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Behavioral heterogeneity in dynamic search situations: Theory and experimental evidence
Abstract
This paper presents models for search behavior and provides experimental evidence that behavioral heterogeneity in search is linked to heterogeneity in individual preferences. Observed search behavior is more consistent with a new model that assumes dynamic updating of utility reference points than with models that are based on expected-utility maximization. Specifically, reference point updating and loss aversion play a role for more than a third of the population. The findings are of practical relevance as well as of interest for researchers who incorporate behavioral heterogeneity into models of dynamic choice behavior in, for example, consumer economics, labor economics, finance, and decision theory.
... Our second goal was to investigate the stability and reliability of the measured cognitive parameters across contexts and to examine their relationship with behavioral measures. This is a critical question, as attempts to link suboptimal search behavior with psychological variables, such as risk preferences, have been unsuccessful (e.g., Frey et al., 2017;Schunk, 2009). Uncovering underlying cognitive processes that are consistent across search contexts would contribute to a comprehensive understanding of individual differences in optimal stopping tasks. ...
... Risk preferences. Some studies have suggested that people use biased decision thresholds and thus search too little because they tend to be risk averse (Bhatia et al., 2021;Schotter & Braunstein, 1981;Schunk, 2009). Unlike the risk-neutral best performing LTM, human decision makers are often found to be risk averse (e.g., Pedroni et al., 2017), preferring the safe over the risky option. ...
... However, there are conflicting findings regarding the impact of risk aversion on optimal stopping behavior. One study reported that there was no relationship between search length in an optimal stopping task and risk preferences elicited in a series of lottery tasks (Schunk, 2009). On the other side, a recent study about optimal sequential search with recall found evidence that in this paradigm, risk aversion is one of the main factors guiding people's behavior (Bhatia et al., 2021). ...
Sequential decision making-making a decision where available options are encountered successively-is a hallmark of everyday life. Such decisions require deciding to accept or reject an alternative without knowing potential future options. Prior work focused on understanding choice behavior by developing decision models that capture human choices in such tasks. We investigated people's adaptive behavior in changing environments in light of their cognitive strategies. We present two studies in which we modified (a) outcome variance and (b) the time horizon and provide empirical evidence that people adapt to both context manipulations. Furthermore, we apply a recently developed threshold model of optimal stopping to our data to disentangle different cognitive processes involved in optimal stopping behavior. The results from Study 1 show that participants adaptively scaled the values of the sampling distribution to its variance, suggesting that the value of an option is perceived in relative rather than absolute terms. The results from Study 2 suggest that increasing the time horizon decreases the initial acceptance level, but less strongly than would be optimal. Furthermore, for longer sequences, participants more weakly adjusted this acceptance threshold over time than for shorter sequences. Further correlations between individual estimates in each condition indicate that individual differences between the participants' thresholds remain fairly stable between the conditions, pointing toward an additive effect of our manipulations. (PsycInfo Database Record (c) 2022 APA, all rights reserved).
... Despite the results showing stable individual differences in cognitive parameters across structurally changing tasks, people are very heterogeneous with respect to their choice behavior. It has been suggested that this heterogeneity in dynamic choice situations is reflected in risk preference heterogeneity (Schotter et al., 1981;Schunk, 2009;Sonnemans, 1998Sonnemans, , 2000 whereas risk averse agents would stop earlier in the sequence. However, studies attempting to link individual risk preferences elicited in single gamble tasks with search behavior in sequential decision tasks have failed to show any relationship Pedroni et al., 2017;Schunk, 2009;Schunk et al., 2009). ...
... It has been suggested that this heterogeneity in dynamic choice situations is reflected in risk preference heterogeneity (Schotter et al., 1981;Schunk, 2009;Sonnemans, 1998Sonnemans, , 2000 whereas risk averse agents would stop earlier in the sequence. However, studies attempting to link individual risk preferences elicited in single gamble tasks with search behavior in sequential decision tasks have failed to show any relationship Pedroni et al., 2017;Schunk, 2009;Schunk et al., 2009). Moreover, the studies throughout this thesis have revealed a time dependence for the participants risk attitudes. ...
... An optimal stopping choice represents a risky decision between a certain outcome and the risk to continue search for a better one. However, studies attempting to link individual risk preferences elicited in single gamble tasks with search behavior in sequential decision tasks have failed to show any relationship Pedroni et al., 2017;Schunk, 2009;Schunk et al., 2009). Nevertheless, this work has found a relationship between risk preferences measured in the gamble task and search length in the optimal stopping task such that participants who were relatively more risk seeking in the single gambles searched more in the optimal stopping task. ...
... Reference points and the different perceptions of gains and losses play an important role in actual consumer economics [1]. In a commodity market, consumers' purchase decisions depend not only on their valuations for the current product but also on their reference valuations for the past observed product. ...
... Let ζ 1 and ζ 2 be two uncertain variables with the uncertainty distribution functions 1 (x) and 2 (x), respectively. We say that ζ 1 uncertainly dominates ζ 2 in the first order, denoted by ζ 1 ζ 2 , if and only if 1 ...
... Because the three products are differentiated but substitutable, the consumer only knows different uncertainty distributions about the three products. Without loss of generality, suppose the consumer's valuations for the three products are linear uncertain variables L (1,9), Z (1,4,9), and Z (1,7,9), respectively. Let β = 0.9, p = 0.7, c 1 = 0.5, c 2 = 1, and c 3 = 1.5. ...
This paper studies a consumer search model with prospect utility in a hybrid uncertain environment. Hybrid uncertainty consists of the uncertainty of the consumer’s valuation for each product and the randomness of stockout. An optimal search strategy is designed for the consumer to search or buy a product. The results show that the presence of prospect utility can result in low purchase threshold. By comparative statics, we demonstrate that the consumer’s purchase threshold for low-value product increases with the risk coefficients for gains and losses, while the purchase threshold for high-value product decreases with the risk coefficients for gains and losses. In addition, we find that the consumer who is more sensitive to the loss will search for much less products. Finally, some numerical examples are given to illustrate the relationships between the model without and with prospect utility and further verify the effectiveness and credibility of the conclusions.
... This, in turn, empowers them to be committed to learning. Scholars have concluded that learners can use goal setting as an effective inspiring tool, which contributes to positive attributes, including intrinsic motivation, positive self-image, and academic performance (e.g., Latham and Locke, 2006;Schunk, 2009). ...
... Setting a goal based on a choice is a requirement for the occurrence of action and, goals must be sought with effort and seriousness. Therefore, setting the appropriate goal as well as the provision of timely and specific feedback can bring higher achievement, successful performance, a high degree of self-efficacy, and self-regulation (Schunk, 2009). This paper seeks to provide insights into how goals and goal-oriented efforts play a role in successful L2 learning. ...
