explains the changes in SMEs’ products and their process innovation capability. Additionally, external knowledge flow was a significant predictor of SMEs’ organizational innovation capability. The findings of the study provide policymakers and managers with many suggestions for developing innovations in SMEs. Additionally, this study provides a basis for researchers to conduct more future studies related to innovation and knowledge flow in SMEs.
... The ostrich effect (or the ostrich problem), a cognitive bias, refers to the investors' behaviors to avoid negative financial information, which brings psychological discomfort (Galai and Sade, 2006). Karlsson et al. (2009) present a model linking information collection to investor psychology. The model predicts that investors collect additional information conditional on favorable news and avoid information following bad news. ...
Purpose. When many anomalies challenge efficiency market hypothesis and rationality, behavioral finance theories are developed to investigate the psychological effects on human behaviors and how their cognitive biases explain why the market is inefficient and anomalies exist. Behavioral finance is a fast-growing branch of financial economics, making this review paper beneficial to academics for developing leading-edge usages of financial theory that behavioral finance underlies and undertaking empirical studies on behavioral finance models. This review paper indoctrinates readers into the introductory concepts of behavioral finance with their prominent literature and empirical evidence. Design/methodology/approach. In this review paper, we swiftly familiarize readers with the introductory concepts of behavioral finance and their salient readings with some empirical evidence. Findings. This paper lays the solid foundation of behavioral finance theory and is the centerpiece of modern financial economics, which is useful to academics for developing cutting-edge treatments of financial theory that EMH and behavioral finance underpin and for undertaking empirical studies on the behavioral bias in the financial markets. Practical Implications. This paper is furthermore helpful to investors in making investment products and strategy choices that suit their risk preferences and behavioral traits predicted from behavioral models. This paper also provides the recent empirical evidence of behavioral finance in literature. The readers can then follow the research methods to undertake empirical studies on this field.
... Sağlık sorunları olan hastaların deve kuşu etkisiyle kararlar aldığı görüldüğünden bu yanlılığın uygulama alanı finanstan çok daha geniştir (Karlsson, Loewenstein ve Seppi , 2005;Sicherman vd., 2016). Deve kuşu etkisinin sağlık alanında da rastlandığına ilişkin ortaya konan araştırmalar; insanların sağlıkla ilgili konularda bilgiyle uğraşmanın hoş olmadığını, insanların bundan kaçınmayı tercih ettiğini göstermektedir. ...
Tüm dünyada, 2020 yılı başından bu yana Yeni Koronavirüs (COVID-19) virüsü ile enfekte olan bireylerin tedavi süreci devam ederken virüs nedeniyle ölümlerin sayısı hızla artmış ve şimdiye kadar dünya tarihinde karşılaşılmamış bir salgınla küresel çapta mücadele devam etmektedir. COVID-19 salgını sadece sağlık alanında değil yaşamın her alanında etkisini hissettirmektedir ve salgının yayılmasını önlemeye yönelik ekonomik kısıtlımalar tüm insanlar için görülmemiş ve duyulmamış bir kaos ve karmaşıklık çağını başlatmıştır. Salgın sürecinde artış ve azalışlar gerçekleşmiş ve pandeminin hafiflediği dönemlerde normal yaşama dönmek üzere kararlar alınmış olsa da Yeni Normal dönem olarak adlandırılan bu yeni süreçte enfekte olmaktan kaçınmak artık hayatın bir parçası haline gelmiştir. Bu durum, sadece bireylerin yaşamında değil, aynı zamanda ekonomik faaliyetler üzerinde de önemli bir unsur olmuştur. COVID-19 pandemi döneminin daha izole bir yaşam tarzına yaratması, seyahat alışkanlıklarının önemli ölçüde değişmesine neden olmuştur. Bu çalışmada, COVID-19'un bireylerin tatil davranışları üzerindeki etkisini ele alınmaktadır. Çalışmanın çerçevesi davranışsal iktisat için önemli kavramlar olan kayıptan kaçınma, özgeci davranış, sürü etkisi ve devekuşu etkisi gibi yanlı davranışlar temel alınarak oluşturulmuştur. Ele alınan literatüre göre; COVID-19 salgını sırasında hükümetlerin uyguladığı politikalara ek olarak, bireylerin de kendi çıkarlarını göz önünde bulundurarak karar vermeleri gerektiğini söylemek mümkündür.
... Sometimes shareholders do not keep themselves informed about the company they have invested in. For instance, they do it when the stock market is down (Karlsson, Loewenstein, & Seppi, 2009), and while having a better personal 'financial position' , i.e., wealth, holdings (Sicherman, Loewenstein, Seppi, & Utkus, 2016). ...
Availability of information is one of the most important factors for financial decision-makers. Having complete information about the probability of losing money should always leave decision-makers better off. However, in some situations financial decision-makers prefer to know less than more. In this study we investigated the impact of selected characteristics of financial threats on individuals’ decisions to avoid risk information in an incentivised online experiment. We found that threat severity, relative risk, and effectiveness of threat prevention alone do not influence decisions to avoid risk information. However, we did find an interaction effect between the first two treatments. Furthermore, our data suggest that coping style, locus of control, and anticipated emotional response are statistically significant predictors of financial risk information avoidance.
... This behaviour is reversed when the influence of these investors diminishes (low sentiment periods). In this context, a number of studies have found that in high sentiment periods, individual investors tend to negotiate more (Karlsson et al., 2005;Baker and Wurgler, 2007;Yuan, 2008;Chau et al., 2016), lending support to the arguments of Yu and Yuan (2011). ...
This study examines the influence of investor sentiment on the risk–return relationship in the Brazilian stock market from 2002 to 2015. Using the Consumer Confidence Index as a substitute for the level of investor sentiment, we find that the relationship between conditional variance and stocks return is positive (negative) in periods of low (high) sentiment, except for small stocks, which always show a negative relationship between the constructs. The deterioration of the positive relationship between risk and return when sentiment is high is a result of the sharp growth in the number of less sophisticated investors under these circumstances.
... This behaviour is reversed when the influence of these investors diminishes (low sentiment periods). In this context, a number of studies have found that in high sentiment periods, individual investors tend to negotiate more (Karlsson et al., 2005;Baker and Wurgler, 2007;Yuan, 2008;Chau et al., 2016), lending support to the arguments of Yu and Yuan (2011). ...
... Previous studies indicate that sentiment investors are reluctant to sell short, and these investors are found to be more active in the run-up market. There is also evidence showing that sentiment investors check their portfolios more frequently during high-sentiment periods than in lowsentiment periods (Yuan 2008, Karlsson et al. 2009). Thus, stocks or portfolios may perform differently with respect to low-and high-sentiment periods. ...
We use the orthogonalized investor sentiment index formed by M. Baker and J. Wurgler (J. Financ. 61(4):1645-1680, 2006) to examine the relationship between investor sentiment and timberland investment returns. The empirical results show that current investor sentiment is an important factor that determines the one-quarter future returns of timberland investment, and the predicting power persists over the next 1 to 5 years. Both the short- and long-term studies obtain negative coefficients on investor sentiment, indicating that current increase in investor sentiment drives prices up and lowers future returns. In addition, significantly different return variances and insignificantly different average returns of timberland investment are obtained between low- and high-sentiment periods. The result further confirms the ability of earning long-term stable returns by timberland investment.
... Noticing is a key process in a decision-making model because, as Starbuck (1988) argues, those individuals unable to notice relevant changes will find it difficult to meet their goals. Such difficulties will arise either because the individual will not properly modify the way they use their knowledge or because they have not recognized the need for further improvement in their knowledge (Karlsson et al., 2005). Once the stimulus has caught the investor's attention, s/he makes sense of it. ...
This paper focuses on the impact of non-financial factors on individual investment decisions when information on a takeover bid announcement is public. Our results indicate that individual traits modulate the impact of information clarity and source reliability on decision-making. Thus, when individual traits are ignored, we find that investors use situational variables to distinguish noises from news. However, information clarity is more helpful than source reliability to interpret the information and take action even when source reliability diminishes. In contrast, when individual traits are considered, we observe that not only the lack of clarity, but also the lack of source reliability reduces situational strength. Furthermore, under uncertainty, individuals who are intuitive and tolerant to ambiguity are more capable of distinguishing between relevant and irrelevant stimuli and are more likely to expect a drop in the target’s share price. Finally, we observe that proactivity, in situations of uncertainty, is more important on action than cognitive style and tolerance to ambiguity. Intuition and proactivity impact positively on trading, while proactivity fosters coherence between perception and decisions.
