John Dickhaut

Escalation Errors And The Sunk Cost Effect - An Explanation Based On Reputation And Information Asymmetries

This paper is concerned with explaining a paradox of human behavior. Consider the following example. A department manager makes a large investment in new production equipment and, soon after, learns of different equipment that could perform the same operations at lower cost. Incremental analysis favors switching, but the manager refuses saying he does not want to waste the investment already made. Such real-world examples have been extensively documented and studied by social scientists (see Thaler [1980] and Staw [1981]). In these examples, the decision maker, having commited to a course of action, subsequently discovers new information that indicates that continuing the earlier commitment would likely result in worse consequences than switching. In spite of this he clings to and even escalates his earlier

Neuronal Substrates for Choice Under Ambiguity, Risk, Gains, and Losses

Economic forces shape the behavior of individuals and institutions. Forces affecting individual behavior are attitudes about payoffs (gains and losses) and beliefs about outcomes (risk and ambiguity). Under risk, the likelihoods of alternative outcomes are fully known. Under ambiguity, these likelihoods are unknown. In our experiment, payoffs and outcomes were manipulated independently during a classical choice task as brain activity was measured with positron emission tomography (PET). Here, we show that attitudes about payoffs and beliefs about the likelihood of outcomes exhibit interaction effects both behaviorally and neurally. Participants are risk averse in gains and risk-seeking in losses; they are ambiguity-seeking in neither gains nor losses. Two neural substrates for choice surfaced in the interaction between attitudes and beliefs: a dorsomedial neocortical system and a ventromedial system. This finding reveals that the brain does not honor a prevalent assumption of economics--the independence of the evaluations of payoffs and outcomes. The demonstration of a relationship between brain activity and observed economic choice attests to the feasibility of a neuroeconomic decision science.

The impact of the certainty context on the process of choice

In this study we examine how the introduction of a reference lottery with nonrandom outcomes alters the way in which choices among pairs of lotteries are made, even if it does not alter the choices. We use different domains (some of the lotteries produce gains, other losses) and different contexts (one member of the pair, the reference lottery, may be either risky or certain). In our experiment, the change from gain to loss domain affects choices: subjects are risk averse in the gain domain, but not in the loss domain. On the contrary, the context effect of the certain lottery does not affect choices. However, the introduction of the certainty reference lottery affects two behavioral variables, response time and brain activation, in a dramatic way. This result suggests that the certainty lottery promotes a different process through which preferences are revealed, even if the differences among lotteries may not be large enough to induce different choices.

A Program for Finding Nash Equilibria

We describe two-player simultaneous-play games. First, we use a zero-sum game to illustrate minimax, dominant, and best-response strategies. We illustrate Nash equilibria in the Prisoners’ Dilemma and the Battle of the Sexes Games, distinguishing among three types of Nash equilibria: a pure strategy, a mixed strategy, and a continuum (partially) mixed strategy. Then we introduce the program, Nash . m, and use it to solve sample games. We display the full code of Nash . m; finally, we discuss the performance characteristics of Nash . m.

Generating Ambiguity in the Laboratory

This article develops a method for drawing samples from a distribution with no finite quantiles or moments. The method provides researchers with a way to give subjects the experience of ambiguity. In any experiment, learning the distribution from experience is impossible for the subjects, essentially because it is impossible for the experimenter. We characterize our method, illustrate it in simulations, and then test it in a laboratory experiment. Our method does not withhold sampling information, does not assume that the subject is incapable of making statistical inferences, is replicable across experiments, and requires no special apparatus. We compare our method to the techniques used in related experiments that attempt to produce an ambiguous experience for the subjects. This paper was accepted by Peter Wakker, decision analysis.