A growing interest can be seen in the studies on the motivation related to second/foreign learning in recent decades. All in all, research verdicts designate that academic motivation plays a key function in the extent to which students are successful in their research. One of the dimensions of academic motivation is goal orientation, which accounts for why learners carry out achievement activities. This type of goal is indicative of the importance one attaches to success concerning a performance standard. Furthermore, goal setting is deemed as a significant cognitive interface that connects motivation to motivational behavior. Indeed, goal setting is an inseparable part of L2 learning that has caught the attention of many researchers. It functions as a booster of motivation and success in various fields. Goals render the activities purposeful, providing individuals with directions. Moreover, goal drives them to invest more resources and effort, pushing them to persevere in learning. The new versions of motivational theories emphasize social-cognitive components underlying motivated behavior. Therefore, they are more inclusive than traditional ones. Achievement goal theory (AGT) has been developed as a motivation-related theory in recent decades. This theory serves as an effective framework to account for motivation associated with social achievement and learning environments. It also deals with the outcomes concerning cognitive and behavioral aspects. Another theory related to motivation is the Goal setting theory, which functions as a cognitive mediator between motivation and second/foreign learning behavior. It also impacts the students’ application of strategies. Drawing on the recent conceptual developments, this review seeks to make a contribution to the related literature on theories of achievement goals, i.e., AGT and goal setting associated with the L2 context. Such a review has pedagogical implications for EFL stakeholders.
... The current study suggests that social comparison effects offer an additional (and overlooked) explanation for the empirical phenomenon that search outcomes are correlated within social networks. 1982, 1987, Oaxaca & Cox 1989 and more recent work has focused on behavioral explanations for deviations from theoretical predictions (Kogut 1990, Sonnemans 1998, Schunk 2009, Schunk & Winter 2009, Brown et al. 2011. A feature of all of this literature is that the search decisions are made in isolation. ...
... Some behavioral theories have been proposed as explanations for these findings and have been tested in the laboratory. Studies suggest that the sunk-cost fallacy (Kogut 1990, Sonnemans 1998, loss and risk aversion preferences combined with bounded rationality (Schunk 2009, Schunk & Winter 2009, Soetevent & Bruzikas 2016 and subjective costs of uncertain waiting time (Brown et al. 2011) all contribute to these regular departures from the theoretical predictions. ...
Using a laboratory experiment we examine how social comparisons affect behavior in a sequential search task. In a control treatment subjects search in isolation, while in two other treatments subjects get feedback on the search decisions and outcomes of a partner subject. The average level and rate of decline of reservation wages are similar across treatments. Nevertheless, subjects who are able to make social comparisons search differently from those who search in isolation. Within a search task we observe a reference wage effect: when a partner exits, the subject chooses a new reservation wage which is increasing in partner income. We also observe a social comparison effect between search tasks: subjects whose partners in a previous task searched for longer choose a higher reservation wage in the next task. Our findings imply that the provision of social information can change job-seekers search behavior.
... This result is also consistent with insights from the literature on optimal stopping. There a common finding is that, relative to the normative benchmark, people stop searching too early and seem to focus on total earnings instead of on the marginal return of another search, similar to a reverse sunk cost effect ( Sonnemans, 1998;Kogut, 1990 ). Subsequent work found that heterogeneity in stopping behavior is related to loss aversion, but not risk aversion (e.g., Schunk, 2009 ). Yet, also this loss aversion based explanation of our findings is difficult to reconcile with the fact that we observe frequent additional investments for the low success probability. ...
We experimentally investigate the effect of sunk cost in a two-stage investment continuation task. After an initial investment, participants have to decide whether or not to continue the project with an additional investment. We do not find a standard sunk cost bias, but observe a robust reverse sunk cost effect: the larger the initial investment, the lower the likelihood to continue investing. This holds despite the fact that we replicate the standard sunk cost bias in hypothetical scenarios. We argue that both, risk aversion without asset integration and loss aversion can account for the reverse sunk cost effect.
... Yet, both misaligned incentives and high cross-module interdependence are likely to provide challenges to the smoothing of coordination. Moreover, we can expect agents to eventually abandon active search as soon as a mutually satisfactory solution is found (Simon, 1955;MacLeod and Pingle, 2005;Schunk, 2009). In the following, we thus develop hypotheses that investigate whether such satisficing occurs and where dyads search during their collaborative search effort. ...
We investigate the search processes that dyads engage in when each human agent is responsible for one module of a complex task. Our laboratory experiment manipulates global vs. local incentives and low vs. high cross-modular interdependence. We find that dyads endogenously learn to coordinate their joint search efforts by engaging in parallel and sequential searches that, over time, give rise to coordinated repeated actions. Such collaborative search emerges despite complexity and misaligned incentives, and without a coordinating hierarchy.
... Consistent with previous work on sequential search, we have found substantial heterogeneity in people's search behaviors (Hey, 1987;Cox & Oaxaca, 1989;Schunk, 2009). One of the strengths of our approach is that we can directly compare the best-fit parameters of our models for different individuals or groups of individuals, rather than merely comparing people's average search length or how consistent they are with the optimal rule. ...
Many everyday decisions require sequential search, according to which available choice options are observed one at a time, with each observation involving some cost to the decision maker. In these tasks, decision makers need to trade-off the chances of finding better options with the cost of search. Optimal strategies in such tasks involve threshold decision rules, which terminate the search as soon as an option exceeding a reward value is found. Threshold rules can be seen as special cases of well-known algorithmic decision processes, such as the satisficing heuristic. Prior work has found that decision makers do use threshold rules, however the stopping thresholds observed in data are typically smaller than the (expected value maximizing) optimal threshold. We put forward an array of cognitive models and use parametric model fits on participant-level search data to examine why decision makers adopt seemingly suboptimal thresholds. We find that people's behavior is consistent with optimal search if we allow participants to display risk aversion, psychological effort cost, and decision error. Thus, decision makers appear to be able to search in a resource-rational manner that maximizes stochastic risk averse utility. Our findings shed light on the psychological factors that guide sequential decision making, and show how threshold models can be used to describe both computational and algorithmic aspects of search behavior.
... 3 | SHOULD I STAY OR SHOULD I SEARCH? Simon (1955) observed that a decision maker stops searching for new alternatives when a satisficing alternative is found (Bearden & Connolly, 2007;MacLeod & Pingle, 2005;Schunk, 2009). The critical question then is how does a decision maker form expectations about what is a satisfactory outcome? ...
Exploration and exploitation in strategic decisionmaking
entails decisions about whether and where to
search for new alternatives to improve the status quo.
Prior research has not explored how decisions about
whether to continue search (vs. stop search or satisfice)
and where to search (near vs. far) are interrelated. We
report laboratory experiment results on how individuals
decide whether and where to search in a complex, combinatorial
task. We find that different feedback variables
influence the decision to stop search from
decisions regarding how broadly to search. Our results
suggest that not accounting for the decision to continue
(or stop) searching, separately from breadth of search,
can lead to incorrect predictions regarding how feedback
influences search behavior.
... In this article, we therefore wish to argue for models of problemistic search that are based on search heterogeneity that incorporates simultaneous local and distant search (Schunk, 2009). Furthermore, we argue that the composition of search heterogeneity will change towards greater frequency of distant search when the individuals that make up the organization, and identify themselves as responsible for organizational performance, are exposed to a stimulus that suggests a greater performance shortfall. ...