... Yu and Yuan (2011) argue that individual traders are the primary candidates for sentiment traders, and empirical evidence shows that individual investors seldom short (Barber and Odean, 2008). Further, there is evidence that these traders are more active in the market during high-sentiment periods (Karlsson et al., 2005). Miller (1977) describes impediments to short selling that effectively limit the extent traders can profit from overpricing. ...
We study how investor sentiment affects the speed with which prices reflect information. Price discovery is more timely for firms with greater sensitivity to sentiment, as measured by a sentiment beta. Our research improves our understanding of the price formation process when sentiment is not assumed to be constant. Our research design is novel as it considers a sentiment beta as well as economy-wide sentiment. This provides more comprehensive evidence on the impact of differing types of sentiment on the price formation process.
... Yu and Yuan (2011) argue that individual traders are the primary candidates for sentiment traders, and empirical evidence shows that individual investors seldom short (Barber and Odean, 2008). Further, there is evidence that these traders are more active in the market during high-sentiment periods (Karlsson et al., 2005). Miller (1977) describes impediments to short selling that effectively limit the extent traders can profit from overpricing. ...
We study how investor sentiment affects the speed with which prices reflect information. Price discovery is more timely for firms with greater sensitivity to sentiment, as measured by a sentiment beta. Our research improves our understanding of the price formation process when sentiment is not assumed to be constant. Our research design is novel as it considers a sentiment beta as well as economy-wide sentiment. This provides more comprehensive evidence on the impact of differing types of sentiment on the price formation process.
... However, our focus is on preferences, not beliefs. Along the lines of our interpretation of the selective exposure bias is work by Karlsson, Loewenstein, and Seppi (2005), who found that people checked the performance of their investments more often when a general market index had risen than when it had declined or remained the same. Other related work examines agents who selectively ignore information in order to justify making self-serving decisions (Dana, Weber, and Kuang, forthcoming;Feiler, 2006), or select out of a playing a dictator game, even at a cost, to avoid facing a potential recipient (Dana, Cain, and Dawes, 2006;Lazear, Malmendier, and Weber, 2006). ...
We provide an array of experimental observations pertaining to agents' endogenous selection of information. We study settings in which agents have to choose one of two actions, the value of which depends on an unknown state of nature. When given a choice between different information sources, more than half of all subjects choose a source that potentially confirms their prior inclinations but is inferior in terms of associated expected payoffs. Introducing externalities between action choices in the form of a majority vote does not alleviate the results, while separating the choice of information structure from the action choice does to some extent. The analysis is potentially important for understanding political and economic phenomena such as people's tendency to read news about their preferred political candidate (rather than political opponents), to learn more about a desired product than about its alternatives, and to track their stocks more frequently when the market is doing well. and CEPR. We gratefully acknowledge financial support from the National Science Foundation (SES 0551014), the Alfred P. Sloan Foundation, and the Dutch National Science Foundation. We thank attendees at the 2006 ESA meetings in Atlanta and Tucson for comments.
... Yu and Yuan (2011) argue that individual traders are the primary candidates for sentiment traders, and empirical evidence shows that individual investors seldom short (Barber and Odean, 2008). Further, there is evidence that these traders are more active in the market during high-sentiment periods (Karlsson et al., 2005). Miller (1977) describes impediments to short selling that effectively limit the extent traders can profit from overpricing. ...
We study how sentiment affects the speed with which prices reflect information. We find that deviations from a steady level of economy-wide sentiment are associated with more timely price discovery. We also find that in general, price discovery is more timely for firms with greater sensitivity to economy-wide sentiment, as measured by a sentiment beta. However, this result does not hold when analyzing economy-wide sentiment and a firm's sentiment beta simultaneously. During bust periods, high sentiment beta stocks have lower timeliness. Our research sheds light on the price formation process when sentiment deviates from normal levels. In particular, our results suggest that a firm's sentiment beta is sensitive to changes in an exogenous economy-wide sentiment.
... Jung Grant, Xie, and Soman (2010) attribute the asymmetric updating partially to memory and investor attention (e.g. Karlsson et al, 2009), and partially due to an increased motivation for investors to sell following a price increase. However, none of these studies consider the actual trading behaviour by individual investors. ...
We propose that the reference price that investors apply to determine whether an investment makes a profit or a loss determines whether a disposition effect can be observed or not. We find that the disposition effect is statistically and economically significant for active individual investors who purchase stocks at one price in one trade. When individuals buy in several transactions, the importance of single purchase prices is reduced and the disposition effect is significantly lower. Market sentiment has an impact on investors who purchase in single transactions, while investors that break up their purchases also time their sales more effectively.
... For example, in 'motivated reasoning ' (Kunda (1990)), the individual draws inferences based on desired conclusions (e.g., that the individual possesses desirable qualities) rather than on the merits. There is also evidence of self-enhancing behaviors in investing; Karlsson, Seppi, and Loewenstein (2005) find that Scandinavian investors reexamine their portfolios more frequently when the market has risen than when it has declined. small step from thinking in a self-enhancing way to talking in such a way. ...
Individual investors often invest actively and lose thereby. Social interaction seems to exacerbate this tendency. In the model here, senders' propensity to discuss their strategies' returns, and receivers' propensity to be converted, are increasing in sender return. The rate of conversion of investors to active investing is convex in sender return. Unconditionally, active strategies (high variance, skewness, and personal involvement) dominate the population unless the mean return penalty to active investing is too large. Thus, the model can explain overvaluation of 'active' asset characteristics even when investors have no inherent preference over them.
... Unfortunately, many people deny and dismiss information that they find frightening (the "ostrich effect"). [31][32][33][34] While fear can motivate action, research from other fields suggests it is most effective when the proposed action helps to neutralize that fear (e.g., a clear strategy to control the disease). 35,36 Second, very technical or overwhelming education may cause patients ironically to feel subjectively less knowledgeable and turn away from instructed behaviors. ...
Despite a revolution in therapeutics, the ability to control chronic diseases remains elusive. We present here a conceptual model of the potential role of behavioral tools in chronic disease control. Clinicians implicitly accept the assumption that patients will act rationally to maximize their self-interest. However, patients may not always be the rational actors that we imagine. Major behavioral barriers to optimal health behavior include patients' fear of threats to health, unwillingness to think about problems when risks are known or data are ambiguous, the discounting of risks that are far in the future, failure to act due to lack of motivation, insufficient confidence in the ability to overcome a health problem, and inattention due to pressures of everyday life. Financial incentives can stimulate initiation of health-promoting behaviors by reducing or eliminating financial barriers, but may not produce long-term behavior change without additional interventions. Strategies have been developed by behavioral economists and social psychologists to address each of these barriers to better decision-making. These include: labeling positive behaviors in ways consistent with patient life goals and priorities; greater focus on more immediate risks of chronic diseases; intermediate subgoals as steps to a large health goal; and implementation of specific plans as to when, where, and how an action will be taken. Such strategies hold promise for improving health behaviors and disease control, but most have not been studied in medical settings. The effectiveness of these approaches should be evaluated for their potential as tools for the clinician.
... Given the incentives they face, they may feel they have no choice: " I was just following orders, " " I'm just trying to make a living, " or " if I didn't do it he would have hired someone else to do it, " are emblematic of the types of phrases one often hears, after the fact, in investigations of atrocities, business fraud, and other forms of immoral behavior. In the real world, these psychological factors often interact with others that reinforce the diffusion of responsibility – for example, self-serving biases and willful disregard of information (Babcock & Loewenstein, 1997; Karlsson, Loewenstein & Seppi, 2005; Dana, Weber & Kuang, 2007). These results may, if anything, understate the impact of agency on selfishness because our study is conservative. ...
