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

optimal consumption and investment with transaction costs and multiple risky assets we consider the optimal intertemporal consumption and investment policy of a constant absolute risk aversion cara investor who faces fixed and proportional transaction costs when trading multiple risky assets we show that when asset returns are uncorrelated the optimal investment policy is to keep the dollar amount invested in each risky asset between two constant levels and upon reaching either of these thresholds to trade to the corresponding optimal targets an extensive analysis suggests that transaction cost is an important factor in affecting trading volume and that it can significantly diminish the importance of stock return predictability as reported in the literature this paper studies the optimal intertemporal consumption and investment policy of an investor with a constant absolute risk aversion cara preference and an infinite horizon the investor can trade in one risk free asset and n 1 risky assets in contrast to the standard setting the investor faces both fixed and proportional transaction costs in trading any of these risky assets in the absence of transaction costs and when risky asset prices follow geometric brownian motions the optimal investment policy is to keep a constant dollar amount in each risky asset as shown by merton 1971 this trading strategy requires continuous trading in all the risky assets in addition the optimal consumption is affine in the total wealth in the presence of transaction costs however trading continuously in a risky asset would incur infinite transaction costs therefore risky assets are traded only infrequently in this case the literature on optimal consumption and investment with multiple risky assets subject to transaction costs is limited leland 2000 examines a multiasset investment fund that is subject to transaction costs and capital gains taxes under the assumption that the fund has an exogenous target for each risky asset he develops a relatively simple numerical procedure to compute the no transaction region akian menaldi and sulem 1996 consider an optimal consumption and investment problem with proportional transaction costs for

non transitive choice event splitting effects or framing effects recent studies have examined possible causes of the robust empirical failure of the transitivity axiom of expected utility theory by pitting regret aversion against alternative explanations such as event splitting effects these tests show that cycles replicate when the latter are controlled but are sensitive to changes in problem representation the control for event splitting effects however does not rule out their contribution to cyclical choices in some circumstances an experiment is reported which investigates this possibility cyclical choices are observed that cannot be due to event splitting effects but appear attributable to within event and between act evaluations of decision problems plus framing effects

probabilistic risk aversion with an arbitrary outcome set abstract this paper analyzes risk aversion when outcomes consequences may not be measurable in monetary terms and people have fuzzy preferences over lotteries i e they choose in a probabilistic manner the paper shows that comparative risk aversion is well defined in a constant error tremble model but not in a strong utility model

are ghettos good or bad spatial separation of racial and ethnic groups may theoretically have positive or negative effects on the economic performance of those groups we examine the effects of segregation on outcomes for blacks in schooling employment and single parenthood we find that blacks in more segregated areas have significantly worse outcomes than blacks in less segregated areas we control for the endogeneity of location choice using instruments based on political factors topographical features and residence before adulthood a one standard deviation decrease in segregation would eliminate one third of the black white differences in most of our outcomes

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

monotone stochastic choice models the case of risk and time preferences suppose that when evaluating two alternatives x and y by means of a parametric utility function low values of the parameter indicate a preference for x and high values indicate a preference for y

portfolio selection with capital gains tax recursive utility and regime switching capital gains taxation has important implications for investors portfolio choice decisions to explore these implications we develop a continuous time investment and consumption model with capital gains tax epstein zin recursive utility and regime switching we find that various factors such as tax rate risk aversion interest rate stock return and volatility jointly affect optimal portfolio allocation whereas intertemporal substitution does not in a regime switching market investors may trade or stop trading purely because of a change in regime and there is a distinct cross regime effect on optimal portfolio allocation in particular investors tend to raise stock investment in a bear regime so as to reduce potential tax payments upon regime switching given reasonable parameter values regime switching has a greater impact on optimal portfolio allocation in a bear regime than in a bull regime this paper was accepted by neng wang finance

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

are preferences monotonic testing some predictions of regret theory in this paper the authors demonstrate that the assumption of regret aversion which has been invoked in regret theory to explain several well documented violations of expected utility theory also implies the existence of strict preferences between some stochastically equivalent actions and implies certain systematic violations of monotonicity the authors report an experimental test of these predictions they find that while choices between stochastically equivalent actions are entirely consistent with expected utility theory there is clear evidence of the monotonicity violations predicted by regret theory copyright 1992 by the london school of economics and political science

a reality check for game theory there is a tendency for some economists who are less familiar with game theory gt to comment that it has never fulfilled its early promise and that it essentially has little to offer as a tool to understand predict and guide human social and economic behaviour for instance in sylvia nasar s book a beautiful mind she recounts the remarkable controversy that surrounded the award of a nobel prize for gt including one committee member apparently asking for a single major example that game theory had any empirical validity whatsoever p 371 an excellent reply to such sceptics would be to present them with a copy of colin camerer s new book behavioral game theory this is not to say that his book catalogues an unbroken string of successes for the theory as we shall see neither gt nor human behaviour emerges unscathed from the body of work reported therein