Research suggests that effective R&D requires the right combination of inward‐looking and outward‐looking absorptive capacity routines. However, we do not have an adequate understanding of how these routines influence innovative output in R&D units with different mandates. In this paper, we argue that adopting an absorptive capacity routine would positively or negatively influence the R&D subsidiary’s innovative output, depending on whether the routine is aligned or misaligned with the subsidiary’s innovation mandate to ‘exploit’ existing knowledge or ‘explore’ new knowledge. We test this using data collected from a global packaged‐software firm with 14 international R&D subsidiaries that implemented six major absorptive capacity routines in the period 2000–2010. Our research provides new insights for both scholars and practitioners in R&D management, by showing that balancing of absorptive capacity routines should be considered in light of innovation mandates of subsidiaries as well as the firm. Our analysis also provides insights on why decision makers may still adopt misaligned routines.
... In this article, we therefore wish to argue for models of problemistic search that are based on search heterogeneity that incorporates simultaneous local and distant search (Schunk, 2009). Furthermore, we argue that the composition of search heterogeneity will change towards greater frequency of distant search when the individuals that make up the organization, and identify themselves as responsible for organizational performance, are exposed to a stimulus that suggests a greater performance shortfall. ...
In this paper, we argue for an expanded view of problemistic search. Recent behavioral theory research suggests that individual search preferences influence problemistic search. We draw on this to challenge the view of problemistic search as a centrally directed organizational process that proceeds sequentially from local to distant search. We argue that search activities in organizations are heterogeneous-some individuals will first engage in local search while others may move directly to distant search. We propose that problemistic search at the macro-organizational level is therefore the result of a mix of local and distant search activities at the micro-level that shifts towards distant search in response to negative performance evaluation. We test this idea in a laboratory experiment using a repetitive task and performance feedback.
... However, subjects behaving in a manner that is consistent with a model which subjects set utility reference points evaluated the next step of the search process as a mixed lottery. Schunk (2009) found considerable heterogeneity of search rules and predominance of early stopping in the population (Cox and Oaxaca (1989); Hey (1987); Sonnemans (1998)). This heterogeneity can be linked to heterogeneity in individual preferences, specially loss aversion, whereas risk aversion is not related to search behavior. ...
The objective of this thesis is to present four essays in behavioral and experimental economics on decision-making under risk and ambiguity. The first essay presents a synthesis and a point of view on the representativeness of experimental results regarding individual preferences: social preferences and risk and time preferences, in developed countries as well as in developing countries. The second essay explores experimentally the effect of risk and ambiguity on job search behavior in an infinite horizon. The results show that in risk and ambiguity, reservation wages are lower than the theoretical values and decrease during the search process. Similarly, subjects behave as ambiguity neutral agents. The third and fourth essay examine the effect of the social context and the correlation of payments on attitudes towards risk and ambiguity respectively in gain, loss and mixed domain. The results show that the introduction of the social context has a significant effect on attitudes towards risk in all three domains. Nevertheless, the correlation of risks has an effect on risk attitudes only in the mixed domain. As for ambiguity, ambiguity attitudes vary across domains. The correlation of payments decreases ambiguity aversion.
... In this article, we therefore wish to argue for models of problemistic search that are based on search heterogeneity that incorporates simultaneous local and distant search (Schunk, 2009). Furthermore, we argue that the composition of search heterogeneity will change towards greater frequency of distant search when the individuals that make up the organization, and identify themselves as responsible for organizational performance, are exposed to a stimulus that suggests a greater performance shortfall. ...
... Existing work in economics and psychology does not provide a good answer to the question of how individuals approach combinatorial tasks. The behavioral economics literature has traditionally concentrated on problems of sequential sampling, with a stream of alternatives exogenously given (Hey 1987, Schunk 2009). Much of the management literature, in contrast, assumes that economic agents play an active role in the generation of alternatives. ...
Organizational culture is widely recognized as a significant factor influencing organizational success. A simulation was developed for a high-tech client to direct change in their culture. Simulation content was captured in ethnographic interviews with employees and included cultural ideals. Significant employee attitude change was measured. Teaching students about organizational culture is difficult because much cultural knowledge is tacit. This simulation is now used in an MBA Leadership class and offers valuable experience. The client had a high- commitment culture that contributed to success and contains constructs and practices that other organizations may wish to adopt.
... Existing work in economics and psychology does not provide a good answer to the question of how individuals approach combinatorial tasks. The behavioral economics literature has traditionally concentrated on problems of sequential sampling, with a stream of alternatives exogenously given (Hey 1987, Schunk 2009). Much of the management literature, in contrast, assumes that economic agents play an active role in the generation of alternatives. ...
This paper presents findings from a laboratory experiment on human decision-making in a complex combinatorial task. We draw on the canonical NK model to depict tasks with varying complexity and find strong evidence for a behavioral model of adaptive search. Success narrows down search to the neighborhood of the status quo, while failure promotes gradually more explorative search. Task complexity does not have a direct effect on behavior, but systematically affects the feedback conditions that guide success-induced exploitation and failure-induced exploration. The analysis also shows that human participants were prone to over-exploration, since they broke off the search for local improvements too early. We derive stylized decision rules that generate the search behavior observed in the experiment and discuss the implications of our findings for individual decision-making and organizational search.
... There is another direction that addresses the relationship between search behavior and heterogeneous preferences. Schunk (2009) …nds that the search model with loss aversion, rather than with risk aversion, is more suitable for the search behavior of a subject in the laboratory. One of the recent topics in this …eld is to explore why subjects stop searching earlier than the theoretically optimal level ( Schunk and Winter, 2009). ...
This paper's objective is to design a laboratory experiment to explore the effect of Knightian uncertainty on a subject's search behavior in a finite sequential search model. Our finding is that the average search duration is shorter when there is Knightian uncertainty in the sense that the true point distribution is unknown to subjects, compared to when the point distribution is known. We also find direct evidence that subjects reduce their own reservation point when there is ambiguity about the point distribution. These results support the implication of Nishimura and Ozaki (2004). Moreover, ambiguity notably affects the search behavior of risk averse subjects, but not of either risk neutral or risk prone subjects.
... Gabaix, Laibson, Moloche, and Weinberg (2006) explore the ability of a specific model of limited rationality --directed cognition—to account for laboratory evidence in search problems, finding that the directed cognition model better matches the lab evidence whenever its predictions diverge from full rationality. Schunk (2009) considers instead the ability of reference point updating (in a model where subjects are assumed to care about the total net earnings –including those that are sunk--from the search) and lossaversion to explain behavior in a laboratory search problem. As in many previous studies, on average Schunk's subjects end their search too soon; he argues that a model in which a subset of agents use suboptimal strategies that depend in part on sunk costs accounts well for this phenomenon. ...
