the causes of preference reversal observed preference reversal cannot be adequately explained by violations of independence the reduction axiom or transitivity the primary cause of preference reversal is the failure of procedure invariance especially the overpricing of low probability high payoff bets this result violates regret theory and generalized nonindependent utility models preference reversal and a new reversal involving time preferences are explained by scale compatibility which implies that payoffs are weighted more heavily in pricing than in choice copyright 1990 by american economic association

does the preference reversal phenomenon necessarily contradict the independence axiom one of the most puzzling paradoxes in decision theory is the preference reversal phenomenon this phenomenon seems to contradict the transitivity axiom for a long time one of the cornerstones of utility theory this paradox is established whenever a decision maker prefers lottery x to lottery y but is willing to put a lower selling price on x than on y such experiments first reported by harold lindman 1971 and sarah lichtenstein and paul slovic 1971 were repeated by david grether and charles plott 1979 werner pommerehne et al 1982 and robert reilly 1982 although the later researchers improved the mechanism through which the selling price emerges they all found systematic reversals a new approach to this problem was developed by charles holt 1986 and edi karni and zvi safra 1987 from two different starting points these authors showed that the preference reversal phenomenon does not necessarily prove a violation of the transitivity axiom as it may contradict the independence axiom this implies that people do not maximize expected utility but in that case the preference reversal phenomenon becomes just another evidence against expected utility theory but not against the transitivity axiom these results have their own disadvantages although the independence axiom is not as fundamental as transitivity it is nevertheless very appealing on normative grounds of course the preference reversal phenomenon necessarily contradicts at least one of the assumptions of expected utility theory but empirical evidence shows that despite its normative appeal violations of the reduction of compound lotteries axiom may happen see for example joshua ronen 1971 and doug snowball and clif brown 1979 in this paper i therefore suggest a decision mechanism for the preference reversals lotteries which is transitive and satisfies the independence axiom but not the reduction axiom

preference reversals and the independence axiom of all of the paradoxical patterns of behavior reported in laboratory experiments one of the most perplexing for decision theorists is the preference reversal phenomenon a subject in a preference reversal experiment is typically given a choice between a lottery with a high probability of winning a modest amount of money a p bet and a lottery with a low probability of winning a large amount of money a bet the lowest amount of money for which the subject would willingly sell either of these lotteries is also elicited the most common reversal is for a subject to choose the p bet over the bet but to put a higher selling price on the bet preference reversals were first reported by harold lindman 1971 and sarah lichtenstein and paul slovic 1971 in discussing the psychologists discovery of such reversals david grether and charles plott remark the inconsistency is deeper than mere lack of transitivity or even stochastic transitivity it suggests that no optimization principles of any sort lie behind even the simplest of human choices 1979 p 623 this paper offers a simple alternative explanation of documented preference reversals an explanation that does not require the abandonment of the transitivity assumption

economic theory of choice and the preference reversal phenomenon a reexamination in a recent issue of this review david grether and charles plott 1979 hereinafter referred to as g p presented a series of experiments that show that individual decisions are made in a manner inconsistent with standard preference theory this inconsistency can be illustrated by the following example individuals under suitable laboratory conditions first have a choice between a lottery with a high probability of winning a small sum of money the p bet probability bet and a lottery with a high stake but low probability of winning the m bet money bet after indicating a preference for one of the lotteries in the pair the same subjects are then asked to place a monetary value on each of the individual lotteries grether and plott found that a large number of participants stated a preference for the p bet in the first round but placed a higher value on the other lottery the m bet in the second round this behavior a preference reversal is inconsistent with the traditional statements of preference theory