choice by sequential procedures article history we propose a rule of decision making the sequential procedure guided by routes and show that three influential boundedly rational choice models can be equivalently understood as special cases of this rule in addition the sequential procedure guided by routes is instrumental in showing that the three models are intimately related we show that choice with a status quo bias is a refinement of rationalizability by game trees which in turn is also a refinement of sequential rationalizability thus we provide a sharp taxonomy of these choice models and show that they all can be understood as choice by sequential procedures

monotone equilibria in bayesian games of strategic complementarities for bayesian games of strategic complementarities we provide a constructive proof of the existence of a greatest and a least bayes nash equilibrium each one in strategies that are monotone in type our main assumptions besides strategic complementarities are that each player s payoff displays increasing differences in own action and the profile of types and that each player s interim beliefs are increasing in type with respect to first order stochastic dominance e g types are affiliated the result holds for general action and type spaces single multi or infinite dimensional continuous or discrete and no prior is assumed we also provide the following comparative statics result the greatest and least equilibria are higher if there is a first order stochastic dominant shift in the interim beliefs we apply this result to strategic information revelation in games of voluntary disclosure

job exit behavior of older men a dynamic programming model of job exit behavior and retirement is constructed and estimated using the method of simulated moments the model and estimation method allow for both unobserved individual effects and unobserved job specific match effects the model is estimated using two different assumptions about individual discount factors first a static model with the discount factor equal to zero is estimated then a dynamic model with the discount factor equal to 95 is estimated in both models it is found that bad health age and lack of education increase the probability of retirement the dynamic model performs better than the static model and has different implications for retirement behavior the job specific effects are an important source of unobserved heterogeneity copyright 1991 by the econometric society

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

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

decisions error and heterogeneity probabilistic choices or choice errors may play an important supporting role in shaping observed risky choices and a variety of restrictions on such choice probabilities play the role of identifying restrictions in empirical decision research we test six restrictions in the context of common ratio effect data for a general class of theories of risky choice two restrictions one for aggregate and one for individual data are supported but none of the heterogeneity restrictions that make the aggregate data model powerful survive scrutiny nor do estimable parametric versions of the individual data model there is room for new stochastic identifying restrictions in empirical decision research

optimal portfolio selection with transaction costs and finite horizons we examine the optimal trading strategy for a crra investor who maximizes the expected utility of wealth on a finite date and faces transaction costs closed form solutions are obtained when this date is uncertain we then show a sequence of analytical solutions converge to the solution to the problem with a deterministic finite horizon consistent with the common life cycle investment advice the optimal trading strategy is found to be horizon dependent and largely buy and hold moreover it might be optimal for the investor in our model not to buy any stock even when the risk premium is positive further analysis of the optimal policy is also provided financial advisers typically recommend that younger investors should allocate a greater share of wealth to stocks than older investors and all investors

optimal tax timing with asymmetric long term short term capital gains tax we develop an optimal tax timing model that takes into account asymmetric long term and short term tax rates for positive capital gains and limited tax deductibility of capital losses in contrast to the existing literature this model can help explain why many investors not only defer short term capital losses to long term but also defer large long term capital gains and losses because the benefit of tax deductibility of capital losses increases with the short term tax rates effective tax rates can decrease as short term capital gains tax rates increase

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

imprecision as an account of the preference reversal phenomenon many individuals choices and valuations involve a degree of uncertainty imprecision this paper reports an experiment designed to obtain some measure of imprecision and to examine the extent to which it can explain preference reversals of two opposite forms one of which appears not to have been reported previously the model of imprecision we examine not only predicts both patterns but also provides an account of earlier results that are otherwise not well explained the results suggest that any successful descriptive theory of choice and valuation will need to allow in some way for the imprecision surrounding people s decisions

the relevance of irrelevant alternatives abstract in an experimental setting subjects face a standard elicitation task for certainty equivalents we show that when a third objectively irrelevant option is added to the standard task the willingness to take risks increases

blockbusting brokers and the dynamics of segregation abstract the paper presents a dynamic model of neighborhood segregation where fee motivated real estate brokers match sellers optimally either to minority or to white buyers in an initially all white neighborhood real estate brokers thus either keep the neighborhood in a steady state white equilibrium or trigger racial transition by matching sellers to minority buyers a process called blockbusting racial transition leads to a higher rate of property turnover in the neighborhood once the fraction of minorities has reached a tipping point but racial transition also leads to lower prices and this is the trade off faced by a broker the model shows that with multiple brokers blockbusting profit per broker is lower as brokers free ride on each other s groundbreaking efforts the model predicts that racial transition will happen in the neighborhood when i the number of brokers is limited ii racial preferences lie in an intermediate range iii the arrival rate of offers is intermediate otherwise real estate brokers steer white households toward white buyers