Principal-agent relationships are typically motivated by efficiency gains from comparative advantage. However, such delegation may also arise because it allows principals the pursuit of selfish outcomes while avoiding explicitly selfish behavior. We report laboratory experiments in which principals repeatedly either decide how much money to share with a recipient or select agents to make sharing decisions on their behalf. Across several treatments, recipients receive significantly less when agents make allocation decisions. This results from principals seeking those agents willing to reliably share the least. We observe instances in which sharing is almost entirely extinguished when decisions are made through agents.
... Investors may even go as far as distancing themselves from the paper losses. Niklas Karlsson, Loewenstein, and Duane J. Seppi (2005) show that investors are substantially less likely to look up their holding on the Internet when the stock market is doing poorly. If investors only evaluate losses when they realize them, as Barberis and Xiong (forthcoming) show with an extension of their model, referencedependent preferences mostly produce the disposition effect patterns. ...
Part I: Nonstandard Preferences This first part of a larger work devoted to the modern behavioral economics considers economic aspects of nonstandard preferences that characterize deviations from the standard model of rational decision-making. The author emphasizes the problems of self-control and the context-dependence of human behavior. He then shows how to apply theoretical ideas to the study of savings, labor market, stock exchange, and other domains of economic behavior.
... find consistent evidence that sentiment-driven investors participate and trade more aggressively in high-sentiment periods (e.g. Karlsson, Loewenstein, and Seppi (2005), Yuan (2008). Second, because sentiment traders tend to be inexperienced and naive investors, they are likely to have a poor understanding of how to measure risk and hence are likely to misestimate the variance of returns, weakening the meanvariance relation. ...
This study shows the influence of investor sentiment on the market's mean–variance tradeoff. We find that the stock market's expected excess return is positively related to the market's conditional variance in low-sentiment periods but unrelated to variance in high-sentiment periods. These findings are consistent with sentiment traders who, during the high-sentiment periods, undermine an otherwise positive mean–variance tradeoff. We also find that the negative correlation between returns and contemporaneous volatility innovations is much stronger in the low-sentiment periods. The latter result is consistent with the stronger positive ex ante relation during such periods.
... Investors may even go as far as distancing themselves from the paper losses. For instance, Karlsson et al. [2005] show that, when the stock market is doing poorly, investors are substantially less likely to look at their holdings on the Internet. ...
This article reviews interventions that are effective in changing behaviours in ways that enhance financial capability. Traditionally, behavior change has been seen through the lens of “changing minds”: if we can change the way people think—their beliefs, attitudes, and goals—then we can change the way they behave. More recent developments in behavioral theory show that “changing contexts” can have a powerful effect on behavior: we can change behavior by sometimes quite subtle changes to the environment or context within which decisions are made. We focus largely on the influence of context and provide examples from current UK banks that have changed the “choice architecture” of their products.
... We argue that investors' attention is lower in high sentiment periods, which are periods in which noise investors overestimate the expected returns of stocks (Lee, Shleifer and Thaler, 1991). During these periods, individual investors tend to be more active (Baker and Stein 2004, Liu 2006, Karlsson, Lowenstein, and Seppi 2005) and hence the limited attention effect is expected to be greater. Also, in high sentiment years, individual investors are optimistic about future stock performance. ...
This study examines the effect of investor sentiment on the accruals anomaly. We find that for small stocks mispricing per unit of accruals is greater in high sentiment periods as compared to low sentiment periods. This result is consistent with the notion that in high sentiment periods individual investors pay less attention towards understanding the accruals and cash flow components of earnings. This effect is observed primarily for small stocks because these stocks are more likely to be followed by individual investors, who tend to have limited attention. We also find that for small stocks reported accruals are greater during high sentiment periods as compared to low sentiment periods, suggesting that managers exploit the greater overvaluation per unit of accruals during high sentiment periods.
... Investors may even go as far as distancing themselves from the paper losses. Niklas Karlsson, Loewenstein, and Duane J. Seppi (2005) show that investors are substantially less likely to look up their holding on the Internet when the stock market is doing poorly. If investors only evaluate losses when they realize them, as Barberis and Xiong (forthcoming) show with an extension of their model, referencedependent preferences mostly produce the disposition effect patterns. ...
This paper evaluates a pilot program run by a company called OPOWER, previously known as Positive Energy, to mail home energy reports to residential utility consumers. The reports compare a household’s energy use to that of its neighbors and provide energy conservation tips. Using data from randomized natural field experiment at 80,000 treatment and control households in Minnesota, I estimate that the monthly program reduces energy consumption by 1.9 to 2.0 percent relative to baseline. In a treatment arm receiving reports each quarter, the effects decay in the months between letters and again increase upon receipt of the next letter. This suggests either that the energy conservation information is not useful across seasons or, perhaps more interestingly, that consumers’ motivation or attention is malleable and non-durable. I show that “profiling,” or using a statistical decision rule to target the program at households whose observable characteristics suggest larger treatment effects, could substantially improve cost effectiveness in future programs. The effects of this program provide additional evidence that non-price “nudges” can substantially affect consumer behavior.
Financial interests in health care are valid to its functioning as a means of employment for thousands of Americans. These interests become conflicts, however, when their importance is prioritized over fiduciary responsibilities to patients. Business matters then challenge ethical medical professionalism for physicians’ attention and loyalty. The Bayh-Dole Act opened the doors of academic medical centers to the corporate sector in 1980, but its effects have not been entirely salutary. A greater potential for bias favoring commercial interests has been introduced not only to clinical trials, but also to medical education (“hidden curriculum”) and the management of research participants with sometimes tragic results. Corporate productivity expectations for physicians have emphasized greater quantities of care at the expense of the precious element of time. Willingly or not doctors are adapting to the business environment. How has this assimilation happened? Potential neurobiological and psychosocial mechanisms to explain the altered mentality of many physicians are reviewed. Although a hegemony of money has enveloped this country, the commercialization of medical professionals remains unjustified. The physician remains the pivotal point for the direction of medicine’s future. Will it survive as a profession or a business?
Purpose
Behavioral economics recognizes that contextual, psychological, social, and emotional factors powerfully influence decision-making. Behavioral economics has the potential to provide a better understanding of, and, through subtle environmental changes, or "nudges," improve persistent quality-of-care challenges, like ambulatory antibiotic overprescribing. Despite decades of admonitions and educational initiatives, in the United States, up to 50% of ambulatory antibiotic prescriptions remain inappropriate or not associated with a diagnosis.
Methods
We conducted a Medline search and performed a narrative review that examined the use of behavioral economics to understand the rationale for, and improvement of, ambulatory antibiotic prescribing.
Findings
Clinicians prescribe antibiotics inappropriately because of perceived patient demand, to maintain patient satisfaction, diagnostic uncertainty, or time pressure, among other reasons. Behavioral economics–informed approaches offer additional improvements in antibiotic prescribing beyond clinician education and communication training. Precommitment, in which clinicians publicize their intent to prescribe antibiotics "only when they are absolutely necessary," leverages clinicians' self-conception and a desire to act in a manner consistent with public statements. Precommitment was associated with a 20% absolute reduction in the inappropriate antibiotic prescribing for acute respiratory infections. Justification alerts, in which clinicians must provide a brief written rationale for prescribing antibiotics, leverages social accountability, redefines the status quo as an active choice, and helps clinicians to shift from fast to slow, careful thinking. With justification alerts, the absolute rate of inappropriate antibiotic prescribing decreased from 23% to 5%. Peer comparison, in which clinicians receive feedback comparing their performance to their top-performing peers, provides evidence of improved performance and leverages peoples' desire to conform to social norms. Peer comparison decreased absolute inappropriate antibiotic prescribing rates from 20% to 4%, a decrease that persisted for 12 months after the end of the intervention. Also, a one-time peer-comparison letter from a high-profile messenger to primary care practices with high rates of prescribing antibiotics, there was a 6-month, 3% decrease inantibiotic prescribing. Future directions in applying behavioral economics to the inappropriate antibiotic prescribing include paying careful attention to design details; improving intervention effectiveness and durability; making harms salient; participants' involvement in the development of interventions (the "Ikea effect"); factoring in patient satisfaction; and patient-facing nudges about antibiotic use and care-seeking. In addition, the COVID pandemic could aid in ambulatory antibiotic prescribing improvements due to changing cognitive frames around respiratory symptom evaluation and antibiotic prescribing.