the intrinsic value of decision rights philosophers psychologists and economists have long argued that certain decision rights carry not only instrumental value but may also be valuable for their own sake the ideas of autonomy freedom and liberty derive their intuitive appeal at least partly from an assumed positive intrinsic value of decision rights providing clean evidence for the existence of this intrinsic value and measuring its size however is intricate here we develop a method capable of achieving these goals the data reveal that the large majority of our subjects intrinsically value decision rights beyond their instrumental benefit the intrinsic valuation of decision rights has potentially important consequences for corporate governance human resource management and optimal job design it may explain why managers value power why employees appreciate jobs with task discretion why individuals sort into self employment and why the reallocation of decision rights is often very difficult and cumbersome our method and results may also prove useful in developing an empirical revealed preference foundation for concepts such as freedom of choice and individual autonomy

a test of the theory of reference dependent preferences eight alternative methods of eliciting preferences between money and a consumption good are identified two of these are standard willingness to accept and willingness to pay measures these methods differ with respect to the reference point used and the dimension in which responses are expressed the loss aversion hypothesis of tversky and kahneman s theory of reference dependent preferences predicts systematic differences between the preferences elicited by these methods these predictions are tested by eliciting individuals preferences for two private consumption goods the experimental design is incentive compatible and controls for income and substitution effects the theory s predictions are broadly confirmed

the effects of endowment and loss aversion in managerial stock option valuation assuming a positive influence of stock price volatility on stock option value incentive alignment proponents argue that stock option compensation encourages managerial risk seeking and thus aligns managers and shareholders risk preferences our findings show that stock option holders overvalue unexercisable options relative to options being offered and to normative e g black scholes valuations further the influence of stock price volatility on holders subjective valuations depends on stock price trend in sum results suggest that during stock option valuation managers draw on heuristics that financial options theory and models fail to capture we discuss implications for compensation design and research

market experience eliminates some anomalies and creates new ones we report two experiments which investigate whether experience of decision making in repeated markets purges behaviour of preference reversals we investigate two behavioural mechanisms that may be shaping bids in repeated auctions a tendency to adjust bids towards previously observed market prices and a tendency to reduce bids following bad market outcomes we find little support for the former but strong support for the latter also whilst just enough market exposure eliminates the typical preference reversal phenomenon continued exposure fosters the mirror image anomaly therefore although market experience shapes behaviour in our experiments it does not generally promote consistency with standard preference theory

actions versus prospects the effect of problem representation on regret suppose that you must choose between lotteries s safer and r riskier shown in the top half of figure 1 there are 100 possible states of the world and the consequence of s and r are indicated for each state the states of the world with the consequence win 8 000 are separate from the states with the consequence win 20 000 you may find s less appealing knowing that if you choose it and one of the states 71 100 occurs you would have received 20 000 had you picked r suppose that you must choose between lotteries s and r shown in the bottom half of figure 1 though the prospects probability distribution of consequences of s and r are identical to those of s and r the states of the world with positive payoffs overlap you may find s more appealing knowing that if you choose it and one of the states 1 30 occurs you would have received 20 000 had you picked r but s pays an 8 000 consolation prize a series of papers by graham loomes 1988a b 1989 and chris starmer and robert sugden 1989 provides evidence that in evaluating identical prospects the juxtaposition of consequences against different states of the world has a systematic effect on choice under uncertainty as predicted by regret theory david e bell 1982 peter c fishburn 1982 loomes and sugden 1982 1987a regret effects violate expected utility theory and all other prospect based theories of choice all of the laboratory evidence of regret or juxtaposition effects however has been generated under the problem representation in figure 1 the matrix of state contingent consequences while loomes 1988b p 468 argues that evidence of regret effects indicates that prospect based theories may all be failing to capture an important element in decision making under uncertainty this paper suggests that the experimental evidence of regret effects observed so far is specific to the matrix problem representation nearly 400 subjects completed versions of two questionnaires in which choice problems were presented in different formats the juxtaposition of consequences sways choices but only under the matrix presentation the first questionnaire indicates that regret effects are not observed when statecontingent consequences are described by ticket numbers rather than a matrix the second questionnaire indicates that if the matrix format is changed slightly to a simple proportional format subjects apparently compare prospects and ignore the juxtaposition of consequences regret theory predicts that choice depends on the juxtaposition of consequences but regret effects should be invariant to different representations of state contingent consequences