stochastic choice an optimizing neuroeconomic model a model is proposed in which stochastic choice results from noise in cognitive processing rather than random variation in preferences the mental process used to make a choice is nonetheless optimal subject to a constraint on available information processing capacity that is partially motivated by neurophysiological evidence the optimal information constrained model is found to oer a better t to experimental data on choice frequencies and reaction times than either a purely mechanical process model of choice the drift diusion

a micro econometric analysis of risk aversion and the decision to self insure this study estimates a von neumann morgenstern utility function using market data and micro econometric methods we investigate the decision whether to purchase insurance against the risk of telephone line trouble in the home using the choices of approximately 10 000 residential customers we determine the shape of the utility function and the degree of risk aversion we find that risk aversion varies systematically in the population and varies with the level of income and that the observed choice behavior is consistent with expected utility maximization we are unable to detect the presence of ambiguity effects or over weighting of low probability events

measuring the value of children by sex and age using a dynamic programming model one of the important determinants of fertility is the value of children as perceived by parents this paper estimates gender and age specific values of children using a dynamic programming model the underlying hypothesis is that observed fertility outcome for any couple is the solution to their life cycle optimization problem findings from the korean data indicate that children impose net costs when young and net benefits when old both the early costs and the later benefits are larger for male children than female children and for better educated women than lowereducated women simulation studies which use estimated values of children suggest that a decrease in the costs of abortion and pre natal gender screening tests may raise the male birth ratio through gender selective abortions

heterogeneity in risky choice behaviour in a broad population we analyse risk preferences using an experiment with real incentives in a representative sample of 1 422 dutch respondents our econometric model incorporates four structural parameters that vary with observed and unobserved characteristics utility curvature loss aversion preferences towards the timing of uncertainty resolution and the propensity to choose randomly rather than on the basis of preferences we find that all four parameters contribute to explaining choice behaviour the structural parameters are significantly associated with socio economic variables but it is essential to incorporate unobserved heterogeneity in each of them to match the rich variety of choice patterns in the data

crime and social interactions the high variance of crime rates across time and space is one of the oldest puzzles in the social sciences this variance appears too high to be explained by changes in the exogenous costs and benefits of crime we present a model where social interactions create enough covariance across individuals to explain the high cross city variance of crime rates this model provides an index of social interactions which suggests that the amount of social interactions is highest in petty crimes moderate in more serious crimes and almost negligible in murder and rape

optimal portfolio choice with wash sale constraints abstract we analytically solve the portfolio choice problem in the presence of wash sale constraints in a two period model with one risky asset our results show that wash sale constraints can heavily affect portfolio choice of investors with unrealized losses the trading behavior of such investors is to a large extent driven by the desire to realize those losses either immediately by sharply decreasing the holding of assets carrying unrealized losses or indirectly by increasing such holdings in order to prepare for a decrease in a future period to earn the tax rebate payment our findings are robust to increasing the number of trading dates and introducing a second risky asset and a correlation structure

testing different stochastic specificationsof risky choice the harless camerer hc hey orme ho and random preference rp models of stochastic variation in choice under uncertainty are compared implications of these models including some that are independent of the deterministic theory with which they are combined are tested in an experiment in which participants respond to decision problems twice the hc model generally performs poorly the ho model predicts more violations of dominance than are observed while the rp model fails to account for those few violations which do occur additional regularities are observed which are inconsistent with all three models when combined with expected utility theory

the common consequence effect testing a unified explanation of recent mixed evidence abstract the common consequence effect is perhaps the most investigated violation of expected utility theory and yet no single generalised expected utility model convincingly organises the experimental data this paper reports a test of a modified version of expected cardinality specific utility theory with boundary effects neilson w s 1992 economics letters 39 275 278 which can explain some recent mixed evidence without recourse to subjective probability weighting models the results do not convincingly support the boundary effect hypothesis and neither support the more usual probability weighting arguments but do indicate instability in preferences largely consistent with event splitting effects

