Generating ambiguity in the laboratory

This article develops a method for drawing samples from which it is impossible to infer any quantile or moment of the underlying distribution. 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 describe our method mathematically, illustrate it in simulations, and then test it in a laboratory experiment. Our technique 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.ambiguity; Ellsberg; Knightian uncertainty; laboratory experiments; ignorance; vagueness JEL Classications: C90; C91; C92; D80; D81

Decision Making and Trade without Probabilities

What is a rational decision-maker supposed to do when facing an unfamiliar problem, where there is uncertainty but no basis for making probabilistic assessments? One answer is to use a form of expected utility theory, and assume that agents assign their own subjective probabilities to each element of the (presumably known) state space. In contrast, this paper presents a model in which agents do not form subjective probabilities over the elements of the state space, but nonetheless use new information to update their beliefs about what the elements of the state space are. This model is shown to lead to different predictions about trading behavior in a simple asset market under uncertainty. A controlled laboratory experiment tests the predictions of this model against those of expected utility theory and against the hypothesis that subjects act na¨ıvely and non-strategically. The results suggest that a lack of subjective probabilities does not imply irrational or unpredictable behavior, but instead allows individuals to use both what they know and knowledge of what they do not know in their decision making. Comment un décideur rationnel est-il censé réagir face à un problème qui ne lui est pas familier lorsquâil existe une certaine incertitude, et en lâabsence dâune base sur laquelle effectuer des estimations probabilistes? Une solution consiste à utiliser une forme de la théorie de lâutilité espérée et de présumer que les agents attribuent leurs propres probabilités subjectives à chaque élément de la représentation dâétat (sans doute connue). Par contraste, notre article présente un modèle où les agents ne forment pas de probabilités subjectives sur les éléments de la représentation dâétat, mais utilisent de nouveaux renseignements afin de mettre à jour leurs croyances sur les éléments formant la représentation dâétat. Le comportement des échanges avec ce modèle dans un marché dâactifs simple et incertain nous mène à des prédictions différentes. En utilisant une expérience contrôlée en laboratoire, nous avons vérifié les prédictions de ce modèle contre celles de la théorie de lâutilité espérée et contre lâhypothèse que les sujets agissent avec naïveté et sans recourir à une stratégie. Les résultats suggèrent quâun manque de probabilités subjectives nâimplique pas un comportement irrationnel ou imprévisible, mais permet plutôt aux individus dâutiliser autant lâinformation quâils possèdent que la connaissance de lâinformation quâils ne possèdent pas dans leur prise de décision.Uncertainty; non-expected utility; incomplete preferences; ambiguity., Incertitude, utilité non espérée, préférences incomplètes, ambiguïté.

Price Formation in Double Auctions

We develop a model of information processing and strategy choice for participants in a double auction. Sellers in this model form beliefs that an offer will be accepted by some buyer. Similarly, buyers form beliefs that a bid will be accepted. These beliefs are formed on the basis of observed market data, including frequencies of asks, bids, accepted asks, and accepted bids. Then traders choose an action that maximizes their own expected surplus. The trading activity resulting from these beliefs and strategies is sufficient to achieve transaction prices at competitive equilibrium and complete market efficiency after several periods of trading.Double auction, bounded rationality, experimental economics

Durability, Re-trading and Market Performance

Key differential structural characteristics of environments studied in previous market experiments have documented large divergences in their observed performance, particularly discrepancies in their convergence to expected equilibrium outcomes. We investigate why this should be so. The type of competitive equilibrium where a market clears at a particular price as initiated by Arrow and Debreu (1954) has long been studied in the laboratory. We refer to these experiments as Supply and Demand (SD) experiments. SD experiments are highly reduced in form: items are not re-tradable, buyers and sellers are specialized in these roles, and no second commodity, cash, is used as a medium of exchange, although cash enters as a numeraire qua reward incentive for subjects. Markets with these features that are repeated over time converge rapidly to the predicted equilibrium under a regime of strict private dispersed information on individual values that define the equilibrium predictions. In contrast, consider asset markets, in which shares can be freely re-traded against cash within and across periods, shares have well-defined common values based on common public information on expected cash “dividend” yields, and individuals are not specialized as buyers or sellers. These markets produce price bubbles that converge only with experience across repeat sessions. The prospect of re-trade, and perhaps the lack of buyer/seller specialization, results in market behavior that contrasts sharply with the perishable goods that characterize the SD experiments. Building on this background analysis we report new experiments that combine features of both environments and initiate an investigation of how commodity durability that constrains re-trading characteristics affect the observed variation in market performance.

Does Information Transparency Decrease Coordination Failure?

This study experimentally tests the effect of information transparency on the probability of coordination failure in global games with finite signals. Prior theory has shown that in global games with unique equilibrium, the effect of information transparency is ambiguous. We find that in global games where the signal space is finite, increased transparency has two effects. First, increasing the level of transparency usually destroys uniqueness and precipitates multiple equilibria, so that the effect of transparency on coordination depends crucially upon which equilibrium is actually attained. Second, the level of transparency determines which of these equilibria is risk dominant. We find that increased transparency facilitates coordination only if it switches the risk-dominant equilibrium from the secure equilibrium to the efficient equilibrium. When the converse is true, improved transparency can be dysfunctional because it increases the probability of coordination failure.

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

A continuing goal of experiments is to understand risky decisions when the decisions are important. Often a decision’s importance is related to the magnitude of the associated monetary stake. Khaneman and Tversky (1979) argue that risky decisions in high stakes environments can be informed using questionnaires with hypothetical choices (since subjects have no incentive to answer questions falsely.) However, results reported by Holt and Laury (2002, henceforth HL), as well as replications by Harrison (2005) suggest that decisions in “high” monetary payoff environments are not well-predicted by questionnaire responses. Thus, a potential implication of the HL results is that studying decisions in high stakes environments requires using high stakes. Here we describe and implement a procedure for studying high-stakes behavior in a low-stakes environment. We use the binary-lottery reward technique (introduced by Berg, et al (1986)) to induce preferences in a way that is consistent with the decisions reported by HL under a variety of stake sizes. The resulting decisions, all of which were made in a low-stakes environment, reflect surprisingly well the noisy choice behavior reported by HL’s subjects even in their highstakes environment. This finding is important because inducing preferences evidently requires substantially less cost than paying people to participate in extremely high-stakes games.

Ageism & Cooperation

Discrimination based on age can affect same-aged and intergenerational interactions, presenting socially and economically undesirable phenomena. To investigate the effects of age stereotypes on cooperation, we presented older adults (over age 50) and younger adults (under age 25) with belief elicitation tasks (about anticipated interactions) and then a series of same, different, and unknown-aged group interactions in a Sender-Receiver game. Compared to the in-group (the age group they belong to) both younger and older participants stereotyped the out-group (the age group they did not belong to) as relatively different and more uncooperative than observed to be. We have only partial support for the notion that stereotypers behaved strategically: while younger stereotypers acted relatively uncooperatively and earned more, older stereotypers acted relatively cooperatively (despite out-group beliefs) and earned less. We discuss the implications of these findings for social identity theory, stereotype theory, and intergenerational interactions in an aging society