Implications
To improve ambulatory antibiotic prescribing, several behavioral economics–informed approaches—especially precommitment, justification alerts, and peer comparison—have reduced the rates of inappropriate prescribing of antibiotics to low levels.
We investigate whether investor sentiment affects the relationships between accounting variables and contemporaneous stock returns. Using price‐relevant accounting variables identified by Chen and Zhang (2007) and the investor sentiment index constructed by Baker and Wurgler (2006), we find that the value relevance of accounting variables is collectively lower in high sentiment periods than in low sentiment periods. More importantly, earnings yield appears to be more related to contemporaneous stock returns in high sentiment periods, while other accounting variables are more related to stock returns in low sentiment periods. The effect of investor sentiment on the value relevance of accounting information is stronger for firms that are more difficult to value and to arbitrage.
This study points out the complexities inherent to stock assessment distortion and how accounting information is priced. We obtain evidence about how investors, who are considered to have bounded rationality, influence the dynamics of the formation of stock prices. This effect was investigated in a Brazilian scenario, an environment of low informational quality, but one that represents an important route for international investments. The results indicate that stock market values do not tend to reflect the accounting information for hard-to-value stocks. In this case, accounting information is priced gradually over time. There is evidence that under more complex conditions, stock prices tend to mainly reflect accounting information related to good news. The results also showed that the adoption of International Financial Reporting Standards (IFRS) in Brazil increased the relevance of accounting information by reducing the complexity involved in stock assessment. Additionally, greater comovement of stock prices was identified for hard-to-value-stocks.
This first part of a larger work devoted to the modern behavioral economics considers economic aspects of nonstandard preferences that characterize deviations from the standard model of rational decision-making. The author emphasizes the problems of self-control and the context-dependence of human behavior. He then shows how to apply theoretical ideas to the study of savings, labor market, stock exchange, and other domains of economic behavior.
How can individuals best be encouraged to take more responsibility for their well-being and their environment or to behave more ethically in their business transactions? Across the world, governments are showing a growing interest in using behavioural economic research to inform the design of nudges which, some suggest, might encourage citizens to adopt beneficial patterns of behaviour. In this fascinating collection, leading academic economists, psychologists and philosophers reflect on how behavioural economic findings can be used to help inform the design of policy initiatives in the areas of health, education, the environment, personal finances and worker remuneration. Each chapter is accompanied by a shorter 'response' that provides critical commentary and an alternative perspective. This accessible book will interest academic researchers, graduate students and policy-makers across a range of disciplinary perspectives.
Everyday fi nancial decisions are the product of diverse factors, including instinct, habit, emotion, reason, and social interaction. Psychologists have long aspired to unravel the determinants of intuitive judgment and choice. Slowly but surely, they have identifi ed various psycho lo gical mechanisms that cause predictable decision biases. This survey puts special emphasis on behavioral research in fi nance that investigates information overload, emotion, social infl uence, and ambiguity aversion. It also discusses selected cognitive models that attempt to integrate the way individuals interpret and act upon information. In general, behavioral research casts serious doubt on the validity of some of the key insights of mainstream fi nance such as portfolio theory, the positive risk-return trade-off, and effi cient markets. © 2001 Asociación Española de Contabilidad y Administración de Empresas.
The present paper examines the microfoundations of how households form subjective expectations about the macroeconomy using a novel survey-based data set. In particular, we are interested in the role of perceived news. The paper outlines a model where households may give unequal importance (or weights) to ‘good’ and ‘bad’ news. We also consider whether the relationship is state-varying and has any structural changes. The ensuing empirical investigation uses time-varying smooth transition autoregressive models. We find that weights given to the news are state-varying, with little, or no, weight given to bad news. There is also a clear structural change in the relationship after September 2001.
Our study extends prior research on the investment decision-making process focusing on investors’ perception. On the basis of the Starbuck and Milliken (1988) model that divides perception into two stages, noticing and sense making, we investigate the driving factors of perception and provide empirical evidence on the interaction between environmental factors and individual traits. We test the empirical predictions of our model with an experiment on a takeover bid. Our results show that: (a) the distinction between noticing and sense making is significant to examine investors’ information processing, since the driving factors and interactions of the two stages are different, (b) a high ambiguity context negatively influences the two phases of investors’ perception; while the individual cognitive profile affects this negative influence on noticing, it does not affect it on sense making, (c) information clarity, without considering other contexts or personality factors, improves noticing but it does not produce significant effects on sense making, (d) the reliability of the source of information only has an effect on noticing and sense making when it interacts with other context variables and the cognitive profile affects this influence, and (e) the most relevant cognitive variable in noticing is ambiguity–tolerance, whereas in sense making it is intuition.
One of the main arguments of behavioral finance is that some properties of asset prices are most probably regarded as deviations from fundamental value and they are generated by the participation of traders who are not fully rational, thus called noise traders. Noise trader theory postulates that sentiment traders have greater impact during high-sentiment periods than during low-sentiment periods, and sentiment traders miscalculate the variance of returns undermining the mean-variance relation. The main objective of this research is to construct a model to evaluate the returns and conditional volatility of various stock market indexes considering the changes in the investor sentiment by measuring the effects of noise trader demand shocks on returns and volatility. EGARCH model is used to determine whether earning shocks have more influence on the conditional volatility in high sentiment periods weakening the mean–variance relation. This paper takes an international approach using weekly market index returns of U.S., Japan, Hong Kong, U.K., France, Germany, and Turkey. Weekly trading volumes of these indexes are regressed against a group of macroeconomic variables and the residuals are used as proxies for investor sentiment and significant evidence is found that there is asymmetric volatility in these market indexes and earning shocks have more influence on conditional volatility when the sentiment is high.
Everyday financial decisions are the product of diverse factors, including instinct, habit, emotion, reason, and social interaction. Psychologists have long aspired to unravel the determinants of intuitive judgment and choice. Slowly but surely, they have identified various psychological mechanisms that cause predictable decision biases. This survey puts special emphasis on behavioral research in finance that investigates information overload, emotion, social influence, and ambiguity aversion. It also discusses selected cognitive models that attempt to integrate the way individuals interpret and act upon information. In general, behavioral research casts serious doubts on the validity of some of the key insights of mainstream finance such as portfolio theory, the positive risk-return trade-off, and efficient markets.
Based on the time series of market price of risk (MPR) corresponding to the A-Share indices of SSE & SzSE, we make an inquiry into the impact of investor sentiment on the MPR. We adopt the vector autoregression (VAR) methodology, and employ impulse response functions to demonstrate the extend to which investor sentiment influences MPR. This approach is due to the fact that both investor sentiment and MPR are two important state variables in the system of stock market. Although we use the same investor sentiment proxy as previous literatures, we decompose this proxy into two components: the rational and the irrational, and explore the exclusive impact of each component to the MPR. We also consider the mutual influence of investor sentiment in Shanghai Stock Exchange (SSE) and Shenzhen Stock Exchange (SzSE) to their MPRs. We find that the response of MPR to a standard shock from the rational component of investor sentiment is significantly negative in the second period, but insignificant to the irrational component. We also find that MPR is significantly different in periods when investor sentiment is pessimistic and optimistic, respectively. More precisely, during the pessimistic period, MPR is positive, while in the optimistic period, MPR is probably negative.
IntroductionLimited Attenton and Return Predictability: TheoryLimited Attention and Return Predictability: EvidenceThe Interaction of Attention and Investor Biases and Market ImperfectionsAllocation of AttentionThe Effect of Investor Limited Attention on Corporate Decision MakingLimited Attention as a Source of Other Psychological BiasesSummary and Conclusions
Discussion QuestionsAbout the Authors
I explore macroeconomic dynamics for a decision maker whose pref-erence depends not only on his actual consumption but also on com-parisons to his beliefs about optimal consumption. The standard de-cision maker is loss averse with respect to this belief-dependent refer-ence point. When loss aversion is low, the decision maker can devi-ate from standard lifecycle consumption behavior. This deviation can help explain some puzzling features of inter-temporal consumption data in general equilibrium. When the decision maker has age-related time-varying degrees of loss aversion and rebalances his consistent consumption through adjusted beliefs, the model generates hump-shaped consumption pro…le that closely tracks the data in a well-calibrated general equilib-rium.