decision making over time and under uncertainty a common approach this paper considers a number of parallels between risky and intertemporal choice we begin by demonstrating a one to one correspondence between the behavioral violations of the respective normative theories for the two domains i e expected utility and discounted utility models we argue that such violations or preference reversals are broadly consistent with three propositions about the weight that an attribute receives in both types of multiattribute choice specifically it appears that 1 if we add a constant to all values of an attribute then that attribute becomes less important 2 if we proportionately increase all values of an attribute or if we change the sign of an attribute from positive to negative then that attribute becomes more important the generality of these propositions as well as the constraints they would impose on separable representations of multiattribute preferences is discussed

preference reversals without the independence axiom the preference reversal phenomenon was believed to be inconsistent with the transitivity axiom of decision theory however recent theoretical papers have demonstrated that the preference reversals that were observed in earlier experiments could be explained by subject violations of the independence axiom or the compound lottery axiom therefore those preference reversals are not known to be inconsistent with generalization of expected utility theory that replace the independence axiom the present paper reports the results of experiments in which a substantial proportion of subject responses violate the asymmetry axiom these results are inconsistent with expected utility theory and its generalizations copyright 1989 by american economic association

the troika paradox in three binary choice problems people reveal a choice pattern which falsifies expected utility theory and many generalized non expected utility theories this new paradox challenges popular non expected utility models analogously to how the allais paradox challenged neoclassical expected utility theory

a new approach to forecasting exchange rates abstract building on purchasing power parity theory this paper proposes a new approach to forecasting exchange rates using the big mac data from the economist magazine our approach is attractive in three aspects firstly it uses easily available big mac prices as input these prices avoid several potential problems associated with broad price indexes such as the consumer price index used in conventional ppp studies secondly this approach provides real time exchange rate forecasts at any forecast horizon these high frequency forecasts could be appealing to those who want up to date exchange rate forecasts finally as our forecasts are obtained through a simulation procedure estimation uncertainty is made explicit in our framework that provides the entire distribution of exchange rates not just a single point estimate using exchange rates of six major currencies to illustrate the approach we compare the big mac forecasts with those derived from a random walk and the cpi and find some support for our approach especially at longer term horizons

decision theory the next 100 years advances in decision theory have often been driven by paradoxes early in the eighteenth century daniel bernoulli and others wrestled with why prudent individuals often violate the principle of maximising expected return they were fascinated by the paradox of people paying at most a few pounds to engage in an infinite expectation game that returns 2 shillings if the first heads in a succession of coin tosses occurs at toss n later in the same century the marquis de condorcet was intrigued by the paradox of cyclical majorities for multicandidate elections in which there is no majority candidate who could defeat or tie every other candidate under simple majority comparisons based on voter preference rankings bernoulli s i 738 resolution of the prudent people paradox was an early version of expected utility theory in which one s utility for money increases at a decreasing rate his legacy is evident in later expected utility theories as well as the principle of diminishing marginal utility of wealth that was so popular

a prism into the ppp puzzles the micro foundations of big mac real exchange rates we match big mac prices with prices of its ingredients as a unique prism to study real exchange rates rers this approach has several advantages first the levels of the big mac rer can be measured meaningfully second as the exact composition of a big mac is known the contributions of its tradable and non tradable components can be estimated relatively precisely third the dynamics of the rer can be studied in a setting free of several biases inherent in cpi based rers finally a large cross country dimension allows us to overturn the engel result on what drives rers in most economies the exchange rate is the single most important relative price one that potentially feeds back into a large range of transactions obstfeld and rogoff 2000

regret theory a bold alternative to the alternatives in their famous 1982 paper in this journal loomes and sugden introduced regret theory now more than 30 years later the case for the historical importance of this contribution can be made