This paper surveys the contributions of laboratory experiments to labor economics. We begin with a discussion of methodological issues: why (and when) is a lab experiment the best approach; how do laboratory experiments compare to field experiments; and what are the main design issues? We then summarize the substantive contributions of laboratory experiments to our understanding of principal-agent interactions, social preferences, union-firm bargaining, arbitration, gender differentials, discrimination, job search, and labor markets more generally.
We study experimentally whether receiving advice from an experienced decision-maker improves decisions in an infinite-horizon search task where individuals typically choose a lower reservation wage than the optimal value. In the experiment, advisors complete 10 rounds of search and leave advice to their advisees who also complete 10 rounds of search after seeing the advice. We find that advisors tend to recommend a smaller reservation wage than their own lower than optimal choices. They formulate recommendation based on their reservation wage choice in the period when they accepted an offer, which is typically their lowest reservation wage choice over the search spell. Advisees follow this recommendation and choose a reservation wage that is further away from the optimal value leading to significant treatment differences between the advisors and advisees. Eliciting advice specifically for the starting period of the search round does not result in such negative effect of advice. Overall, we find that receiving advice does not facilitate the optimal choice in the search task.
Employees in organizations are frequently subject to performance goals such as sales or publication targets. However, often employees do not know what actions will allow them to meet these goals. To perform such tasks effectively, employees need to explore to quickly learn from experience which among the available alternatives offers the higher reward potential, so that they can concentrate subsequent efforts on exploiting it. Prior work models such explore-exploit problems as an adaptive learning process, where employees sequentially sample various options and learn from feedback. However, we currently do not know how performance goals influence this adaptive learning process. We argue that performance goals influence the adaptive learning process by modifying how feedback is perceived. Individuals subject to challenging goals are more likely to interpret feedback from poor alternatives as failures. Therefore, they quickly develop high belief strength that the inferior alternative is worse than the superior alternative, enabling them to reduce “useless exploration,” but also making them slow to adapt to environmental shocks. We test our predictions in a series of laboratory experiments and find that decision makers subject to challenging goals exploit more (relative to those with moderate goals). We also show that such an exploitation focus, while beneficial in stable environments, is detrimental in unstable ones. Our finding that challenging performance goals improve performance in learning tasks stands in contrast to prior findings that such goals inhibit performance in search tasks, an insight that warrants further study to improve our understanding of goal setting in the knowledge economy.
Funding: K. Srikanth was supported by SMU Seed Funding Grant for the initial version of this paper.
Supplemental Material: The e-companion is available at https://doi.org/10.1287/orsc.2019.13311 .
Search and switching costs are two market frictions that are well known in the literature for preventing people from switching to a new and cheaper provider. Previous experimental literature has studied these two frictions in isolation. However, field evidence shows that these two frictions frequently occur together. Recently, a theoretical framework has been developed (Wilson in Eur Econ Rev 56(6):1070–1086) which studies the interplay between these two costs. We report on an experiment testing this theory to see if individual behaviour with search and switching costs is in line with the theoretical predictions derived from the optimal choice rule of Wilson. The results show the crucial role of the search strategy: not only, according to Wilson model, the search cost has a greater deterrent impact on search than the switching costs, but also the sub-optimality of the search strategy is the major source of sub-optimality in the switching behaviour.
We propose a committee extension of the individual sequential search model called the “secretary problem,” where collective decisions on when to stop the search are reached via a prespecified voting rule. We offer a game-theoretic analysis of our model and then report two experiments on three-person committees with either uncorrelated or perfectly correlated preferences under three different voting rules followed by a third experiment on single decision makers. Relative to equilibrium predictions, committees with uncorrelated preferences oversearched under minority and majority voting rules but, otherwise, undersearched or approximated equilibrium play. Individually, committee members were often less strategic when their preferences were uncorrelated than when they were perfectly correlated. Collectively, committees’ decisions were more strategic than single decision makers’ only under the unanimity rule, although still not significantly better in terms of the decision makers’ welfare. Finally, across our experiments that involved committee search, the unanimity rule always optimized committee welfare.
This paper was accepted by Yan Chen, behavioral economics.
This paper reconsiders the wide agreement that females are more risk averse than males. We survey the existing experimental literature, finding that significance and magnitude of gender differences are task specific. We gather data from 54 replications of the Holt and Laury risk elicitation method, involving about 7,000 subjects. Gender differences appear in less than 10% of the studies and are significant but negligible in magnitude once all the data are pooled. Results are confirmed by structural estimations, which also support a constant relative risk aversion representation of preferences. Gender differences correlate with the presence of a safe option and fixed probabilities in the elicitation method.
The objective of this chapter is to design a laboratory experiment for an infinite-horizon sequential committee search model in order to test some of the implications obtained by the model in Albrech et al. (J Econ Theory 145:1386–1407, 2010) (AAV). We find that, compared with single-agent search, the search duration is longer for committee search under the unanimity rule, but is shorter for committee search in which at least one vote is required to stop searching. In addition, according to estimates from round-based search decisions, subjects are more likely to vote to stop searching in committee search than in single-agent search. This confirms that agents are less picky in committee search. Overall, the experimental outcomes are consistent with the implications suggested by the AAV model. However, despite the prediction from the AAV model, we could not obtain a significant outcome in relation to the size order of the probabilities of voting to stop searching in committee search for the various plurality voting rules.
This textbook is a first major introduction to behavioral economics, designed primarily for advanced undergraduate students. Unquestionably the hottest new field to have emerged in the social sciences over the past decade, behavioral considerations are now making themselves felt across academia and beyond and books such as Richard Thaler and Cass Sunstein's Nudge have become blueprints for a new way of thinking. This text will introduce all the key concepts to a student audience.
The objective of this study is to design a laboratory experiment to explore the effect of ambiguity on a subject’s search behavior in a finite-horizon sequential search model. In so doing, we employ a strategy to observe the potential trend of reservation points that is usually unobserved. We observe that subjects behaving consistently across treatments reduce their reservation points in the face of ambiguity over point distribution. Our result is consistent with the theoretical implication obtained by Nishimura and Ozaki (J Econ Theory 119:299-333, 2004).
This paper reconsiders the wide agreement that females are more risk averse than males. We survey the existing experimental literature, finding that significance and magnitude of gender differences are task specific. We gather data from 54 replications of the Holt and Laury risk elicitation method, involving about 7,000 subjects. Gender differences appear in less than 10% of the studies and are significant but negligible in magnitude once all the data are pooled. Results are confirmed by structural estimations, which also support a constant relative risk aversion representation of preferences. Gender differences correlate with the presence of a safe option and fixed probabilities in the elicitation method.
This paper was accepted by John List, behavioral economics.
In many sequential search situations, decisions are reached by groups. We examine behavior in such situations experimentally using an extension of the “secretary problem”. In our setup, group members (players) with non-aligned preferences inspect alternatives or “applicants” one at a time with no backward solicitation. A minimal information structure is assumed where players are only informed of the relative ranks of the alternatives as they inspect them sequentially. We present the equilibrium solution, and then use it as a benchmark for our analysis. We report the results from a controlled experiment showing that subjects over-searched relative to equilibrium. Decisions were affected by theoretically irrelevant observations including the relative rank of the previous alternative and the other player’s relative rank of the current alternative. For managers engaged in committee sequential search tasks, our findings highlight the importance of being aware to reach compromises early on, among other implications.