This article investigates collective denial and willful blindness in groups, organizations, and markets. Agents with anticipatory
preferences, linked through an interaction structure, choose how to interpret and recall public signals about future prospects.
Wishful thinking (denial of bad news) is shown to be contagious when it is harmful to others, and self-limiting when it is
beneficial. Similarly, with Kreps–Porteus preferences, willful blindness (information avoidance) spreads when it increases
the risks borne by others. This general mechanism can generate multiple social cognitions of reality, and in hierarchies it
implies that realism and delusion will trickle down from the leaders. The welfare analysis differentiates group morale from
groupthink and identifies a fundamental tension in organizations' attitudes towards dissent. Contagious exuberance can also
seize asset markets, generating investment frenzies and crashes.
Recently, researchers have gone a step further from just documenting biases of individual investors. More and more studies analyze how experience affects decisions and whether biases are eliminated by trading experience and learning. A necessary condition to learn is that investors actually know what happened in the past and that the views of the past are not biased. We contribute to the above mentioned literature by showing why learning and experience go hand in hand. Inexperienced investors are not able to give a reasonable self-assessment of their own past realized stock portfolio performance which impedes investors' learning ability. Based on the answers of 215 online broker investors to an Internet questionnaire, we analyze whether investors are able to correctly estimate their own realized stock portfolio performance. We show that investors are hardly able to give a correct estimate of their own past realized stock portfolio performance and that experienced investors are better able to do so. In general, we can conclude that we find evidence that investor experience lessens the simple mathematical error of estimating portfolio returns, but seems not to influence their “behavioral” mistakes pertaining to how good (in absolute sense or relative to other investors) they are.
According to prospect theory [Kahneman, D., & Tversky, A. (1979). Prospect theory: An analysis of decision under risk, Econometrica, 47, 263–292], gains and losses are measured from a reference point. We attempted to ascertain to what extent the reference point shifts following gains or losses. In questionnaire studies, we asked subjects what stock price today will generate the same utility as a previous change in a stock price. From participants’ responses, we calculated the magnitude of reference point adaptation, which was significantly greater following a gain than following a loss of equivalent size. We also found the asymmetric adaptation of gains and losses persisted when a stock was included within a portfolio rather than being considered individually. In studies using financial incentives within the BDM procedure [Becker, G. M., DeGroot, M. H., & Marschak, J. (1964). Measuring utility by a single-response sequential method. Behavioral Science, 9(3), 226–232], we again noted faster adaptation of the reference point to gains than losses. We related our findings to several aspects of asset pricing and investor behavior.
This dissertation examines two related biases in information acquisition, information avoidance and selective exposure to information. The first essay focuses on the use of information avoidance to justify self-serving decisions. Participants in an experimental dictator game are given the chance to avoid costless information about a recipient's payoffs. Many dictators choose an allocation that maximizes their own profit without learning whether this allocation will help or hurt the recipient. Even subjects who make equitable choices when non-aligned payoffs are known will avoid information, especially when it is likely that doing so will not hurt the recipient. Through assessing the role of beliefs in information avoidance, this chapter provides an evaluation of several theoretical models of avoidance. The second essay considers the effects of both information avoidance and information-seeking behavior on charitable donations. Experimental subjects are allowed to avoid or seek out a range of information about a charity before deciding how much to donate to the organization. Donation sizes are positively correlated with the amount of information subjects choose to obtain. When subjects are required to read descriptions of charities, longer descriptions lead to higher donations. This indicates that agents may avoid further information if they have already learned about a person or charity in need, because learning more could obligate them to give more. The final essay studies selective exposure, the tendency to seek information that could support or validate one's beliefs or preferences but not maximize payoffs. Subjects in a context-free environment have to guess an unknown state of nature, and we induce preferences for one particular state. When given a choice between different information sources, around half of all subjects choose a source that potentially confirms that the state is the one they prefer, but is inferior in terms of expected payoffs. This finding holds consistently across a variety of contexts. The results of these studies have implications within experimental economics, since experiments tend to impose information on subjects that they might not otherwise gain. They also demonstrate that the ability to selectively acquire or avoid information can have a large impact on economic decisions.
Presents a theory of norms and normality and applies the theory to phenomena of emotional responses, social judgment, and conversations about causes. Norms are assumed to be constructed ad hoc by recruiting specific representations. Category norms are derived by recruiting exemplars. Specific objects or events generate their own norms by retrieval of similar experiences stored in memory or by construction of counterfactual alternatives. The normality of a stimulus is evaluated by comparing it with the norms that it evokes after the fact, rather than to precomputed expectations. Norm theory is applied in analyses of the enhanced emotional response to events that have abnormal causes, of the generation of predictions and inferences from observations of behavior, and of the role of norms in causal questions and answers. (3 p ref) (PsycINFO Database Record (c) 2012 APA, all rights reserved)
Standard models of choice assume that the weight given to information from different sources depends exclusively on its diagnosticity. In this paper we study whether directly experienced information influences behavior more strongly than vicariously obtained information. We conducted two experiments that, unlike prior studies, maintain content, format and relevance of the information constant, while varying only its source. The experiments consisted of repeated games in which groups of players were randomly reassigned into groups every round and were informed of the behavior of all players. As predicted, subjects' behavior was more strongly influenced by the actions of players they directly interacted with than by those they only observed.
This paper studies the interactions between an individual’s self–esteem and his social environment, whether in the workplace, at school, or in personal relationships. A person generally has only imperfect knowledge of his own ability (or long–term payoff) in pursuing a task, and will undertake it only if he has sufficient self–confidence. People who interact with him (parent, spouse, friend, teacher, manager, colleague, etc.) often have complementary information about his ability, but also a vested interest in his completing the task. This generates an incentive for such principals to distort their signals so as to manipulate the agent’s self–con…dence. We first study situations where an informed principal chooses an incentive structure, such as offering payments or rewards, delegating a task, or simply giving encouragement. We show that rewards may be weak reinforcers in the short term and that, as stressed by psychologists, they may have hidden costs in that they become negative reinforcers once withdrawn. By offering a low–powered incentive scheme, the principal signals that she trusts the agent. Conversely, rewards (extrinsic motivation) have a limited impact on the agent’s current performance, and reduce his intrinsic motivation to undertake similar tasks in the future. Similarly, empowering the agent is likely to increase his motivation and effort, while offers of help or assistance may
Presents an overview of research on the effects of an optimistic orientation to life on psychological well-being. The chapter begins by commenting on a distinction between two ways of assessing optimism and pessimism. Then the authors review some of the empirical evidence linking positive thinking to well-being, focusing on prospective studies in both health- and nonhealth-related contexts. They then consider why optimism might confer benefits, arguing that the benefits are due, in part, to the way in which optimists and pessimists cope with problems. The conclusion addresses whether or not the effects of optimism are always good and the effects of pessimism are always bad. (PsycINFO Database Record (c) 2012 APA, all rights reserved)
Research on selective exposure to information consistently shows that, after having made a decision, people prefer supporting over conflicting information. However, in all of these experiments participants were given an overview of all available pieces of information, selected them simultaneously, and did not process the requested information during the selection phase. In the present research the authors show that an even stronger preference for supporting information arises if information is presented and processed sequentially instead of simultaneously (Experiment 1), and they demonstrate that this stronger confirmation bias is due to sequential presentation and not to sequential processing of information (Experiment 2). The authors provide evidence that the increase in confirmation bias under sequential presentation is caused by heightened commitment due to the participants' increased focusing on their decision (Experiments 3 and 4).
Willingness to accept (WTA) is usually substantially higher than willingness to pay (WTP). These constructs have been studied for roughly 30 years and with a wide variety of goods. This paper reviews those studies. We find that the less the good is like an “ordinary market good,” the higher is the ratio. The ratio is highest for non-market goods, next highest for ordinary private goods, and lowest for experiments involving forms of money. A generalization of this pattern holds even when we account for differences in survey design: ordinary goods have lower ratios than non-ordinary ones. We also find that ratios in real experiments are not significantly different from hypothetical experiments and that incentive-compatible elicitation yields higher ratios.