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

experimental economics hard science or wasteful tinkering i take it that in raising the question what have we learned from experimental economics under the broader umbrella of controversy the point is not to solicit a catalogue of experimental findings but rather to signal the more pointed question are we learning anything at all or at least much that is very useful form experimentation in economics as a practising experimentalist i am convinced that experiments do have the potential to make a significant contribution to knowledge in economics this abstract was borrowed from another version of this item

portfolio investment with the exact tax basis via nonlinear programming computing the optimal portfolio policy of an investor facing capital gains tax is a challenging problem because the tax to be paid depends on the price at which the security was purchased the tax basis the optimal policy is path dependent and the size of the problem grows exponentially with the number of time periods dammon et al 2001 2002 2004 garlappi et al 2001 and gallmeyer et al 2001 address this problem byapproximating the exact tax basis by the weighted average purchase price our contribution is threefold first we show that the structure of the problem has several attractive features that can be exploited to determine the optimal portfolio policy using theexact tax basis via nonlinear programming second we characterize the optimal portfolio policy in the presence of capital gains tax when using theexact tax basis third we show that the certainty equivalent loss from using the average tax basis instead of the exact basis is very small it is typically less than 1 for problems with up to 10 periods and this result is robust to the choice of parameter values and to the presence of transaction costs dividends intermediate consumption labor income tax reset provision at death and wash sale constraints

tipping and the dynamics of segregation schelling dynamic models of segregation journal of mathematical sociology 1 1971 143 186 showed that extreme segregation can arise from social interactions in white preferences once the minority share in a neighborhood exceeds a tipping point all the whites leave we use regression discontinuity methods and census tract data from 1970 through 2000 to test for discontinuities in the dynamics of neighborhood racial composition we find strong evidence that white population flows exhibit tipping like behavior in most cities with a distribution of tipping points ranging from 5 to 20 minority share tipping is prevalent both in the suburbs and near existing minority enclaves in contrast to white population flows there is little evidence of nonlinearities in rents or housing prices around the tipping point tipping points are higher in cities where whites have more tolerant racial attitudes

hierarchical maximum likelihood parameter estimation for cumulative prospect theory improving the reliability of individual risk parameter estimates an individual s tolerance of risk can be quantified by using decision models with tuned parameters that maximally fit a set of risky choices the individual has made a goal of this model fitting procedure is to identify parameters that correspond to stable underlying risk preferences these preferences can be modeled as an individual difference indicating a particular decision maker s tastes and willingness to accept risk using hierarchical statistical methods we show significant improvements in the reliability of individual risk preference parameter estimates over other common methods for cumulative prospect theory this hierarchical procedure uses population level information in addition to an individual s choices to break ties or near ties in the fit quality for sets of possible risk preference parameters by breaking these statistical ties in a sensible way researchers can avoid overfitting choice data and thus more resiliently measure individual differences in people s risk preferences thi

race segregation and postal employment new evidence on spatial mismatch abstract the spatial mismatch hypothesis posits that employment decentralization isolated urban blacks from work opportunities this paper focuses on one large employer that has remained in the central city over the twentieth century the u s postal service we find that blacks substitute towards postal work as other employment opportunities leave the city circa 1960 the response is particularly strong in segregated areas where black neighborhoods are clustered near the central business district furthermore this pattern only holds for non mail carriers many of whom work in central processing facilities more recently the relationship between black postal employment and segregation has declined suggesting that spatial mismatch has become less important over time

sequentially rationalizable choice a sequentially rationalizable choice function is a choice function that can be retrieved by applying sequentially to each choice problem the same xed set of asymmetric binary relations rationales to remove inferior alternatives these con cepts translate into economic language some human choice heuristics studied in psychology and explain cyclical patterns of choice observed in experiments we study some properties of sequential rationalizability and provide a full character ization of choice functions rationalizable by two and three rationales

a context dependent model of the gambling effect this paper presents a context dependent theory of decision under risk the relevant contextual factor is the presence of a riskless lottery in a preference comparison the theory only deviates from expected utility if the set of options contains both riskless and risky lotteries the main motivation for the theory is to explain the gambling effect contrary to previous theories of the gambling effect the present theory is consistent with stochastic dominance it can however violate transitivity the theory allows for a decomposition of the interaction between risk aversion and gambling aversion and thereby extends the classical arrow pratt measure of risk aversion

disappointment and dynamic consistency in choice under uncertainty the central proposition of disappointment theory is that an individual forms expectations about uncertain prospects and that if the actual consequence turns out to be worse than or better than that expectation the individual experiences a sensation of disappointment or elation generating a decrement or increment of utility which modifies the basic utility derived from the consequence by incorporating a simple disappointment elation function into a model of individual choice many observed violations of conventional expected utility axioms including violations of savage s sure thing principle and the isolation effect can be predicted and defended as rational and dynamically consistent behaviour