The objective of this paper is to design a laboratory experiment for an infinite-horizon sequential committee search model in order to test some of the implications obtained by the model in Albrecht, Anderson, and Vroman (2010) (AAV). We find that, compared with single-agent search, the search duration is longer for committee search under the unanimity rule, but is shorter for committee search in which at least one vote is required to stop searching. In addition, according to estimates from round-based search decisions, subjects are more likely to vote to stop searching in committee search than in single-agent search. This confirms that agents are less picky in committee search. Overall, the experimental outcomes are consistent with the implications suggested by the AAV model. However, despite the prediction from the AAV model, we could not obtain a significant outcome in relation to the size order of the probabilities of voting to stop searching in committee search for the various plurality voting rules.
In the classic Secretary Problem it has been established that people tend to search somewhat less than is optimal, and a number of explanations have been suggested. Here we propose a new explanation, the Similar-But-Incorrect Intuitions Hypothesis, which says that suboptimal search behavior is to be expected because optimal strategies vary disproportionately with subtle details of the search problem setup, whereas people seem to entertain general intuitions about optimal search. We find support for this hypothesis in experiments on a new search problem, the Explore-and-Collect Problem, where the player collects utility from an option every time it is tried and options can be recalled. Although the optimal search effort in this problem is much smaller than for the Secretary Problem, people tend to search only marginally less. This is not predicted by previous explanations for suboptimal search.
The amount of information produced by and available to every member of today’s society grows at a stunning pace. Driven by
the importance of an efficient information distribution, a large field of heterogeneous research streams has developed in
the course of the last four decades in various scientific domains. Major and important contributions have been created with
respect to the behavior of organizations, groups and individuals towards the acquisition and processing of information. Furthermore,
the outcome effects of these activities such as decision-making and sense-making have been investigated. This article focuses
on literature dealing with the exploration and explanation of specific behavioral patterns occurring when individuals interact
with information in computer-mediated contexts.
We study behavior in a search experiment where sellers receive randomized bids from a computer. At any time, sellers can accept the highest standing bid or ask for another bid at positive costs. We find that sellers stop searching earlier than theoretically optimal. Inducing a mild form of time pressure strengthens this finding in the early periods. We find no significant differences in search behavior between individuals and groups of two participants. However, there are marked gender differences. Men search significantly shorter than women, and teams of two women search much longer and recall more frequently than groups with at least one man.
Experimental studies of search behavior suggest that individuals stop searching earlier than the optimal, risk-neutral stopping rule predicts. Two different classes of
decision rules could generate this behavior: rules that are optimal conditional on utility functions departing from risk neutrality, or heuristics derived from limited cognitive processing capacities and satisficing. To discriminate between these possibilities, we conduct an experiment that consists of a search task as well as a lottery task designed to elicit utility functions. We find that search heuristics are not related to measures of risk aversion, but to measures of loss aversion.
This paper surveys learning-to-forecast experiments (LtFEs) with human subjects to test theories of expectations and learning. Subjects must repeatedly forecast a market price, whose realization is an aggregation of individual expectations. Emphasis is given to how individual forecasting rules interact at the micro-level and which structure they cocreate at the aggregate, macro-level. In particular, we focus on the question wether the evidence from laboratory experiments is consistent with heterogeneous expectations.
We investigate expectation formation in a controlled experimental environment. Subjects are asked to predict the price in a standard asset pricing model. They do not have knowledge of the underlying market equilibrium equations, but they know all past realized prices and their own predictions. Aggregate demand for the risky asset depends upon the forecasts of the participants. The realized price is then obtained from market equilibrium with feedback from six individual expectations. Realized prices differ significantly from fundamental values and typically exhibit oscillations around, or slow convergence to, this fundamental. In all groups participants coordinate on a common prediction strategy. Copyright 2005, Oxford University Press.
We study sequential search behavior in a generalized "secretary problem" in which a single object is to be selected from a set ofnalternatives. Alternatives are inspected in a random order, one at a time, and only the rank order of the current alternative relative to the ones that have already been observed can be ascertained. At each period, the consumer may either accept the current alternative, continue to search and pay a fixed cost, or recall an alternative that has already been inspected. A recalled alternative is assumed to be available with a known probability. The consumer's goal is to select the overall best alternative from the fixed set.
We describe the results of an experiment designed to test the optimal model and compare it to a behavioral decision model that incorporates local patterns of the observed sequence. Both set size and search cost are manipulated experimentally in a 2x2 factorial design. Our results show that cost and set size affect the amount of search in the predicted direction. However, in the two no-cost conditions subjects search too little in comparison to the optimal model, whereas in the two cost conditions they search too much. The behavioral decision rule that we propose provides a possible account for the observed pattern of the behavioral regularities.
Based on measurements among 332 owner-managers, we investigate how the global shape of the utility function (i.e., S-shaped versus concave or convex over the total range of outcomes) relates to choice behavior. We find that the global shape of the utility function differs across decision makers (about one-third of the owner-managers exhibit an S-shaped utility function) and that the global shape is linked to organizational behavior (i.e., the production system employed), a result that does not change when using different methods to identify the decision maker's global shape of the utility function. The decision maker's risk attitude (risk averse or risk seeking) does not affect the choice of the production system. Whereas the degree of risk aversion, based on the local shape of the utility function, may be important in explaining owner-managers' trading behavior (Pennings and Smidts 2000), more structural organizational behavior appears to be linked to the global shape of the utility function
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.
Although the concept of reference point dependent preferences has been adopted to almost all fields of behavioral economics, especially marketing and behavioral finance, we still know very little about how decision makers form their reference points given a sequence of prices. Our paper provides both a theoretical framework on reference point formation over time, based on cumulative prospect theory’s s-shaped weighting function, and a new experimental method for eliciting subjects’ individual reference points in a finance context. Consistent with our model, we document our subjects’ reference points to be best described by the first and the last price of the time series, with the equally weighted average and the highest price receiving smaller weights.. Results, however, vary strongly on the individual level and are also affected by the elicitation question applied.