Decision outcomes sometimes result in negative emotions. This can
occur when a decision appears to be wrong in retrospect, and/or when
the obtained decision outcome does not live up to expectations. Regret
and disappointment are the 2 emotions that are of central interest
in the present article. Although these emotions have a lot in common,
they also differ in ways that are relevant to decision making. In
this article, the authors review theories and empirical findings
concerning regret and disappointment. The authors first discuss how
regret and disappointment differ with respect to their antecedent
conditions, appraisals, and phenomenology. Possible behavioural consequences
of experiencing these emotions are also discussed. Next, the authors
consider how the anticipation of regret and disappointment may influence
decision making. They use regret and disappointment theory as a framework
for the discussion. It is argued that combining the theoretical approaches
and research paradigms of behavioural decision theory with emotion
theories will significantly increase knowledge of antecedents and
consequences of emotions. (PsycINFO Database Record (c) 2009 APA,
all rights reserved)
Distinctions have been proposed between systems of reasoning for centuries.
This article distills properties shared by many of these distinctions
and characterizes the resulting systems in light of recent findings
and theoretical developments. One system is associative because its
computations reflect similarity structure and relations of temporal
contiguity. The other is "rule based" because it operates on symbolic
structures that have logical content and variables and because its
computations have the properties that are normally assigned to rules.
The systems serve complementary functions and can simultaneously
generate different solutions to a reasoning problem. The rule-based
system can suppress the associative system but not completely inhibit
it. The article reviews evidence in favor of the distinction and
its characterization.
In economic analyses of asymmetric information, better-informed agents are assumed capable of reproducing the judgments of less-informed agents. The authors discuss a systematic violation of this assumption that they call the "curse of knowledge." Better-informed agents are unable to ignore private information even when it is in their interest to do so; more information is not always better. Comparing judgments made in individual-level and market experiments, they find that market forces reduce the curse by approximately 50 percent, but do not eliminate it. Implications for bargaining, strategic behavior by firms, principal-agent problems, and choice under uncertainty are discussed. Copyright 1989 by University of Chicago Press.
The equity premium puzzle refers to the empirical fact that stocks have outperformed bonds over the last century by a surprisingly
large margin. We offer a new explanation based on two behavioral concepts. First, investors are assumed to be “loss averse,”
meaning that they are distinctly more sensitive to losses than to gains. Second, even long-term investors are assumed to evaluate
their portfolios frequently. We dub this combination “myopic loss aversion.” Using simulations, we find that the size of the
equity premium is consistent with the previously estimated parameters of prospect theory if investors evaluate their portfolios
annually.
In 4 experiments, 144 depressed and 144 nondepressed undergraduates (Beck Depression Inventory) were presented with one of a series of problems varying in the degree of contingency. In each problem, Ss estimated the degree of contingency between their responses (pressing or not pressing a button) and an environmental outcome (onset of a green light). Depressed Ss' judgments of contingency were suprisingly accurate in all 4 experiments. Nondepressed Ss overestimated the degree of contingency between their responses and outcomes when noncontingent outcomes were frequent and/or desired and underestimated the degree of contingency when contingent outcomes were undesired. Thus, predictions derived from social psychology concerning the linkage between subjective and objective contingencies were confirmed for nondepressed but not for depressed Ss. The learned helplessness and self-serving motivational bias hypotheses are evaluated as explanations of the results. (41/2 p ref) (PsycINFO Database Record (c) 2006 APA, all rights reserved).
It is proposed that motivation may affect reasoning through reliance on a biased set of cognitive processes--that is, strategies for accessing, constructing, and evaluating beliefs. The motivation to be accurate enhances use of those beliefs and strategies that are considered most appropriate, whereas the motivation to arrive at particular conclusions enhances use of those that are considered most likely to yield the desired conclusion. There is considerable evidence that people are more likely to arrive at conclusions that they want to arrive at, but their ability to do so is constrained by their ability to construct seemingly reasonable justifications for these conclusions. These ideas can account for a wide variety of research concerned with motivated reasoning.
The dependent variable was the amount of button pressing to produce momentary elimination of the static that partially masked tape-recorded messages. In 4 experiments, employing 112 undergraduates, it was repeatedly found that: smokers pressed more than nonsmokers to remove static from a message disputing the link between smoking and lung cancer; smokers made fewer attempts than nonsmokers to clarify a message affirming a smoking-cancer link; persons having considerable recourse to prayer and church attendance pressed less to clarify a message attacking Christianity than persons weakly committed to religion. Novelty, utility, relevance, and other factors affecting information receptivity were empirically analysed. It was concluded that dissonance theory adequately handles selective attention but that prediction of selective exposure, receptivity to future nonsupportive messages, requires taking into account the amount of supportive information already assimilated.
Is it better to be realistic or optimistic? A realistic outlook improves chances to negotiate the environment successfully, whereas an optimistic outlook places priority on feeling good. But are realistic and optimistic outlooks necessarily in conflict? The author suggests that the fuzzy nature of accuracy typically places only loose boundaries on what it means to be realistic. As a result, there are many forms of optimism that do not, in principle, yield unrealistic assessments. Nevertheless, there remain numerous "optimistic biases" that do involve self-deception, or convincing oneself of desired beliefs without appropriate reality checks. The author describes several ways that realistic and unrealistic optimism can be differentiated and explores the impact of this distinction for current views of optimism. This critique reveals how positive psychology may benefit from a focus on personal meaning and knowledge as they relate to making the most of life.
"Readership of auto advertising by new and old car owners was investigated in order to test some predictions of Festinger's theory of dissonance concerning selective exposure to information following decisions. It was found that new car owners read advertisements of their own car more often than of cars they considered but did not buy and other cars not involved in the choice. These selective tendencies in readership were much less pronounced among old car owners. This finding supports the theoretical derivation that persons in general seek out consonant or supporting information after an important decision in an attempt to reduce dissonance resulting from it." (PsycINFO Database Record (c) 2012 APA, all rights reserved)
2 hypotheses about resistance to influence were tested: (a) warning Ss that they are going to be exposed to a communication with which they disagree will increase their resistance to influence; (b) distracting Ss from the content of such a communication will decrease resistance to influence. The results support the 1st hypothesis, but provide only minimal support for the 2nd. In addition the study provides data on the mechanisms by which forewarning increases resistance, and suggests than an active rehearsal of supporting arguments is the major process by which resistance is increased.
Microeconomic theory typically concerns
exchange between individuals or firms in a
market setting. To make predictions precise,
individuals are usually assumed to use the
laws of probability in structuring and revising
beliefs about uncertainties. Recent evidence,
mostly gathered by psychologists,
suggests probability theories might be inadequate
descriptive models of individual choice.
(See the books edited by Daniel Kahneman
et al., 1982a, and by Hal Arkes and Kenneth
Hammond, 1986.)
The research agendas of psychologists and economists now have several overlaps, with behavioural economics providing theoretical and experimental study of the relationship between behaviour and choice, and hedonic psychology discussing appropriate measures of outcomes of choice in terms of overall utility or life satisfaction. Here we model the relationship between values (understood as principles guiding behaviour), choices and their final outcomes in terms of life satisfaction, and use data from the BHPS to assess whether our ideas on what is important in life (individual values) are broadly connected to what we experience as important in our lives (life satisfaction).
Despite numerous attempts, the selective exposure prediction of Festinger's (A theory of cognitive dissonance. Evanston, Ill.: Row, Peterson, 1957) theory of cognitive dissonance has not been consistently demonstrated. In previous studies, this failure can be attributed to design deficiencies, and other related problems. The present study manipulated dissonance by having subjects write a counterattitudinal essay under conditions of high or low choice. Information in the form of pamphlets and discussion groups was offered to the subjects such that they could choose information that was consonant and dissonant with the decision to write the essay. The information was offered either before or after an attitude measure on the essay topic, as the attitude measure could also be a source of dissonance reduction. The results indicate that the high choice manipulation yielded greater attitude change than the low-choice manipulation. High-choice subjects desired consonant information more and dissonant information less than did low-choice subjects. This effect was found for both measures of information desire (pamphlets and discussion groups). Low-choice subjects who received the attitude questionnaire before the information measures wanted information more than if offered the information before the attitude questionnaire, implying a sensitizing effect produced by the attitude questionnaire for the low-choice subjects. The various effects are discussed as providing support for predictions from Festinger's dissonance theory.