expected utility violations implications for agricultural and natural resource economics nomic toolkit they compare the dogged defense of eu by economists to that of a monty python character playing the role of a petstore owner disputing the state of an obviously dead parrot the shop owner goes through incredible machinations to avoid replacing the bird let us consider another analogy the behavior of a caged parrot can likely tell us very little about the behavior of parrots in the wild a biologist may want to incorporate the behavior of caged parrots into the study of wild birds but would undoubtedly need to be extremely careful about understanding the underlying differences in the opportunities and constraints faced by caged versus wild birds before inferring much about wild parrot behavior to some extent experimental violations of eu present us with the same problem as the hypothetical parrot biologist subjects in these risk experiments are in a setting and are completing tasks very different from the setting and tasks they face in their everyday economic and social context what is missing relates to the power of the rationality assumption discussed in friedman that relies not only on the person s skill but also on the feedback they receive from the market friedman s expert billiards players are selected by a market because of their skill in billiards and th se are the players who fit friedman s as if description 1 risk researchers should not ignore experimental data however before we eliminate eu we should more fully understand the underlying reasons for the experimental behavior that violates eu agricultural and natural resource economists are well suited to assess

monetary rewards and decision cost in experimental economics a survey of thirty one experimental studies which report data on the comparative effects of monetary rewards and opportunity cost shows 1 several studies in which increased rewards shift the central tendency of the data toward the predictions of rational models 2 in virtually all cases rewards reduce the variance of the data around the predicted outcome this is consistent with a model in which rewards are balanced against decision cost in agent behavior and explicates the argument that when rational models fail it can be attributed to low opportunity cost of deviations from the rational prediction

expectations and the timing of neighborhood change abstract we study the role of expectations when agents have a preference for segregation and households face moving frictions in a fixed environment there are multiple equilibria agents expectations determine whether an ethnic transition occurs however the outcome is unique if there is a deterministic trend that gradually makes the neighborhood more appealing to the outside group it is also unique if the relative payoff from living in the neighborhood is subject to small shocks in both cases the insiders must leave at the first possible moment when the outsiders would outbid them if an immediate ethnic transition were expected

a theory of anticipated utility abstract a new theory of cardinal utility with an associated set of axioms is presented it is a generalization of the von neumann morgenstern expected utility theory which permits the analysis of phenomena associated with the distortion of subjective probability

optimal stock trading with personal taxes implications for prices and the abnormal january returns abstract the tax law confers upon the investor a timing option to realize capital losses and defer capital gains with the tax rate on long term gains and losses being about half the short term rate the law provides a second timing option to realize losses short term and gains long term if at all our theory and simulation over the 1962 1977 period establish that taxable investors should realize long term gains in high variance stocks and repurchase stock in order to realize potential future losses short term tax trading does not explain the small firm anomaly but predicts a seasonal pattern in trading volume which maps into a seasonal pattern in stock prices the january anomaly only if investors are irrational or ignorant of the price seasonality

incorporating a stochastic element into decision theories abstract recent papers by harless and camerer 1994 and hey and orme 1994 have employed two rather different models of errors in decision making under uncertainty the present paper develops a third approach and shows how different stochastic specifications of the same deterministic core theory may generate very different and sometimes surprising hypotheses

observing violations of transitivity by experimental methods the preference reversal phenomenon is usually interpreted as evidence of nontransitivity of preference but has also been explained as the result of the difference between individuals responses to choice and valuation problems the devices used by experimenters to elicit valuations and the random lottery selection incentive system this paper reports an experiment designed so that none of these factors could generate systematic nontransitivities yet systematic violations of transitivity were still found the pattern of violation was analogous with that found in previous preference reversal experiments and is consistent with regret theory copyright 1991 by the econometric society

behavior in the centipede game a decision theoretical perspective the centipede game is a two player finite game of perfect information where a unique subgame perfect nash equilibrium appears to be intuitively unappealing and descriptively inadequate this paper analyzes behavior in the centipede game when a traditional game theoretical assumption that players maximize expected utility is relaxed we demonstrate the existence of a descriptively adequate subgame perfect equilibrium under two standard decision theoretical assumptions first players choose under uncertainty in a probabilistic manner as captured by embedding a core deterministic decision theory in a model of probabilistic choice second players adopt non linear decision weights and overweight the likelihood of rare events as captured for example by rank dependent utility or prospect theory

rational choice with status quo bias abstract motivated by the empirical findings concerning the importance of one s current situation on her choice behavior the main objective of this paper is to propose a rational choice theory that allows for the presence of a status quo bias and that incorporates the standard choice theory as a special case we follow a revealed preference approach and obtain two nested models of rational choice that allow phenomena like the status quo bias and the endowment effect and that are applicable in any choice situation to which the standard static choice model applies