goal based construction of preferences task goals and the prominence effect preferences inferred from choice are more likely to favor the alternative that is superior with respect to the prominent most important or salient attribute than are preferences inferred from matching direct tradeoff judgments this prominence effect violates standard models of rational choice and complicates the task of measuring preferences in this article we propose a new task goal hypothesis regarding the prominence effect the prominent attribute receives more weight in tasks whose goal is to differentiate among options than in tasks whose goal is to equate options we use this hypothesis to generalize the prominence effect beyond choice and matching to several additional tasks including the choice based matching and difference comparison methods that are widely employed in decision analysis the results of three studies provide strong support for the task goal account of the prominence effect and cast doubt on competing explanations we discuss the implications of these findings for descriptive decision theory and for preference measurement in decision analysis public policy and marketing

endogenous price zones and investment incentives in electricity markets an application of multilevel optimization with graph partitioning in the course of the energy transition load and supply centers are growing apart in electricity markets worldwide rendering regional price signals even more important to provide adequate locational investment incentives this paper focuses on electricity markets that operate under a zonal pricing market design for a fixed number of zones we endogenously derive the optimal configuration of price zones and available transfer capacities on a network in order to optimally govern investment and production decisions in the long run in a multilevel mixed integer nonlinear model that contains a graph partitioning problem on the first level we determine welfare maximizing price zones and available transfer capacities for a given electricity market and analyze their impact on market outcomes using a generalized benders decomposition approach developed in grimm et al 2019 and a problem tailored scenario clustering for reducing the input data size we are able to solve the model to global optimality even for large instances we apply the approach to the german electricity market as an example to examine the impact of optimal zoning on key performance indicators such as welfare generation mix and locations or electricity prices it turns out that even for a small number of price zones an optimal configuration of zones induces a welfare level that almost approaches the first best

burgernomics the economics of the big mac standard abstract in the course of ppp research much of the debate over the validity has been over the choice of an appropriate basket for making purchasing power comparisons the different compositions of goods and services in these baskets across countries have resulted in arguments against their usefulness for ppp purposes this problem is augmented by the existence of productivity differentials in traded and non traded goods across countries therefore we consider the use of the big mac as the international monetary standard as being a more palatable alternative it is produced locally in over 80 countries around the world with only minor changes in recipe and thus has the flavour of the perfect universal commodity our results indicate that the big mac index is surprisingly accurate in tracking exchange rates over the long term which is consistent with previous ppp research findings we subsequently enhance our ppp comparisons by taking into account the productivity differentials between countries and excluding non traded goods from the big mac index to derive the no frills index

measuring consumers willingness to pay at the point of purchase abstract economists psychologists and marketing researchers rely on measures of consumers willingness to pay wtp in estimating demand for private and public goods and in designing optimal price schedules existing market research techniques for measuring wtp differ in whether they provide an incentive to consumers to reveal their true wtp and in whether they simulate actual point of purchase contexts the authors present an empirical comparison of several procedures for eliciting wtp that are applicable directly at the point of purchase in particular the authors test the applicability of becker degroot and marschak s 1964 well known incentive compatible procedure for assessing the utility of lotteries to measuring consumers wtp in three studies the authors explore the reliability validity and feasibility of the procedure and show that it yields lower wtp estimates than do non incentive compatible methods such as open ended and double bounded contingent valuation they show experimentally t

indifference or indecisiveness choice theoretic foundations of incomplete preferences abstract a commonly held belief in economics is that an individual s preferences that are revealed by her choices must be complete this paper takes issue with this position by showing that one may be able to distinguish between indifference and indecisiveness of an agent upon observing her choice behavior we relax the standard weak axiom of revealed preferences warp and show that a potent theory of individual choice with and without risk can be founded on this weaker axiom when it is coupled with some other standard postulates the most notable features here are that an agent is allowed to be indifferent between certain alternatives and indecisive about others moreover an outside observer can identify which of these actually occur upon examining the observable choice behavior of the decision maker as an application we also show how our theory may be able to cope with the classical preference reversal phenomenon