In this article two experiments are reported in which the degree of seriousness of a "self-threat" was varied and both behavioral and cognitive consequences were tested. Subjects in both experiments received fictitious intelligence test results that were always negatively discrepant from their self-evaluations (self-threat), but varied in their degree of seriousness. The degree of seriousness was manipulated by telling subjects that their fictitious test results were either reliably or not reliably scored. Subjects were then given the opportunity to choose among several articles containing information that emphasized either the validity or invalidity of intelligence tests. In both experiments it was found that subjects in the serious self-threat conditions were more prone to search selectively for information disparaging intelligence tests and to rate being highly intelligent as less important compared with subjects in the less serious self-threat conditions. The implications of these results for self-esteem theory are discussed.
This study explores the implications of dissapointment, a psychological reaction caused by comparing the actual outcome of a lottery to one's prior expectations, for decision making under uncertainty. Explicit recognition that decision makers may be paying a premium to avoid potential disappointment provides an interpretation for some known behavioral paradoxes, and suggests that decision makers may be sensitive to the manner in which a lottery is resolved. The concept of disappointment is integrated into utility theory in a prescriptive model.
About 3,000 Israeli voters were asked to predict the outcomes of the 1992 general election and to state their political preference. Political science students were found to possess more accurate knowledge than education students about some outcomes of the previous (1988) election, but the predictions made by both groups varied as a function of their preferences, indicating a wishful thinking effect. Wishful thinking effects of the same magnitude were found for groups differing in the accuracy of their knowledge about the outcomes of the previous election and for respondents who had been provided with partial or full base-rate information about the outcomes of the previous election. Thus, accurate knowledge did not reduce the effects of wishful preferences on predictions. Respondents' predictions differed from the results of public opinion polls published at the same time in the Israeli printed media. The results were more compatible with a motivational than with a purely cognitive interpretation.
We ran two experiments to test whether people value objects more highly when they obtain those objects due to exemplary performance at a task. In the first, subjects who believed they had obtained a prize due to their performance on a classroom exercise valued it more highly than those who believed they had obtained it by chance. In the second, subjects who obtained a prize due to exemplary performance on a task valued it more highly than those who obtained it due to their poor performance. In both experiments, this ‘source dependence’ effect is approximately equal in strength to the endowment effect, which compares the valuation of subjects with and without the prize. We suggest a possible explanation for this source-dependence effect based on associationism, and rule out two alternative explanations.
The fear appeal literature is diverse and inconsistent. Existing fear appeal theories explain the positive linear results occurring in many studies, but are unable to explain the boomerang or curvilinear results occurring in other studies. The present work advances a theory integrating previous theoretical perspectives (i.e., Janis, 1967; Leventhal, 1970; Rogers, 1975, 1983) that is based on Leventhal's (1970) danger control/fear control framework. The proposed fear appeal theory, called the Extended Parallel Process Model (EPPM), expands on previous approaches in three ways: (a) by explaining why fear appeals fail; (b) by re‐incorporating fear as a central variable; and (c) by specifying the relationship between threat and efficacy in propositional forms. Specific propositions are given to guide future research.
Two essays taken from the concluding section of the Author's book. "Being and Nothingness." Is a presentation of a new psychoanalysis based on the principles of existentialism. Contains a criticism of traditional psychoanalytic schools. (PsycINFO Database Record (c) 2012 APA, all rights reserved)
adumbrates [a general framework for understanding the principles and mechanisms of motivated cognition within social psychological research] and uses it to discuss several major facets of the motivation-cognition interface / the present analysis incorporates 2 basic assumptions: (a) even though motivation and cognition may be usefully treated as separate systems, in another sense (b) they are inextricably intertwined in that nearly all motivation encompasses cognitive aspects and nearly all cognition encompasses motivational aspects / the separate characteristics of the motivational and cognitive systems are briefly considered (PsycINFO Database Record (c) 2012 APA, all rights reserved)
Wishful thinking (WT)—defined as predicting a more favorable outcome for a preferred team—was investigated in soccer stadia and betting stations in Israel. High levels of WT were found in all contexts investigated. As hypothesized, the intensity of WT varied between contexts as a function of the “legitimacy” of emotionalism and subjectivity, and within each context as a function of self-defined levels of fanhood and preference. An explicit instruction to be objective did not reduce WT in predicting game outcomes. Paid betting forms represented an ecologically valid voluntary behavior most contradictory of wishful thinking, since bettors are strongly motivated to be objective and impartial. The results showed that fans could not overcome their wishful thinking, betting emotionally and against their financial interest.
Decision makers have a strong tendency to consider problems as unique. They isolate the current choice from future opportunities and neglect the statistics of the past in evaluating current plans. Overly cautious attitudes to risk result from a failure to appreciate the effects of statistical aggregation in mitigating relative risk. Overly optimistic forecasts result from the adoption of an inside view of the problem, which anchors predictions on plans and scenarios. The conflicting biases are documented in psychological research. Possible implications for decision making in organizations are examined.
The well-known tendency of investors to favor cash dividends emerges quite naturally in two new theories of choice behavior [the theory of self-control due to Thaler and Shefrin (1981), and the version of prospect theory set out by Kahneman and Tversky (1979)]. Although our treatment is novel when viewed from the perspective of standard financial theory, it provides explanations for a phenomenon that has long been described as perplexing.
In psychological games the payoff to each player depends not only on what every player does but also on what he thinks every player believes, and on what he thinks they believe others believe, and so on. In equilibrium, beliefs are assumed to correspond to reality. Yet psychological games and psychological equilibria allow one to model belief-dependent emotions such as anger and surprise that are problematic for conventional game theory. We are particularly interested in issues of sequential rationality for psychological games. We show that although backward induction cannot be applied, and “perfect” psychological equilibria may not exist, subgame perfect and sequential equilibria always do exist.
Self-esteem has become a household word. Teachers, parents, therapists, and others have focused efforts on boosting self-esteem, on the assumption that high self-esteem will cause many positive outcomes and benefits—an assumption that is critically evaluated in this review.
Appraisal of the effects of self-esteem is complicated by several factors. Because many people with high self-esteem exaggerate their successes and good traits, we emphasize objective measures of outcomes. High self-esteem is also a heterogeneous category, encompassing people who frankly accept their good qualities along with narcissistic, defensive, and conceited individuals.
The modest correlations between self-esteem and school performance do not indicate that high self-esteem leads to good performance. Instead, high self-esteem is partly the result of good school performance. Efforts to boost the self-esteem of pupils have not been shown to improve academic performance and may sometimes be counterproductive. Job performance in adults is sometimes related to self-esteem, although the correlations vary widely, and the direction of causality has not been established. Occupational success may boost self-esteem rather than the reverse. Alternatively, self-esteem may be helpful only in some job contexts. Laboratory studies have generally failed to find that self-esteem causes good task performance, with the important exception that high self-esteem facilitates persistence after failure.
People high in self-esteem claim to be more likable and attractive, to have better relationships, and to make better impressions on others than people with low self-esteem, but objective measures disconfirm most of these beliefs. Narcissists are charming at first but tend to alienate others eventually. Self-esteem has not been shown to predict the quality or duration of relationships.
High self-esteem makes people more willing to speak up in groups and to criticize the group's approach. Leadership does not stem directly from self-esteem, but self-esteem may have indirect effects. Relative to people with low self-esteem, those with high self-esteem show stronger in-group favoritism, which may increase prejudice and discrimination.
Neither high nor low self-esteem is a direct cause of violence. Narcissism leads to increased aggression in retaliation for wounded pride. Low self-esteem may contribute to externalizing behavior and delinquency, although some studies have found that there are no effects or that the effect of self-esteem vanishes when other variables are controlled. The highest and lowest rates of cheating and bullying are found in different subcategories of high self-esteem.
Self-esteem has a strong relation to happiness. Although the research has not clearly established causation, we are persuaded that high self-esteem does lead to greater happiness. Low self-esteem is more likely than high to lead to depression under some circumstances. Some studies support the buffer hypothesis, which is that high self-esteem mitigates the effects of stress, but other studies come to the opposite conclusion, indicating that the negative effects of low self-esteem are mainly felt in good times. Still others find that high self-esteem leads to happier outcomes regardless of stress or other circumstances.