experimental investigations of errors in decision making under risk abstract many if not all of the recent theories of decision making under risk that have been developed in the light of experimentally observed violations of expected utility theory are essentially deterministic in nature yet it is clear that actual decision making contains a random or error component this paper surveys the assumptions that have been employed in previous analyses of such experimental data and tries to find better explanations both from an economic and an econometrics point of view of such errors hopefully such work will lead to a unified theory in which the stochastic component is an integral part

understanding preference imprecision the term preference imprecision seems to have different meanings to different people in the literature one can find references to a number of expressions for example vagueness incompleteness randomness unsureness indecisiveness and thick indifference curves some of these are theoretical constructs some are empirical the purpose of this paper is to survey the various different approaches and to try to link them together to see if they are all addressed to the same issue and to come to some conclusions in the course of this survey we report on evidence concerning the existence of preference imprecision and its impact on theoretical and empirical work

testing new theories of choice under uncertainty using the common consequence effect a generalised common consequence problem is used to contrast the predictions of expected utility theory and several new theories of choice under uncertainty an experiment designed to test these predictions is reported systematic violations of expected utility theory are detected but although a consistent pattern emerges from the data it offers little support for any of the new theories the analysis is extended to test predictions which are unique to regret theory and significant regret effects are detected

optimal consumption and investment with capital gains taxes this article characterizes optimal dynamic consumption and portfolio decisions in the presence of capital gains taxes and short sale restrictions the optimal decisions are a function of the investor s age initial portfolio holdings and tax basis our results capture the trade off between the diversification benefits and tax costs of trading over an investor s lifetime the incentive to rediversify the portfolio is inversely related to the size of the embedded gain and investor s age contrary to standard financial advice the optimal equity holding increases well into an investor s lifetime in our model due to the forgiveness of capital gains taxes at death taxes play an important role in the decision making process of individuals concerning their consumption and investment plans the taxation of returns on financial assets alters the benefits of saving for future consumption and thus affects the trade off between current consumption and investment moreover the ability of investors to defer the taxation of capital gains alters the relative valuation of stocks and bonds and thus affects the optimal portfolio composition of investors the deferral feature of capital gains taxes also affects the trade off investors face regarding taxes and diversification investors would like to maintain an optimally diversified portfolio over time

are stocks desirable in tax deferred accounts abstract existing literature suggests that in order to maximize the tax benefit of retirement accounts investors should follow a pecking order location rule of placing highly taxed assets e g bonds in a tax deferred account and lightly taxed assets e g stocks in a taxable account empirical evidence however documents that a large number of investors violate this rule in this paper we show that such violations can be optimal for risk averse investors who face portfolio constraints in particular while the strategy of placing bonds in the tax deferred account maximizes the expected level of tax benefit it may lead to volatile benefits under different realizations of stock returns by holding a similar portfolio in both accounts investors can achieve a more balanced growth in the two accounts minimize the likelihood of violating the constraints in the future and hence smooth the volatility of the tax benefit for some risk averse investors this smoothing motive can lead to the observed violation of the pecking order location rule our model predicts that such violations are more likely when future tax benefits are more volatile which can occur for example when i the tax rate differential across assets increases over time due either to tax law changes or to tax bracket changes for investors ii asset returns are more volatile and iii investors anticipate large future liquidity needs

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

cognitive imprecision and small stakes risk aversion observed choices between risky lotteries are difficult to reconcile with expected utility maximization both because subjects appear to be too risk averse with regard to small gambles for this to be explained by diminishing marginal utility of wealth as stressed by rabin 2000 and because subjects responses involve a random element we propose a unified explanation for both anomalies similar to the explanation given for related phenomena in the case of perceptual judgments they result from judgments based on imprecise and noisy mental representations of the decision situation in this model risk aversion results from a sort of perceptual bias but one that represents an optimal decision rule given the limitations of the mental representation of the situation we propose a quantitative model of the noisy mental representation of simple lotteries based on other evidence regarding numerical cognition and test its ability to explain the choice frequencies that we observe in a laboratory experiment

equity and efficiency in human capital investment the local connection a general model of community formation and human capital accumulation with social spillovers and decentralized school funding is used to analyse the causes of economic segregation and its consequences for equity and efficiency significant polarization arises from minor differences in endowments preferences or access to capital markets this makes income inequality more persistent across generations but the same need not be true for wealth equilibrium stratification tends to be excessive resulting in low aggregate surplus whether state equalization of school resources can remedy these problems hinges on how purchased social and family inputs interact in education and in mobility decisions

