Doron Sonsino

On loss aversion, level-1 reasoning, and betting

Previous research suggests that human reaction to risky opportunities reflects two contradicting biases: “loss aversion”, and “limited level of reasoning” that leads to overconfidence. Rejection of attractive gambles is explained by loss aversion, while counterproductive risk seeking is attributed to limited level of reasoning. The current research highlights a shortcoming of this popular (but often implicit) “contradicting biases” assertion. Studies of “negative-sum betting games” reveal high rate of counterproductive betting even when limited level of reasoning and loss aversion imply no betting. The results reflect two reasons for the high betting rate: initial tendency to participate and slow learning. Under certain conditions, the observed betting rate was higher than the rate predicted under random choice even after 250 trials with immediate feedback. These results can be captured with a model that assumes a tendency to select strategies that have led to good outcomes in a small set of similar past experiences, and allows for an initial framing effect.

Disentangling trust from risk-taking: Triadic approach

The willingness to trust human receivers is compared to the inclination to take lottery risk in six distinct scenarios, controlling the return distributions. Trust shows significantly smaller responsiveness to return expectations compared to parallel pure-risk lottery allocation, and paired comparisons reveal that investors sacrifice 5% of the expected payoff to trust anonymous receivers. Trust is more calculated and volatile for males, while appearing relative stable for females. The results complement the accumulating evidence regarding physiological differences between trust and risk, in addition suggesting that the trust-risk gap is larger for females.

Separating Accuracy from Forecast Certainty: A Modified Miscalibration Measure

The standard interval forecasting task is modified, asking subjects to provide point predictions for future returns and assess the likelihood of fixed length intervals around their point estimates. The difference between the subjective likelihood estimates and the realized hit rate is advanced as an improved miscalibration measure. Class and take-home studies reveal that 140 of 169 finance students and experts overestimate their hit rates, confirming the overprecision hypothesis. A comparative study additionally shows that the revised task weakly decreases the miscalibration rates from 50% to 38% (p=0.16).

The Valuation of Composite Investment Instruments

The return on composite investment instruments takes the form of weighted-average, derived from the performance of at least two economic indicators. Three allocation experiments illustrate that prospective investors tend to valuate composites by-tranche, consistently violating the rational premise of reduction. Valuation-by-tranche shows for uncertain and risky composites, and reflects in allocation problems and binary choice. The willingness to invest in a given composite still strongly increases when one tranche hedges against the other, suggesting that reduced-form considerations might interfere with the inclination to value components separately. A hybrid model where investors weight the values of underlying tranches, but also respond to the reduced-form prospect, approximates the data most accurately. Personal tendency to valuate composites by-tranche negatively correlates with choice consistency, suggesting that component-level processing might bias investment decision and open space for profitable composite engineering.