High self-esteem does not prevent children from smoking, drinking, taking drugs, or engaging in early sex. If anything, high self-esteem fosters experimentation, which may increase early sexual activity or drinking, but in general effects of self-esteem are negligible. One important exception is that high self-esteem reduces the chances of bulimia in females.
Overall, the benefits of high self-esteem fall into two categories: enhanced initiative and pleasant feelings. We have not found evidence that boosting self-esteem (by therapeutic interventions or school programs) causes benefits. Our findings do not support continued widespread efforts to boost self-esteem in the hope that it will by itself foster improved outcomes. In view of the heterogeneity of high self-esteem, indiscriminate praise might just as easily promote narcissism, with its less desirable consequences. Instead, we recommend using praise to boost self-esteem as a reward for socially desirable behavior and self-improvement.
This study explores the ways in which information about other individual's action affects one's own behavior in a dictator game. The experimental design discriminates behaviorally between three possible effects of recipient's within-game reputation on the dictator's decision: Reputation causing indirect reciprocity, social influence, and identification. The separation of motives is an important step in trying to understand how impulses towards selfish or generous behavior arise. The statistical analysis of experimental data reveals that the reputation effects have a stronger impact on dictators' actions than the social influence and identification.
People exaggerate the degree to which their future tastes will resemble their current tastes. We present evidence from a variety of domains which demonstrates the prevalence of such projection bias, develop a formal model of it, and use this model to demonstrate its importance in economic environments. We show that, when people exhibit habit formation, projection bias leads people to consume too much early in life, and to decide, as time passes, to consume more-and save less-than originally planned. Projection bias can also lead to misguided purchases of durable goods. We discuss a number of additional applications and implications. © 2001 the President and Fellows of Harvard College and the Massachusetts Institute of Technology
We extend expected utility theory to situations in which agents experience feelings of anticipation prior to the resolution
of uncertainty. We show how these anticipatory feelings may result in time inconsistency. We provide an example from portfolio
theory to illustrate the potential impact of anticipation on asset prices.
Does the period over which individuals evaluate outcomes influence their investment in risky assets? Results from this study
show that the more frequently returns are evaluated, the more risk averse investors will be. The results are in line with
the behavioral hypothesis of “myopic loss aversion,” which assumes that people are myopic in evaluating outcomes over time,
and are more sensitive to losses than to gains. The results have relevance for the equity premium puzzle, and also for the
marketing strategies of fund managers.
According to cognitive-experiential self-theory (CEST), individuals have 2 systems for processing information, a rational system and an experiential system. Research conducted under norm theory (NT) has provided impressive evidence of an if only (IO) effect associated with postoutcome processing of aversive events that are highly consistent with formulations in CEST. Two studies involving vignettes adapted from NT were conducted that tested 4 hypotheses and corollaries derived from CEST. It was demonstrated, in support of hypotheses, that the IO effect can be obtained with ratings of one's own and of a protagonist's specific behaviors, as well as with ratings of a protagonist's diffuse emotions (the usual procedure); that a rational orientation decreases the IO effect; that increasing the intensity of outcomes increases it; and that priming the experiential system reduces people's ability to subsequently think rationally. The theoretical and research implications of these findings are discussed.
People like to help those who are helping them and to hurt those who are hurting them. Outcomes rejecting such motivations are called fairness equilibria. Outcomes are mutual-max when each person maximizes the other's material payoffs, and mutual-min when each person minimizes the other's payoffs. It is shown that every mutual-max or mutual-min Nash equilibrium is a fairness equilibrium. If payoffs are small, fairness equilibria are roughly the set of mutual-max and mutual-min outcomes; if payoffs are large, fairness equilibria are roughly the set of Nash equilibria. Several economic examples are considered and possible welfare implications of fairness are explored. Copyright 1993 by American Economic Association.
This paper investigates the dynamic relation between market-wide trading activity and returns in 46 markets. Many stock markets exhibit a strong positive relation between turnover and past returns. These findings stand up in the face of various controls for volatility, alternative definitions for turnover, and differing sample periods, and are present at both the weekly and daily frequency. However, the magnitude of this relation varies widely across markets. Several competing explanations are examined by linking cross-country variables to the magnitude of the relation. The relation between returns and turnover is stronger in countries with restrictions on short sales and where stocks are highly cross-correlated; it is also stronger among individual investors than among foreign or institutional investors. In developed economies, turnover follows past returns more strongly in the 1980s than in the 1990s. The evidence is consistent with models of costly stock market participation in which investors infer that their participation is more advantageous following higher stock returns.
An axiomatic model of preferences over lotteries is developed. It is shown that this model is consistent with the Allais paradox, includes expected utility theory as a special case, and is only one parameter (" beta") richer than the expected utility model. Allais paradox type behavior is identified with positive values of "beta." Preferences with positive "beta" are said to be disappointment averse. It is shown that risk aversion implies disappointment aversion and that the Arrow-Pratt measures of risk aversion can be generalized in a straight-forward manner to the current framework. Copyright 1991 by The Econometric Society.
This paper presents a model of intertemporal choice that incorporates "savoring" and "dread"-i.e., utility from anticipat ion of delayed consumption. The model explains why an individual with positive time preference may delay desirable outcomes or get unpleas ant outcomes over with quickly, contrary to the prediction of convent ional formulations of intertemporal choice. Implications of savoring and dread for savings behavior, empirical estimation of discount rate s, and public policy efforts to combat myopic behavior are explored. The model provides an explanation for common violations of the indepe ndence axiom as applied to intertemporal choice. Copyright 1987 by Royal Economic Society.
The central proposition of disappointment theory is that an individual forms expectations about uncertain prospects, and that
if the actual consequence turns out to be worse than (or better than) that expectation, the individual experiences a sensation
of disappointment (or elation) generating a decrement (or increment) of utility which modifies the basic utility derived from
the consequence. By incorporating a simple disappointment-elation function into a model of individual choice, many observed
violations of conventional expected utility axioms—including violations of Savage's sure-thing principle and the “isolation
effect”—can be predicted and defended as rational and dynamically consistent behaviour.
This paper introduces a tractable, structural model of subjective beliefs. Since agents that plan for the future care about expected future utility flows, current felicity can be increased by believing that better outcomes are more likely. On the other hand, expectations that are biased towards optimism worsen decision making, leading to poorer realized outcomes on average. Optimal expectations balance these forces by maximizing the total well-being of an agent over time. We apply our framework of optimal expectations to three different economic settings. In a portfolio choice problem, agents overestimate the return of their investment and underdiversify. In general equilibrium, agents' prior beliefs are endogenously heterogeneous, leading to gambling. Second, in a consumption-saving problem with stochastic income, agents are both overconfident and overoptimistic, and consume more than implied by rational beliefs early in life. Third, in choosing when to undertake a single task with an uncertain cost, agents exhibit several features of procrastination, including regret, intertemporal preference reversal, and a greater readiness to accept commitment.
Psychological research indicates that people have a cognitive bias that leads them to misinterpret new information as supporting
previously held hypotheses. We show in a simple model that such confirmatory bias induces overconfidence: given any probabilistic assessment by an agent that one of two hypotheses is true, the appropriate
beliefs would deem it less likely to be true. Indeed, the hypothesis that the agent believes in may be more likely to be wrong than right. We also show that the agent may come to believe with near certainty in a false hypothesis despite receiving an
infinite amount of information.
We propose a new framework for pricing assets, derived in part from the traditional consumption-based approach, but which also incorporates two long-standing ideas in psychology: the prospect theory of Kahneman and Tversky #1979#, and the evidence of Thaler and Johnson #1990# and others on the in#uence of prior outcomes on risky choice. Consistent with prospect theory, the investor in our model derives utility not only from consumption levels but also from changes in the value of his #nancial wealth. He is much more sensitive to reductions in wealth than to increases, the #loss-aversion# feature of prospect utility. Moreover, consistent with experimental evidence, the utility he receives from gains and losses in wealth depends on his prior investment outcomes; prior gains cushion subsequent losses # the so-called #house-money# e#ect # while prior losses intensify the pain of subsequent shortfalls. We study asset prices in the presence of agents with preferences of this ...
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