Psychology and Economics: Evidence from the Field

The research in Psychology and Economics (a.k.a. Behavioral Economics) suggests that individuals deviate from the standard model in three respects: (i) non-standard preferences; (ii) non-standard beliefs; and (iii) non-standard decision-making. In this paper, I survey the empirical evidence from the field on these three classes of deviations. The evidence covers a number of applications, from consumption to finance, from crime to voting, from giving to labor supply. In the class of non-standard preferences, I discuss time preferences (self-control problems), risk preferences (reference dependence), and social preferences. On non-standard beliefs, I present evidence on overconfidence, on the law of small numbers, and on projection bias. Regarding non-standard decision-making, I cover limited attention, menu effects, persuasion and social pressure, and emotions. I also present evidence on how rational actors -- firms, employers, CEOs, investors, and politicians -- respond to the non-standard behavior described in the survey. I then summarize five common empirical methodologies used in Psychology and Economics. Finally, I briefly discuss under what conditions experience and market interactions limit the impact of the non-standard features.

Overestimating Self_Control: Evidence from the Health Club Industry

Experimental evidence suggests that people make time-inconsistent choices and display overconfidence about positive personal attributes. Do these features affect consumer behavior in the market? To address this question we use a new panel data set from three US health clubs with information on the contract choices and the day-to-day attendance decisions of 7,978 health club members over three years. Members who choose a contract with a flat monthly fee of over $70 attend on average 4.8 times per month. They pay a price per expected visit of more than$17, even though a $10-per-visit fee is also available. On average, these users forgo savings of$700 during their membership. We review many aspects of the consumer behavior, including the interval between last attendance and contract termination, the survival probability, and the correlation between different consumption choices. The empirical results are difficult to reconcile with the standard assumption of time-consistent preferences and rational expectations. A model of time-inconsistent agents with overconfidence about future patience explains the findings. The agents overestimate the future attendance and delay contract cancellation whenever renewal is automatic. Salesman pressure and overstimation of future efficiency are the leading alternative explanations.

The Fox News Effect: Media Bias and Voting

Does media bias affect voting? We address this question by looking at the entry of Fox News in cable markets and its impact on voting. Between October 1996 and November 2000, the conservative Fox News Channel was introduced in the cable programming of 20 percent of US towns. Fox News availability in 2000 appears to be largely idiosyncratic. Using a data set of voting data for 9,256 towns, we investigate if Republicans gained vote share in towns where Fox News entered the cable market by the year 2000. We find a significant effect of the introduction of Fox News on the vote share in Presidential elections between 1996 and 2000. Republicans gain 0.4 to 0.7 percentage points in the towns which broadcast Fox News. The results are robust to town-level controls, district and county fixed effects, and alternative specifications. We also find a significant effect of Fox News on Senate vote share and on voter turnout. Our estimates imply that Fox News convinced 3 to 8 percent of its viewers to vote Republican. We interpret the results in light of a simple model of voter learning about media bias and about politician quality. The Fox News effect could be a temporary learning effect for rational voters, or a permanent effect for voters subject to non-rational persuasion.

Investor Inattention, Firm Reaction, and Friday Earnings Announcements

Do firms release news strategically in response to investor inattention? We consider news about earnings and analyze the response of returns to announcements on Friday and other weekdays. Friday announcements have less immediate and more delayed stock return response. The delayed response as a percentage of the total response is 60 percent on Friday and 40 percent on other weekdays. In addition, abnormal trading volume around announcement day is 10 percent lower for Friday announcements. These findings suggest that weekends distract investor attention temporarily. They support explanations of post-earning announcement drift based on underreaction to information caused by limited attention. We also document that firms release worse announcements on Friday. Friday announcements are associated with a 45 percent higher probability of a negative earnings surprise and a 50 basis points lower abnormal return. The firm-based evidence of strategic news release corroborates the investor-based evidence of inattention on Friday. The results for stock returns, volume, and strategic behavior support the hypothesis of limited attention.

Attention, Demographics, and the Stock Market

Do investors pay enough attention to long-term fundamentals? We consider the case of demographic information. Cohort size fluctuations produce forecastable demand changes for age-sensitive sectors, such as toys, bicycles, beer, life insurance, and nursing homes. These demand changes are predictable once a specific cohort is born. We use lagged consumption and demographic data to forecast future consumption demand growth induced by changes in age structure. We find that demand forecasts predict profitability by industry. Moreover, forecasted demand changes 5 to 10 years in the future predict annual industry returns. One additional percentage point of annualized demand growth due to demographics predicts a 5 to 10 percentage point increase in annual abnormal industry stock returns. However, forecasted demand changes over shorter horizons do not predict stock returns. The predictability results are more substantial for industries with higher barriers to entry and with more pronounced age patterns in consumption. A trading strategy exploiting demographic information earns an annualized risk-adjusted return of 5 to 7 percent. We present a model of underreaction to information about the distant future that is consistent with the findings.

