Boğaçhan Çelen

Observational learning under imperfect information

Abstract We explore Bayes-rational sequential decision making in a game with pure information externalities, where each decision maker observes only her predecessors binary action. Under perfect information the martingale property of the stochastic learning process is used to establish convergence of beliefs and actions. Under imperfect information, in contrast, beliefs and actions cycle forever. However, despite the stochastic instability, over time the private information is ignored and decision makers become increasingly likely to imitate their predecessors. Consequently, we observe longer and longer periods of uniform behavior, punctuated by increasingly rare switches.

Implications of Executive Hedge Markets for Firm Value Maximization

This paper analyzes the incentive implications of executive hedge markets. The manager can promise the return from his shares to third parties in exchange for a fixed payment—swap contracts—and/or he can trade a customized security correlated with his firm-specific risk. The customized security improves incentives by diversifying the managers firm-specific risk. However, unless they are exclusive, swap contracts lead to a complete unraveling of incentives. When security customization is sufficiently high, the manager only trades the customized security—but not any nonexclusive swap contracts, and incentives improve. Access to highly customized hedge securities and/or exclusive swap contracts increases the managers pay-performance sensitivity.

Social Learning Through Endogenous Information Acquisition: An Experiment

This paper provides a test of a theory of social learning through endogenous information acquisition. A group of subjects face a decision problem under uncertainty. Subjects are endowed with private information about the fundamentals of the problem and make decisions sequentially. The key feature of the experiment is that subjects can observe the decisions of predecessors by forming links at a cost. The model predicts that the average welfare is enhanced in the presence of a small cost. Our experimental results support this prediction. When the informativeness of signals changes across treatments, behavior changes in accordance with the theory. However, within treatments, there are important deviations from rationality such as a tendency to conform and excessive link formation. Given these biases, our results indicate that subjects would, except when faced with a small cost, have been better off not forming any links. This paper was accepted by Teck Ho, behavioral economics.

On blame and reciprocity: Theory and experiments

The theory of reciprocity is predicated on the assumption that people are willing to reward kind acts and to punish unkind ones. This assumption raises the question of what kindness is. In this paper, we offer a novel definition of kindness based on a notion of blame. This notion states that for player j to judge whether or not player i is kind to him, player j has to put himself in the position of player i, and ask if he would act in a manner that is worse than what he believes player i does. If player j would act in a worse manner than player i, then we say that player j does not blame player i. If, however, player j would be nicer than player i, then we say that player j blames player i. We believe this notion is a natural, intuitive and empirically functional way to explain the motives of people engaging in reciprocal behavior. After developing the conceptual framework, we test this concept by using data from two laboratory experiments and find significant support for the theory.

On Blame-freeness and Reciprocity: An Experimental Study ∗

The theory of reciprocity is predicated on the assumption that people are willing to reward nice or kind acts and to punish unkind ones. This assumption raises the question as to how to define kindness. In this paper we offer a new definition of kindness that we call “blame-freeness.” Put most simply, blame-freeness states that in judging whether player i has been kind or unkind to player j in a social situation, player j would have to put himself in the strategic position of player i, while retaining his preferences, and ask if he would have acted in a manner that was worse than i did under identical circumstances. If j would have acted in a more unkind manner than i acted, then we say that j does not blame i for his behavior. If, however, j would have been nicer than i was, then we say that “j blames i” for his actions (i’s actions were blameworthy). We consider this notion a natural, intuitive and empirically relevant way to explain the motives of people engaged in reciprocal behavior. After developing the conceptual framework, we then test this concept in a laboratory experiment involving tournaments and find significant support for the theory.

Final-Offer Arbitration with Uncertainty Averse Parties

Final-offer arbitration (FOA) is a widely used binding dispute resolution mechanism, where an impartial arbitrator is constrained to choose one of the two final offers pro- posed by two disputing parties. We build an equilibrium model of FOA with agents averse to arbitral uncertainty to study three important issues: the role of FOA in incentivizing negotiated settlements, convergence of final offers, and the effect of diversity of arbitrator opinion on welfare. Uncertainty increases the likelihood of non-arbitrated settlement and make the final offers converge to each other. Risk aversion is not necessary. Precision and mean of arbitral uncertainty matter differently and can be con- trolled separately. Moreover, as also argued by the industry practitioners, diversity (of opinion) in the arbitrator pool increases the welfare of negotiating parties.

Diversity of Opinion in Social Networks

Agents on a network experiment repeatedly, and simultaneously with the aim of choosing the optimal (uncertain) action between two alternatives. If each agent is forward looking and rational and observes the behavior only of those in his reference group, could different opinions emerge eventually? Are there structural features of the network that yield diversity of opinion? Does a larger group of agents learn better than a smaller group? We demonstrate, in a strategic learning framework with a social network structure, that the answer to these questions is affirmative and that the critical feature is informational connectedness.

Acquisition of Information to Diversify Contractual Risk

Are hedging transactions that diversify a manager’s compensation risk detrimental to incentives, or can they improve contracting efficiency? If hedging provides efficiency benefits, should the manager or the firm undertake it? In our model, both the firm and the manager can trade financial portfolios to diversify the manager’s compensation risk. Prior to the portfolio selection, the parties need to acquire information on how different financial portfolios fit their diversification purposes. We illustrate that financial portfolios correlated with firm‐specific risk improve contracting efficiency. For equal information costs, it is optimal for the firm to undertake the hedging on the manager’s behalf.