This paper experimentally investigates a preference condition for loss aversion in the framework of cumulative prospect theory (CPT). We propose the concepts of absolute and relative loss premiums in order to measure the extent of loss aversion and to derive notions of increasing, constant, and decreasing loss aversion. While in only one of the 28 choice situations analyzed loss neutrality and loss seeking can be rejected, about 51 percent of all choices are loss averse and, due to the large extent of loss aversion revealed by these choices, the average loss premium is positive for most choice situations. Female subjects exhibit both a more frequent occurrence and a larger extent of loss aversion. Copyright 2002 by Kluwer Academic Publishers
In this article we explain the essential role of controlled experiments in testing job-search models. We derive the testable implications of a finite-horizon job-search model and lay out the design of the controlled experiments that we use to test those implications. We present the results of several parametric and nonparametric tests, all conditional on the actual draws of the wage offers. Overall, we find close agreement between the predictions of the search model and observations of search duration and income for several experimental treatments. Copyright 1989 by Kluwer Academic Publishers
This paper estimates the risk preferences of cotton farmers in Southern Peru, using the results from a multiple-price-list lottery game. Assuming that preferences conform to two of the leading models of decision under risk--Expected Utility Theory (EUT) and Cumulative Prospect Theory (CPT)--we find strong evidence of moderate risk aversion. Once we include individual characteristics in the estimation of risk parameters, we observe that farmers use subjective nonlinear probability weighting, a behavior consistent with CPT. Interestingly, when we allow for preference heterogeneity via the estimation of mixture models--where the proportion of subjects who behave according to EUT or to CPT is endogenously determined--we find that the majority of farmers' choices are best explained by CPT. We further hypothesize that the multiple switching behavior observed in our sample can be explained by nonlinear probability weighting made in a context of large random calculation mistakes; the evidence found on this regard is mixed. Finally, we find that attaining higher education is the single most important individual characteristic correlated with risk preferences, a result that suggests a connection between cognitive abilities and behavior towards risk.
A menu of paired lottery choices is structured so that the crossover point to the high-risk lottery can be used to infer the degree of risk aversion. With normal laboratory payoffs of several dollars, most subjects are risk averse and few are risk loving. Scaling up all payoffs by factors of twenty, fifty, and ninety makes little difference when the high payoffs are hypothetical. In contrast, subjects become sharply more risk averse when the high payoffs are actually paid in cash. A hybrid "power/expo" utility function with increasing relative and decreasing absolute risk aversion nicely replicates the data patterns over this range of payoffs from several dollars to several hundred dollars.
This paper concerns utility functions for money. A measure of risk aversion in the small, the risk premium or insurance premium for an arbitrary risk, and a natural concept of decreasing risk aversion are discussed and related to one another. Risks are also considered as a proportion of total assets.
Introduction, 99. — I. Some general features of rational choice, 100.— II. The essential simplifications, 103. — III. Existence
and uniqueness of solutions, 111. — IV. Further comments on dynamics, 113. — V. Conclusion, 114. — Appendix, 115.
Within the expected-utility framework, the only explanation for risk aversion is that the utility function for wealth is concave: A person has lower marginal utility for additional wealth when she is wealthy than when she is poor. This paper provides a theorem showing that expected-utility theory is an utterly implausible explanation for appreciable risk aversion over modest stakes: Within expected-utility theory, for any concave utility function, even very little risk aversion over modest stakes implies an absurd degree of risk aversion over large stakes. Illustrative calibrations are provided. Keywords: Diminishing Marginal Utility, Expected Utility, Risk Aversion JEL Classifications: B49, D11, D81 Acknowledgments: Many people, including David Bowman, Colin Camerer, Eddie Dekel, Larry Epstein, Erik Eyster, Mitch Polinsky, Drazen Prelec, Richard Thaler, and Roberto Weber, as well as Andy Postlewaite and two anonymous referees, have provided useful feedback on this paper. I th...
The endowment effect describes the fact that people demand much more to give up an object than they are willing to spend to acquire it. The existence of this effect has been documented in numerous experiments. We attempt to explain this effect by showing that evolution favors individuals whose preferences embody an endowment effect. The reason is that an endowment effect improves one's bargaining position in bilateral trades. We show that for a general class of evolutionary processes strictly positive endowment effects will survive in the long run.
This paper proposes a two-step method to successively elicit utility functions and decision weights under rank-dependent expected utility theory and its "more descriptive" version: cumulative prospect theory. The novelty of the method is that it is parameter-free, and thus elicits the whole individual preference functional without imposing any prior restriction. This method is used in an experimental study to elicit individual utility and probability weighting functions for monetary outcomes in the gain and loss domains. Concave utility functions are obtained for gains and convex utility functions for losses. The elicited weighting functions satisfy upper and lower subadditivity and are consistent with previous parametric estimations. The data also show that the probability weighting function for losses is more "elevated" than for gains.
Two major approaches to measuring risk attitude are compared. One, based on the expected utility model is derived from responses to lotteries and direct scaling. The other measure is a psychometric approach based on Likert statements that produces a unidimensional risk attitude scale. The data are from computer-assisted interviews of 346 Dutch owner-managers of hog farms, who made decisions about their own businesses. While the measures demonstrate some degree of convergent validity, those measures based on lotteries were better predictors of actual market behavior. In contrast the psychometric scale showed more agreement to selfreported measures of innovativeness, market orientation, and the intention to reduce risk. In light of the higher predictive validity of lottery-based measurements, werecommend elicitation methods based on the expected utility paradigm.
This paper proposes a new method, the (gamble-)tradeoff method, for eliciting utilities in decision under risk or uncertainty. The elicitation of utilities, to be used in the expected utility criterion, turns out to be possible even if probabilities are ambiguous or unknown. A disadvantage of the tradeoff method is that a few more questions usually must be asked to clients. Also, the lotteries that are needed are somewhat more complex than in the certainty-equivalent method or in the probability-equivalent method. The major advantage of the tradeoff method is its robustness against probability distortions and misconceptions, which constitute a major cause of violations of expected utility and generate inconsistencies in utility elicitation. Thus the tradeoff method retains full validity under prospect theory, rank-dependent utility, and the combination of the two, i.e., cumulative prospect theory.
The tradeoff method is tested for monetary outcomes and for outcomes describing life-duration. We find higher risk aversion for life duration, but the tradeoff method elicits similar curvature of utility. Apparently the higher risk aversion for life duration is due to more pronounced deviations from expected utility.
We show how to calibrate a prospect model of decision making under risk for an individual. The prospect model is empirically compared to a utility model on two criteria, verification of the postulates of each model, and predictive accuracy. The empirical comparison is performed via three experiments. In Experiment 1, predictive accuracy of the models is compared in nonparadoxical situations, those which favor neither model. In contrast the predictions in Experiment 2 are for paradoxical choices, those which favor the prospect model. In Experiment 1, the prospect model is compared to a model comprising a utility function which permits separate risk attitudes for gain and losses, and hence is more flexible than a utility model as traditionally assessed. In contrast the utility model in Experiment 3 is assessed as is traditionally done assuming constant risk attitude across gains and losses. Several calibration procedures are contrasted across experiments.
Our results show a high degree of consistency with the postulates of both models. On predictive accuracy the prospect model outperforms the utility model for paradoxical choices. However, for nonparadoxical situations there is little difference in the predictive ability of both models.
Empirical findings suggest that in decisions under uncertainty people evaluate outcomes relative to a reference level: they
are risk seeking in the domain of losses and risk averse in the domain of gains. This finding is used in the finance literature
to predict/explain the “disposition effect,” which is the tendency of investors to sell assets that have gained value (“winners”)
too early and ride assets that have lost value (“losers”) too long. The current experiment was designed to overcome some of
the difficulties involved in using real market data to test the disposition effect. One of the main goals was to find evidence
on how prior gains and losses influence the risk behavior of people, by shifting the reference level. The results were consistent
with the disposition effect hypothesis. Furthermore, it was found that the data are best described by assuming that participants
use the historical peak of the process as a reference level.
