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Biases in markets

Systematic mistakes in judgements affect economic decisions in many contexts. Over- and underconfidence can affect decisions by job searchers to accept job offers. The endowment effect hinders efficient trading. Finally, people tend to exaggerate the availability of their own information for others or their own past selves (hindsight bias). This leads not only to incorrect performance evaluations of subordinates, but also to suboptimal decisions to compete with others.

Fehr, Dietmar/Hakimov, Rustamdjan/Kübler, Dorothea (2015). The Willingness to Pay–Willingness to Accept Gap: A failed replication of Plott and Zeiler. In European Economic Review 78,120-128, 2015.

The well-known willingness to pay–willingness to accept (WTP–WTA) gap refers to the observation that individuals attach a higher value to objects they own (WTA) than to objects they do not own (WTP). We report on experiments to re-investigate the possibility that the WTP–WTA gap arises from subject misconceptions due to experimental procedures as suggested by Plott and Zeiler (2005). The contribution of this paper is two-fold: first, we attempt to replicate the findings by Plott and Zeiler that the WTP–WTA gap disappears when using procedures that are aimed at reducing misconceptions, such as extensive training and practice rounds for the BDM mechanism. However, we fail to do so as the WTP–WTA gap persists in the main task where subjects state their WTA or WTP for a mug. Second, we use the paid practice rounds to identify subjects without apparent misconceptions and find that also for those subjects who never make dominated choices in the lottery tasks, the WTP–WTA gap in the mug task exists. Thus, we find no evidence of the idea that subject misconceptions are the main source of the WTP–WTA gap.

Kodritsch, Sebastian (2013): On Time-Inconsistency in Bargaining. Discussion Paper SP II 2014-205. Berlin: WZB.

This paper analyzes dynamically inconsistent time preferences in Rubinstein's (1982) seminal model of bargaining. When sophisticated bargainers have time preferences that exhibit a form of present bias—satisfied by the hyperbolic and quasi-hyperbolic time preferences increasingly common in the economics literature—equilibrium is unique and lacks delay. However, when one bargainer is more patient about a single period’s delay from the present than one that occurs in the near future, the game permits a novel form of equilibrium multiplicity and delay. Time preferences with this property have most recently been empirically documented; they can also arise when parties who weight probabilities non-linearly bargain under the shadow of exogenous breakdown risk, as well as in settings of intergenerational bargaining with imperfect altruism. The paper's main contributions are (i) a complete characterization of the set of equilibrium outcomes and payoffs for separable time preferences, and (ii) present bias as a readily interpretable sufficient condition for uniqueness at the level of individual preferences.

van Veldhuizen, Roel/Sonnemans, Joep (2013): Nonrenewable Resources, Strategic Behavior and the Hotelling Rule: An Experiment. Discussion Paper SP II 2014-203. Berlin: WZB.

This study uses the methods of experimental economics to investigate possible reasons for the lack of empirical support for the Hotelling rule for nonrenewable resources. We argue that as long as resource stocks are large enough, producers may choose to (partially) ignore the dynamic component of their production decision, shifting production to the present and focusing more on strategic behavior. We experimentally vary stock size in a nonrenewable resource duopoly setting and find that producers with large stocks indeed pay significantly less attention to variables related to dynamic optimization, and overproduce relative to the Hotelling rule.

Haan, Thomas de/van Veldhuizen, Roel (2013): Willpower depletion and framing effects. Discussion Paper SP II 2013-206. Berlin: WZB.

We investigate whether depleting people’s cognitive resources (or ‘willpower’) affects the degree to which they are susceptible to framing effects. Recent research in social psychology and economics has suggested that willpower is a resource that can be temporarily depleted and that a depleted level of willpower is associated with self-control problems in a variety of contexts. In this study, we extend the willpower depletion paradigm to framing effects and argue that willpower depletion should increase framing effects. To test this we designed two experiments in which we depleted participants’ willpower and subsequently had them take part in a series of tasks, including a framed prisoner’s dilemma, an attraction effect task, a compromise effect task, and an anchoring task. However, we find no evidence that framing effects were indeed more prevalent in willpower-depleted participants than in controls.

Danz, David/Kübler, Dorothea/Mechtenberg, Lydia/Schmid, Julia (2013): On the failure of hindsight-biased principals to delegate optimally. Forthcoming in Management Science.

With the help of a simple model, we show that the hindsight bias can lead to inefficient delegation decisions. This prediction is tested experimentally. In an online experiment that was conducted during the FIFA World Cup 2010 participants were asked to predict a number of outcomes of the ongoing World Cup and had to recall their assessments after the outcomes had been realized. This served as a measure of the hindsight bias for each participant. The participants also had to make choices in a delegation game. Our data confirm that hindsight-biased subjects more frequently fail to delegate optimally than subjects whom we have classified as not hindsight biased.

Dwenger, Nadja/Kübler, Dorothea/Weizsäcker, Georg (2013): Flipping a coin: Theory and evidence. Empirical and Experimental Evidence. Discussion Paper SP II 2013-201r. Berlin: WZB.

We investigate violations of consequentialism in the form of the stochastic dominance property. The property is shared by many theories of choice and implies that the decisionmaker prefers receiving the best outcome for sure over all lotteries that involve multiple outcomes. We run experiments to demonstrate that dominated randomization can be attractive. In treatments where decision-makers are asked to submit multiple decisions without knowing which one is relevant, many participants submit contradictory sets of decisions and thereby induce a dominated lottery between outcomes. Explicit choice of non-consequentialist randomization is observed in a separate treatment. A possible reason for the effect is the desire to avoid having to make the decision. A large data set on (highstake) university applications in Germany shows patterns that are consistent with a preference for randomization.

Dittmann, Ingolf/Kübler, Dorothea/Maug, Ernst/Mechtenberg, Lydia (2013): Why Votes Have Value: Instrumental Voting with Overconfidence and Overestimation of Others’ Errors. In Games and Economic Behavior 84, 17–38, 2014.

We perform an experiment in which subjects bid for participating in a vote. The setting precludes conflicts of interests or direct benefits from voting. The theoretical value of participating in the vote is therefore zero if subjects have only instrumental reasons to vote and form correct beliefs. Yet, we find that experimental subjects are willing to pay for the vote and that they do so for instrumental reasons. The observed voting premium in the main treatment is high and can only be accounted for if some subjects either overestimate their pivotality or do not pay attention to pivotality at all. A model of instrumental voting, which assumes that individuals are overconfident and that they overestimate the errors of others, is consistent with results from treatments that make the issue of pivotality salient to experimental subjects.