temporal stability of time preferences abstract the preferences assumed to govern intertemporal trade offs are generally considered to be stable economic primitives though evidence on this stability is notably lacking we present evidence from a large field study conducted over two years with around 1 400 individuals using incentivized intertemporal choice experiments aggregate choice profiles and corresponding estimates of discount parameters are unchanged over the two years and individual correlations through time are high by existing standards however some individuals show signs of instability by linking experimental measures to administrative tax records we showthat identified instability is uncorrelated with both levels and changes in sociodemographic variables

are risk preferences stable across contexts evidence from insurance data using a unique dataset we test whether households deductible choices in auto and home insurance reflect stable risk preferences our test relies on a structural model that assumes households are objective expected utility maximizers and claims are generated by household coverage specific poisson processes we find that the hypothesis of stable risk preferences is rejected by the data our analysis suggests that many households exhibit greater risk aversion in their home deductible choices than their auto deductible choices our results are robust to several alternative modeling assumptions jel d11 d83

developments in non expected utility theory the hunt for a descriptive theory of choice under risk this article reviews recent developments in the economic theory of individual decision making under risk since the 1950s it has been known that individual choices violate the standard model of expected utility in predictable ways considerable research effort has now been devoted to the project of developing a superior descriptive model following an overview of non expected utility theories which distinguishes between conventional and non conventional approaches the paper seeks to assess these alternative models in terms of empirical success using laboratory and field data and theoretical usefulness the closing sections reflect on some new directions emerging in this literature

choice under uncertainty evidence from ethiopia india and uganda we review experimental evidence collected from risky choice experiments using poor subjects in ethiopia india and uganda using these data we estimate that just over 50 of our sample behaves in accordance with expected utility theory and that the rest subjectively weight probability according to prospect theory our results show that inferences about risk aversion are robust to whichever model we adopt when we estimate each model separately however when we allow both models to explain portions of the data simultaneously we infer risk aversion for subjects behaving according to expected utility theory and risk seeking behaviour for subjects behaving according to prospect theory

preference reversal information processing effect or rational non transitive choice preference reversal is often explained as an information processing effect whereby individuals respond differently to valuation problems than to straight choices regret theory offers the alternative explanation that individuals act on consistent but nontransitive preferences regret theory in its most general form is shown to make specific predictions about nontransitive pairwise choices that correspond with the preferences reversal phenomenon some experiments designed to discriminate between these two explanations are reported the main finding is that as regret theory predicts the preference reversal phenomenon can be reproduced in situations in which subjects confront only choice problems copyright 1989 by royal economic society

incentives in experiments a theoretical analysis experimental economists currently lack a convention for how to pay subjects in experiments with multiple tasks we provide a theoretical framework for analyzing this question assuming statewise mo

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

the relative performance of real estate marketing platforms mls versus fsbomadison com we compare house sales on a for sale by owner fsbo platform to multiple listing service mls sales and find that fsbo precommission prices are no lower but that fsbo is less effective in terms of time to sell and probability of a sale we do not find direct evidence of the importance of network size as a reason for the lower effectiveness of fsbo we do find evidence of endogenous platform differentiation patient sellers use fsbo while patient buyers transact more often on the mls where they avoid patient sellers we discuss the implications for platform competition two sided markets and welfare

intrinsic variability in group and individual decision making the paper examines the random preference model which can explain inherent variability of preferences in managerial and individual decision making and provides axiomatizations for the utility components of two such models differentiated by the structure of core preferences expected utility eu and betweenness like preferences we then examine the possibility of violations of weak stochastic transitivity for these models and for a model with core dual eu preferences such violations correspond to the existence of condorcet cycles and therefore the analysis has implications for managerial decision making and for majority rule voting the paper also investigates implications of its findings for two popular experimental settings this paper was accepted by james smith decision analysis

racial segregation and the black white test score gap abstract racial segregation is often blamed for some of the achievement gap between blacks and whites we study the effects of school and neighborhood segregation on the relative sat scores of black students across different metropolitan areas using large microdata samples for the 1998 2001 test cohorts our models include detailed controls for the family background of individual test takers school level controls for selective participation in the test and city level controls for racial composition income and region we find robust evidence that the black white test score gap is higher in more segregated cities holding constant family background and other factors a shift from a highly segregated city to a nearly integrated city closes about one quarter of the raw black white gap in sat scores specifications that distinguish between school and neighborhood segregation suggest that neighborhood segregation has a consistently negative impact while school segregation has no independent effect though we cannot reject equality of the two effects additional tests indicate that much of the effect of neighborhood segregation operates through neighbors incomes not through race per se data on enrollment in honors courses suggest that within school segregation increases when schools are more highly integrated potentially offsetting the benefits of school desegregation and accounting for our findings