Job Search and Impatience

How does impatience affect job search? More impatient workers search less intensively and set a lower reservation wage. The effect on the exit rate from unemployment is unclear. In this paper we show that, if agents have exponential time preferences, the reservation wage effect dominates for sufficiently patient individuals, so increases in impatience lead to higher exit rates. The opposite is true for agents with hyperbolic time preferences: more impatient workers search less and exit unemployment later. Using two large longitudinal data sets, we find that various measures of impatience are negatively correlated with search effort and the exit rate from unemployment, and are orthogonal to reservation wages. Overall, impatience has a large effect on job search outcomes in the direction predicted by the hyperbolic discounting model.

Detecting Illegal Arms Trade

Illegal arms are responsible for thousands of deaths in civil wars every year. Yet, their trade is very hard to detect. We propose a method to statistically detect illegal arms trade based on the investor knowledge embedded in financial markets. We focus on eight countries under UN arms embargo in the period 1990-2005, and analyze eighteen events during the embargo that suddenly increase or decrease conflict intensity. If the weapon-making companies are not trading or are trading legally, an event worsening the hostilities should not affect their stock prices or affect them adversely, since it delays the removal of the embargo. Conversely, if the companies are trading illegally, the event may increase stock prices, since it increases the demand for illegal weapons. We detect no significant effect overall. However, we find a large and significant positive reaction for companies head-quartered in countries where the legal and reputation costs of illegal trades are likely to be lower. We identify such countries using measures of corruption and transparency in arms trade. We also suggest a method to detect potential embargo violations based on stock reactions by individual companies, including chains of reactions. The presumed violations are higher for conflicts with more UN investigations and for companies with more Internet stories regarding embargo.

Five minutes with Stefano DellaVigna: “It turns out that voters hate to lie”

As election turnout levels in the U.S. continue to fall, political leaders and academics have become increasingly interested in what motivates people to actually vote. USApp Editor, Chris Gilson talks to Stefano DellaVigna about his recent research that posits that people vote because they might be asked about whether or not they voted. He finds that in general, voters hate to lie, even when offered a monetary reward to do so, and that there is a distinct ‘cost’ to people when they lie about not voting. Professor DellaVigna recently spoke at the LSE Government Department PSPE Research Seminar, click here for further details

The Effect of Fast Food Restaurants on Obesity

We investigate the health consequences of changes in the supply of fast food using the exact geographical location of fast food restaurants. Specifically, we ask how the supply of fast food affects the obesity rates of 3 million school children and the weight gain of over 1 million pregnant women. We find that among 9th grade children, a fast food restaurant within a tenth of a mile of a school is associated with at least a 5.2 percent increase in obesity rates. There is no discernable effect at .25 miles and at .5 miles. Among pregnant women, models with mother fixed effects indicate that a fast food restaurant within a half mile of her residence results in a 2.5 percent increase in the probability of gaining over 20 kilos. The effect is larger, but less precisely estimated at .1 miles. In contrast, the presence of non-fast food restaurants is uncorrelated with obesity and weight gain. Moreover, proximity to future fast food restaurants is uncorrelated with current obesity and weight gain, conditional on current proximity to fast food. The implied effects of fast-food on caloric intake are at least one order of magnitude smaller for mothers, which suggests that they are less constrained by travel costs than school children. Our results imply that policies restricting access to fast food near schools could have significant effects on obesity among school children, but similar policies restricting the availability of fast food in residential areas are unlikely to have large effects on adults.Food Consumption/Nutrition/Food Safety, Health Economics and Policy,

Persuasion: Empirical Evidence

We provide a selective survey of empirical evidence on the effects as well as the drivers of persuasive communication. We consider persuasion directed at consumers, voters, donors, and investors. We organize our review around four questions. First, to what extent does persuasion affect the behavior of each of these groups? Second, what models best capture the response to persuasive communication? In particular, we distinguish information-based models from preference-based models. Third, what are persuaders' incentives and what limits their ability to distort communications? Finally, what evidence exists on the equilibrium outcomes of persuasion in economics and politics?