High Stakes Behavior with Low Payoffs: Inducing Preferences with Holt-Laury Gambles

Kahneman and Tversky (1979) argued that risky decisions in high stakes environments can be informed using questionnaires with hypothetical choices. Yet results by Holt and Laury (2002) suggest that questionnaire responses and decisions in hypothetical and low monetary payoff environments do not well predict decisions in higher monetary payoff environments. This raises the question of whether investigating decision making in high stakes environments requires using high stakes. Here we show that one can induce preferences using the binary-lottery reward technique (e.g., Berg et al., 1986) in order to study high-stakes decision making using low-stakes. In particular, we induce preferences such that decisions in a low-stakes environment reflect well the choices made in the high stakes environment of Holt and Laury (2002). This finding is of interest to anyone interested in studying high-stakes decision behavior without paying high stakes.

Recordkeeping Alters Economic History by Promoting Reciprocity

We experimentally demonstrate a causal link between recordkeeping and reciprocal exchange. Recordkeeping improves memory of past interactions in a complex exchange environment, which promotes reputation formation and decision coordination. Economies with recordkeeping exhibit a beneficially altered economic history where the risks of exchanging with strangers are substantially lessened. Our findings are consistent with prior assertions that complex and extensive reciprocity requires sophisticated memory to store information on past transactions. We offer insights on this research by scientifically demonstrating that reciprocity can be facilitated by information storage external to the brain. This is consistent with the archaeological record, which suggests that prehistoric transaction records and the invention of writing for recordkeeping were linked to increased complexity in human interaction.

Economics and emotion: Institutions matter

Abstract In two different types of institutions, English and Dutch auctions, we collect heart rate data, a proxy for emotion, to test hypotheses based on findings in neural science about the effect of emotion on economic behavior. We first demonstrate that recording heart rates does not distort prices in these auctions. Next we ask if knowledge of the intensity of a participants emotional state improves our ability to predict price setting behavior beyond predictions of price based on usual economic variables. Our answer is that “institutions matter.” In the Dutch (English) auctions we find (no) evidence that knowledge of emotional intensity affects our ability to predict price setting behavior. We then entertain the proposition that the cardiac system is an information system that processes economic events. We are able to show that this hypothesis is consistent with our observations and furthermore that the processes differ across institutions.

A neuroeconomic theory of the decision process

We develop a neuronal theory of the choice process (NTCP), which takes a subject from the moment in which two options are presented to the selection of one of the two. The theory is based on an optimal signal detection, which generalizes the signal detection theory by adding the choice of effort as optimal choice for a given informational value of the signal for every effort level and a cost of effort. NTCP predicts the choice made as a stochastic choice: That is, as a probability distribution over two options in a set, the level of effort provided, the error rate, and the time to respond. The theory provides a unified account of behavioral evidence (choices made, error rate, time to respond) as well as neural evidence (represented by the effort rate measured for example by the level of brain activation). The theory also provides a unified explanation of several facts discovered and interpreted in the last decades of experimental economic analysis of choices, which we review.

Judgment and decision-making research in accounting and auditing: The individual versus the aggregate

Introduction To what degree do individual decision biases affect aggregate behavior? This question was introduced, and “answered, ” in the accounting literature twenty years ago when Gonedes and Dopuch (1974) argued that market efficiency necessarily precluded any impact of individual bias on aggregate capital–market behavior (that is, price). We know now that this claim need not be true. Recent advances in both theoretical and empirical research open the door for the influence of individual bias on aggregate–level behavior in capital markets as well as other aggregate settings. Experimental methods enhance our ability to pinpoint when biases do occur, measure the cost of bias, and examine what factors extinguish biases. In this chapter, we review the historical development of the issue of individual and aggregate behavior and develop a framework to systematically advance our knowledge in this area. Since no generally accepted theory linking individual behavior to aggregate level behavior exists, we develop a framework enumerating the observable factors that distinguish individual decision–making settings from aggregate decision–making settings. Since these factors transcend theoretical paradigms, they form the basis for dialog between those that draw theory from economics and those that draw theory from psychology. In the spirit of enhancing such a dialog, we use this framework to examine several streams of research, and begin to address how changes in observable factors affect aggregate behavior. In examining these settings, we ask not only whether individual biases persist at the aggregate level, but also whether aggregate settings introduce “new” biases of their own.