patterns in exchange rate forecasts for twenty five currencies the properties of exchange rate forecasts are investigated with a data set encompassing a broad cross section of currencies over the entire sample expectations appear to be biased this result is robust to the possibility of random measurement error in the survey measures there appear to be statistically significant differences in the degree of bias in subgroupings of the data the bias is lower for the high inflation countries the bias is greater for the major currencies studied in earlier papers and the bias is also greater for the ems currencies copyright 1994 by ohio state university press

non transitive preferences over gains and losses although transitivity is often regarded as an indispensable principle of rational choice under uncertainty some decision models allow nontransitive preferences one of these regret theory is consistent with a particular pattern of choice cycles when payoffs are nonnegative and the opposite pattern of cycles when payoffs are nonpositive this paper presents evidence from an experiment designed to test these implications of regret theory copyright 1992 by royal economic society

further evidence of preference reversals choice valuation and ranking over distributions of life expectancy moving between choice and direct valuation procedures can cause substantial systematic preference reversals which is problematic because it leaves us unsure as to which procedure if any is best this article reports a study that tests whether using a ranking procedure to infer values rather than more conventional direct valuation can negate this phenomenon the results suggest that the ranking procedure can render strict preference reversals both less substantial and less systematic this could have important implications for the valuation of health outcomes and in attempting to ascertain whether choice valuation or ranking best uncovers people s preferences similar tests in the context of more realistic health outcome descriptions are recommended

choice under uncertainty problems solved and unsolved ffifteen years ago the theory of choice under uncertainty could be considered one of the success stories of economic analysis it rested on solid axiomatic foundations it had seen important breakthroughs in the analytics of risk risk aversion and their applications to economic issues and it stood ready to provide the theoretical underpinnings for the newly emerging information revolution in economics 1 today choice under uncertainty is a field in flux the standard theory is being challenged on several grounds from both within and outside economics the nature of these challenges and of our profession s responses to them is the topic of this paper

preference reversals in willingness to pay and choice a fundamental contribution of consumer behavior research is to help marketing scholars develop an understanding of how people think about and express their preferences in this article we find that two commonly used preference elicitation procedures willingness to pay wtp and choice are consistently associated with different expressed preferences specifically choices are associated with a relatively greater preference for hedonic goods while wtp is associated with a relatively greater preference for utilitarian goods we find that this is caused in part by the greater reliance on deliberation in determining wtp values while preferences in choices are determined by an affect heuristic unlike other choice and wtp preference reversals we find that this effect is not caused by mechanical determinants such as scale compatibility as the effect persists with continuous scale measures that rely on affect and with choice based scale measures that rely on determining valuation

purchasing power parity price indices and exchange rate forcasts abstract this paper addresses the issue of using aggregate price indices for purchasing power parity ppp tests and the fitness of ppp as a model for exchange rate forecasting compared with consumer price index cpi and wholesale price index wpi the price index of traded goods tpi appears to be a more appropriate price index for both ppp tests and exchange rate forecasting it performs better in the tests and provides superior exchange rate forecasts both within and out of sample while the half life of the estimated deviations from ppp is about two years for the cpi and wpi based real exchange rates it is only one year for the tpi based real exchange rates

the purchasing power parity debate originally propounded by the 16th century scholars of the university of salamanca the concept of purchasing power parity ppp was revived in the interwar period in the context of the debate concerning the appropriate level at which to re establish international exchange rate parities broadly accepted as a long run equilibrium condition in the post war period it first was advocated as a short run equilibrium by many international economists in the first few years following the breakdown of the bretton woods system in the early 1970s and then increasingly came under attack on both theoretical and empirical grounds from the late 1970s to the mid 1990s accordingly over the last three decades a large literature has built up that examines how much the data deviated from theory and the fruits of this research have provided a deeper understanding of how well ppp applies in both the short run and the long run since the mid 1990s larger datasets and nonlinear econometric methods in particular have improved estimation as deviations narrowed between real exchange rates and ppp so did the gap narrow between theory and data and some degree of confidence in long run ppp began to emerge again in this respect the idea of long run ppp now enjoys perhaps its strongest support in more than 30 years a distinct reversion in economic thought