demand aggregation and the weak axiom of stochastic revealed preference abstract we address the problem of aggregating demand across a group of consumers who are identical in terms of wealth and face identical price vectors but vary in their chosen consumption bundles we show that when a stochastic demand function is constructed to aggregate a number of deterministic demand functions satisfaction of the weak axiom of stochastic revealed preference by this stochastic demand function is weaker than the restriction that every underlying deterministic demand function satisfy samuelson s weak axiom of revealed preference journal of economic literature classification number d11

violence and risk preference experimental evidence from afghanistan comment in this comment on callen et al 2014 i revisit recent evidence uncovering a preference for certainty in violation of dominant normative and descriptive theories of decision making under risk i show that the empirical findings are potentially confounded by systematic noise i then develop choice lists that allow me to disentangle these different explanations experimental results obtained with these lists reject explanations based on a preference for certainty in favor of explanations based on random choice from a theoretical point of view the levels of risk aversion detected in the choice list involving certainty can be accounted for by prospect theory through reference dependence activated by salient outcomes

do preference reversals disappear when we allow for probabilistic choice the preference reversal phenomenon a systematic disparity between people s valuations and choices poses challenges for theory and policy using a very general formulation of probabilistic preferences we show that the phenomenon is not mainly due to intransitive choice we find a high degree of regularity within choice tasks and also within valuation tasks but the two types of tasks appear to evoke very different cognitive processes even when the experimental environment tries to minimise differences we discuss possible implications for modelling and eliciting preferences data as supplemental material are available at http dx doi org 10 1287 mnsc 2015 2333 this paper was accepted by manel baucells decision analysis

dynamic choice and the common ratio effect an experimental investigation the common ratio effect is a well attested violation of expected utility theory this paper uses four principles of dynamic choice to characterise alternative theoretical strategies for explaining the effect it reports an experiment which tests these principles and by implication several well known accounts of the common ratio effect unlike previous work the experimental design uses real financial incentives without presupposing any dynamic choice principles we find violation of a principle of timing independence which is part of most existing theories of dynamic choice we examine the implications of this finding for decision theory and economics

testing expected utility in the presence of errors one possible conclusion from recent experimental research on decision making under risk is that observed behaviour can be reasonably accommodated by expected utility plus an error term this conclusion implies that the violation rate of expected utility should decrease if errors are excluded this article reports on an experiment which investigates this implication by presenting the same choice problems to subjects three times the results show that the exclusion of errors leads to a significant reduction of the violation rate for most of the cases this observation can be regarded as supporting evidence for expected utility plus error term the common consequence effect and the common ratio effect both introduced by allais 1953 are the most prominent and most investigated violations of expected utility eu they have motivated the development of alternative theories of choice under risk which are able to accommodate the observed behavioural patterns nowadays a large number of alternative theories exist see starmer 2000 sugden 2004 and schmidt 2004 for surveys and naturally the question arises which theory can explain observed behaviour best many studies have addressed this question most prominent seem to be those of harless and camerer 1994 and hey and orme 1994 since eu and its alternatives are deterministic theories but observed choices are stochastic both papers integrated an error term into their estimations this fact has aroused interest in a general discussion of the role of errors in decision making under risk the discussion can be disentangled into two issues the first issue concerns the modelling of the stochastic component harless and camerer 1994 hey and orme 1994 camerer and ho 1994 hey 1995 loomes and sugden 1995 and corresponding experimental tests carbone 1997 ballinger and wilcox 1997 loomes and sugden 1998 carbone and hey 2000 buschena and zilberman 2000 loomes et al 2002 the second issue concerns the performance of eu and its alternatives for given specifications of the error term in this context hey 1995 building upon the results of hey and orme 1994 arrives at the following conclusion

crises and prices information aggregation multiplicity and volatility crises are volatile times when endogenous sources of information are closely monitored we study the role of information in crises by introducing a financial market in a coordination game with imperfect information the asset price aggregates dispersed private information acting as a public noisy signal in contrast to the case with exogenous information our main result is that uniqueness may not obtain as a perturbation from perfect information multiplicity is ensured with small noise in addition we show that a multiplicity may emerge in the financial price itself b less noise may contribute toward nonfundamental volatility even when the equilibrium is unique and c similar results obtain for a model where individuals observe one another s actions highlighting the importance of endogenous information more generally

on money pumps abstract the question of whether money pump arguments justify standard consistency assumptions about behavior has remained unresolved partly because of the absence of an appropriate analytical framework we present a new framework which fills this gap provide a formal definition of invulnerability to money pumps and formulate a requirement of maximal opportunism we show that behavior which satisfies none of the standard consistency assumptions can be both invulnerable and maximally opportunist we present two conditions which combined with maximal opportunism imply the existence of a choice function rationalized by an ordering and satisfying the sure thing principle journal of economic literature classification numbers b41 c73 d81