This paper surveys the existing empirical research that uses search theory to empirically analyze labor supply questions in a structural framework, using data on individual labor market transitions and durations, wages, and individual characteristics. The starting points of the literature are the Mincerian earnings function, Heckman's classic selection model, and dynamic optimization theory. We develop a general framework for the labor market where the search for a job involves dynamic decision making under uncertainty. It can be specialized to be in agreement with most published research using labor search models. We discuss estimation, policy evaluation with the estimated model, equilibrium model versions, and the decomposition of wage variation into factors due to heterogeneity of various model determinants as well as search frictions themselves. We summarize the main empirical conclusions.
The strategy method is becoming an important tool in experimental methodology. This study examines how well this method works in an individual decision experiment. Subjects are faced with a sequential search problem. After extensive practice in solving the problem and formulating strategies, they play 20 periods for money. In each period the subjects first make decisions by hand, after that their strategy operates on the same sequence of bids. In each period, only one of the results is paid out (randomly determined). After each period, subjects can change their strategy. This method makes a direct comparison between strategies and decisions possible.
Experimental studies of search behavior suggest that individuals stop searching earlier than the optimal, risk-neutral stopping rule predicts. Two different classes of
decision rules could generate this behavior: rules that are optimal conditional on utility functions departing from risk neutrality, or heuristics derived from limited cognitive processing capacities and satisficing. To discriminate between these possibilities, we conduct an experiment that consists of a search task as well as a lottery task designed to elicit utility functions. We find that search heuristics are not related to measures of risk aversion, but to measures of loss aversion.
This chapter surveys work on dynamic heterogeneous agent models (HAMs) in economics and finance. Emphasis is given to simple models that, at least to some extent, are tractable by analytic methods in combination with computational tools. Most of these models are behavioral models with boundedly rational agents using different heuristics or rule of thumb strategies that may not be perfect, but perform reasonably well. Typically these models are highly nonlinear, e.g. due to evolutionary switching between strategies, and exhibit a wide range of dynamical behavior ranging from a unique stable steady state to complex, chaotic dynamics. Aggregation of simple interactions at the micro level may generate sophisticated structure at the macro level. Simple HAMs can explain important observed stylized facts in financial time series, such as excess volatility, high trading volume, temporary bubbles and trend following, sudden crashes and mean reversion, clustered volatility and fat tails in the returns distribution.
The tendency of some investors to hold on to their losing stocks, driven by prospect theory and mental accounting, creates a spread between a stock's fundamental value and its equilibrium price, as well as price underreaction to information. Spread convergence, arising from the random evolution of fundamental values and the updating of reference prices, generates predictable equilibrium prices interpretable as possessing momentum. Empirically, a variable proxying for aggregate unrealized capital gains appears to be the key variable that generates the profitability of a momentum strategy. Controlling for this variable, past returns have no predictability for the cross-section of returns.
Under prospect theory, three components influence the risk attitude of a decision maker: the utility function, the probability weighting function, and loss aversion. Loss aversion reflects the observed behavior of decision makers' being more sensitive to losses than to gains, resulting in a utility function that is steeper for losses than for gains. Much of the empirically observed risk aversion is due to loss aversion. This paper proposes an index of loss aversion. It also demonstrates how the degree of loss aversion of two decision makers can be compared and how its influences on comparative risk aversion can be examined. The main result characterizes comparative loss aversion in terms of preferences.
The evolution of many economic variables is affected by expectations that economic agents have with respect to the future development of these variables. We show, by means of laboratory experiments, that market behavior depends to a large extent on whether realized market prices respond positively or negatively to average price expectations. In the case of negative expectations feedback, as in commodity markets, prices converge quickly to their equilibrium value, confirming the rational expectations hypothesis. In the case of positive expectations feedback, as is typical for speculative asset markets, large fluctuations in realized prices and persistent deviations from the benchmark fundamental price are likely. We estimate individual forecasting rules and investigate how these explain the differences in aggregate market outcomes.
Thirty empirically assessed utility functions on changes in wealth
or return on investment were examined for general features and susceptability
to fits by linear, power, and exponential functions. Separate fits
were made to below-target data and above-target data. The usual "target"
was the no-change point. The majority of below-target functions were
risk seeking; the majority of above-target functions were risk averse;
and the most common composite shape was convex-concave, or risk seeking
in losses and risk averse in gains. The least common composite was
concave-concave. Below-target utility was generally steeper than
above-target utility with a median below-to-above slope ratio of
about 4.8. The power and exponential fits were substantially better
than the linear fits. Power functions gave the best fits in the majority
of convex below-target and concave above-target cases, and exponential
functions gave the best fits in the majority of concave below-target
and convex above-target cases. Several implications of these results
for decision making under risk are mentioned.
The identification of sellers and the discovery of their prices is given as an example of the role of the search for information in economic life.
Corruption in the public sector erodes tax compliance and leads to higher tax evasion. Moreover, corrupt public officials abuse their public power to extort bribes from the private agents. In both types of interaction with the public sector, the private agents are bound to face uncertainty with respect to their disposable incomes. To analyse effects of this uncertainty, a stochastic dynamic growth model with the public sector is examined. It is shown that deterministic excessive red tape and corruption deteriorate the growth potential through income redistribution and public sector inefficiencies. Most importantly, it is demonstrated that the increase in corruption via higher uncertainty exerts adverse effects on capital accumulation, thus leading to lower growth rates.
We investigate expectation formation in a controlled experimental environment. Subjects are asked to predict the price in
a standard asset pricing model. They do not have knowledge of the underlying market equilibrium equations, but they know all
past realized prices and their own predictions. Aggregate demand for the risky asset depends upon the forecasts of the participants.
The realized price is then obtained from market equilibrium with feedback from six individual expectations. Realized prices
differ significantly from fundamental values and typically exhibit oscillations around, or slow convergence to, this fundamental.
In all groups participants coordinate on a common prediction strategy.
Part I of this survey presents a comprehensive and inte- grated analysis of job search. The labor market is characterized by incomplete information and search is conducted in an optimal manner. A variety of job search models are studied in this microeconomic setting. The paper contains a number of new results. Part 11 of the survey [to appear in the September 1976 issue of Economic Inquiry] addresses the empirical and policy implications of search theory.
Given falling birth rates, ageing baby boomers approaching retirement age as well as a pension crisis in most advanced economies, understanding the characteristics of the labour supply function of the elderly have taken on a new significance. Even in developing countries, with labour surplus economies, this is a major issue as these poor countries try to build a pension scheme with at least a minimum amount of state provision for the elderly. What motivates retired people to enter or continue in the labour force is the focus of our analysis. We use panel data from Korea which is an interesting country since it transited from developing to developed economy status within the last few decades and therefore exhibits characteristics of both underdevelopment and economic advancement. The econometric methods include probit models of: pooled data; panel data with random effects; and 2SCML, to allow for possible endogeneity bias induced by the self-declared health status of the elderly. We stress the crucial importance of pecuniary and non-pecuniary factors in determining labour supply of the elderly. Contrary to expectations, non-pecuniary factors such as health status are crucial in the decision-making process of whether to work or not to work for the elderly.