an evaluation of survey exchange rate forecasts abstract a non parametric test of direction is employed to evaluate the survey forecasts provided by the money market services empirical results suggest that the forecasts are useful for predicting the direction of exchange rate changes the results are consistent with a weaker form of rationality than unbiasedness

justification effects on consumer choice of hedonic and utilitarian goods abstract people want to have fun and they are more likely to have fun if the situation allows them to justify it this research studies how people s need for justifying hedonic consumption drives two choice patterns that are observed in typical purchase contexts first relative preferences between hedonic and utilitarian alternatives can reverse depending on how the immediate purchase situation presents itself a hedonic alternative tends to be rated more highly than a comparable utilitarian alternative when each is presented singly but the utilitarian alternative tends to be chosen over the hedonic alternative when the two are presented jointly second people have preferences for expending different combinations of time effort and money for acquiring hedonic versus utilitarian items they are willing to pay more in time for hedonic goods and more in money for utilitarian goods the author explores the topic through a combination of four experiments and field studies

the end of the opportunism vs trust debate bounded reliability as a new envelope concept in research on mne governance modern transaction cost economics tce thinking has developed into a key intellectual foundation of international business ib research but the williamsonian version has faced substantial criticism for adopting the behavioral assumption of opportunism in this paper we assess both the opportunism concept and existing alternatives such as trust within the context of ib research especially work on multinational enterprise mne governance case analyses of nine global mnes illustrate an alternative to the opportunism assumption that captures more fully the mechanisms underlying failed commitments inside the mne as a substitute for the often criticized assumption of opportunism we propose the envelope concept of bounded reliability brel an assumption that represents more accurately and more completely the reasons for failed commitments without invalidating the other critical assumption in conventional tce and internalization theory thinking namely the widely accepted envelope concept of bounded rationality brat bounded reliability as an envelope concept includes two main components within the context of global mne management opportunism as intentional deceit and benevolent preference reversal the implications for ib research of adopting the bounded reliability concept are far reaching as this concept may increase the legitimacy of comparative institutional analysis in the social sciences

discount rates for time versus dates the sensitivity of discounting to time interval description abstract six experiments examine the impact of time interval descriptions on consumers discount rates consumers exhibit more discounting e g they demand more money to delay income when delay intervals are described by extents of time than when delay intervals are described by dates this pattern holds in various contexts including gains and losses and is robust to response mode changes findings further indicate that this effect may arise because compared with date descriptions extent descriptions enhance perceptions of interval length the author discusses other potential mechanisms and implications

repeated dichotomous choice formats for elicitation of willingness to pay simultaneous estimation and anchoring effect repeated dichotomous choice contingent valuation data are generated from responses to a succession of binary questions regarding alternative prices for an environmental good in this paper we propose a simultaneous equation model that allows for endogeneity and error correlation across the responses at each stage of the bidding process the model allows us to study the evolution of anchoring effects after the second dichotomous choice question estimation involves the bayesian techniques of gibbs sampling and data augmentation and the application focuses on the preservation value of a natural area the results for a data set involving up to four successive dichotomous choice questions show that restricted multiple bounded models are rejected by the data with the general model in addition willingness to pay tends to stabilize after the second stage in the elicitation process for the general unrestricted model when taking anchoring effects into consideration it is revealed that individuals responses in the latter stages are influenced by the sequence of bid prices offered in earlier questions nevertheless they do not have a significant effect on welfare estimates

the overvaluation of purchasing power parity abstract recent panel studies of purchasing power parity have reported strong evidence of mean reversion in real exchange rates however these studies fail to control for cross sectional dependence in the data this failure has dramatic consequences raising the significance level of tests with a nominal size of 5 percent to as much as 50 percent it is shown in this paper that controlling for cross sectional dependence no evidence against the random walk null can be found in panels of up to 64 real exchange rates this finding cannot be attributed to low power as there is ample power in panels of this size to reject the unit root null