We develop a new version of prospect theory that employs cumulative rather than separable decision weights and extends the theory in several respects. This version, called cumulative prospect theory, applies to uncertain as well as to risky prospects with any number of outcomes, and it allows different weighting functions for gains and for losses. Two principles, diminishing sensitivity and loss aversion, are invoked to explain the characteristic curvature of the value function and the weighting functions. A review of the experimental evidence and the results of a new experiment confirm a distinctive fourfold pattern of risk: risk aversion for gains and risk seeking for losses of high probability; risk seeking for gains and risk aversion for losses of low probability. Copyright 1992 by Kluwer Academic Publishers
I test the disposition effect, the tendency of investors to hold losing investments too long and sell winning investments too soon, by analyzing trading records for 10,000 accounts at a large discount brokerage house. These investors demonstrate a strong preference for realizing winners rather than losers. Their behavior does not appear to be motivated by a desire to rebalance portfolios, or to avoid the higher trading costs of low priced stocks. Nor is it justified by subsequent portfolio performance. For taxable investments, it is suboptimal and leads to lower after-tax returns. Tax-motivated selling is most evident in December. Copyright The American Finance Association 1998.
We use laboratory experiments to investigate the effect that assuming rational expectations has on structural inference in a dynamic discrete decision problem. Our design induces preferences up to the subjective rate of time preference, leaving unrestricted both this parameter and subjects' decision rules. We estimate subjects' discount rates under the assumption that all subjects use the rational expectations decision rule, and under weaker behavioral assumptions that allow decision rule heterogeneity. We find that certain sophisticated heuristics fit subjects' decisions statistically significantly better than rational expectations. However, the rational expectations assumption does not distort inferences about the cross-sectional discount rate distribution.
Corruption in the public sector erodes tax compliance and leads to higher tax evasion. Moreover, corrupt public officials abuse their public power to extort bribes from the private agents. In both types of interaction with the public sector, the private agents are bound to face uncertainty with respect to their disposable incomes. To analyse effects of this uncertainty, a stochastic dynamic growth model with the public sector is examined. It is shown that deterministic excessive red tape and corruption deteriorate the growth potential through income redistribution and public sector inefficiencies. Most importantly, it is demonstrated that the increase in corruption via higher uncertainty exerts adverse effects on capital accumulation, thus leading to lower growth rates.
We propose a model of consumption and saving based on Kahneman and Tversky's Prospect Theory that implies a fundamental asymmetry in consumption behavior inconsistent with other models of consumption. When there is sufficient income uncertainty, a person resists lowering consumption in response to bad news about future income. This resistance is greater than the resistance to increasing consumption in response to good news. We present empirical evidence from five countries that confirms this behavior.
Two experiments are designed to examine the strategies people use in search behavior. In the first experiment an electronic information board is used to register on which aspects of the situation subjects focus their attention and after that subjects also submit a formal strategy. Although efficiency is rather high, most subjects do not use the theoretical optimal strategy. Many subjects seem to focus on the total earnings instead of the marginal return of another draw. On an average, subjects stop searching too early. This cannot totally be explained by risk aversion. The second experiment shows that the tendency to search too little can be (partly) explained by learning processes.
This paper presents the findings of some preliminary ‘laboratory’ investigations into ‘actual’ search behavior. Specifically we looked at situations in which searchers' initial information about the distributions was negligible. It seemed likely that simple ‘rules of thumb’ would be used in such situations. Our findings confirmed this view: we identified five such rules which between them ‘accounted’ for a high proportion of observed behaviour. Moreover, these rules although not ‘optimal’) appear to be reasonably good and may be fairly robust; jointly, they may constitute a better explanation (and predictor) of actual search behaviour than do the currently popular supposedly optimal rules.
The Economics of Search has made rapid progress in recent years and its results have contributed siginificantly to economic knowledge. Recent work has been particularly marked for the steadily increasing realism of the assumptions describing the environment surrounding the searcher. However, concomitant with this improvement has been a steady growth in the technical complexity of the problem supposedly solved by the searcher. Indeed, many of the recent models are so complicated that their solutions are beyond the capacity of even modern-day computers. After elaborating on this impracticability of optimal search rules, the paper goes on to consider two more realistic and practical alternatives — the adoption of either ‘suboptimal’ or ‘reasonable’ rules. Paradoxically, reasonable rules may, in some circumstances, be better than ‘optimal’ rules. The paper contains a preliminary discussion of what might be meant by ‘reasonable’ behaviour, and shows that a minimal set of criteria for reasonableness leads to the major qualitative conclusions at a market level of optimal search theory.
This paper presents the results of four economic experiments involving 41 undergraduate students who were assigned the task of searching for the lowest price from a known distribution of prices. Economic theory predicts that individuals should continue to draw until the expected gain of another search is less than the marginal search cost. Additionally, once individuals have made a draw and then continued, they should never return to a price drawn earlier (exercise recall). Both of these predictions are tested in the paper and the results show that behavior is not always consistent with them. It appears that individuals are making decisions based on the total return from searching, rather than simply the marginal return from another draw.
The theoretical literature on the search behavior of workers and consumers typically considers three search strategies. These strategies are characterized by alternative assumptions about the temporal and atemporal intensity of search. The first strategy is an atemporally intensive fixed-sample-size strategy which restricts the agent to collecting exactly one sample of contemporaneous offers but allows him to choose the sample size. The second strategy is a temporally intensive pure-sequential strategy which allows the agent to collect as many samples as he chooses but restricts the size of each to unity. The third strategy is a variable-sample-size strategy, a generalization of the first two which allows the agent to sequentially choose both how many samples to take and the size of each sample. We report an experimental comparison and evaluation of these three search strategies. Copyright 1990 by Royal Economic Society.
Forecasts are an inherent part of economic science and the quest for perfect foresight occupies economists and researchers in multiple fields. The release of economic forecasts (and its revisions) is a popular and often publicized event, with a multitude of institutions and think-tanks devoted almost exclusively to that task. The European Central Bank (ECB) also publishes its forecasts for the euro area, however ECB’s forecast accuracy is not a deeply researched theme. The ECB forecasts’ accuracy is the main point developed in this paper, which tries to contribute to understand the nature of the errors committed by the ECB forecasts and its main differences compared to other projections. What we try to infer is whether the ECB is accurate in its projections, making less errors than the others, maybe due to some informational advantage. We conclude that the ECB seems to consistently underestimate the HICP inflation rate and overestimate GDP growth. Comparing it with the others, the ECB shows a superior performance, committing almost always fewer errors. So, this signals a possible informational advantage from the ECB. Since the forecasting errors could jeopardize ECB’s credibility public criticism could be avoided if the ECB simply let forecasts for the others. Naturally, this change should be weighted against the benefits of publishing forecasts.