Constructed preferences SS200 Colin Camerer

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Constructed preferencesSS200 Colin Camerer

• Preferences complete, transitive u(x),
  tradeoffs among goods
• Historical note Axioms not empirically
  well-founded. They were designed to provide
  simple mathematical framework for aggregation
  (utility? demand) and because Pareto won the
  what is utility? battle
• Constructed suggests expression of preference
  is like problem-solving
• Will you vote for John Kerry?
• Answered by rapid intuition (tall, good hair)
  and/or deliberate logic (positions on issues)
• Alternative views of preference
• Learned (reinforcement, locked in a closet
  story)
• Discovered (Plott, implies path-independence)
• Hybrid view Combination of predisposition (e.g.,
  language, preparedness), learning and logic

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Constructed preference effects

• Context-dependence (comparative)
• Description-dependent framing (descriptions
  guide attention)
• Reference-dependence (changes, not levels
  anchoring)
• Some values protected/sacred (health,
  environment)
• Is too much choice bad?
• Open questions
• Are effects smaller with familiar choices?
• Experts?
• Markets?
• New predictions (e.g. big tip labor supply
  experiment)
• Cross-species (pigeons, rats, capuchins)

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1/n heuristic partition dependence in the lab
(cf. corporate socialism, Scharfstein Stein,
at corporate level)
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Context-dependence (comparative)

• Objects judged relative to others in a choice set
• Asymmetric dominance
• Compromise effects
• Economic question What is sellers optimal
  choice set given context-dependent preferences?

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Description-dependent framing (descriptions
guide attention)

• Analogy to figure-ground in perception
• Actual study with n792 docs (Harvard Med,
• Brigham Womens, Hebrew U McNeil et al
• JAMA 80s)
• treatment 1 yr 5 yrs choice
• Surgery 10 32 66 53
• Radiation 0 23 78
  47
• treatment 1 yr 5 yrs choice both frames
• Surgery 90 68 34
  82 60
• Radiation 100 77 22
  18 40
• Asian disease problem (-200 vs (1/3) of -600 /
  400 vs (2/3) 600
• Pro-choice vs pro-life
• Politics spin (Lakoff)
• e.g. arent we better off w/ Hussein gone?
• Liberation vs. occupation
• other examples?
• Supply-side response Competitive framing which
  frame wins?

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Reference-dependence

• Sensations depend on reference points r
• E.g. put two hands in separate hot and cold
  water, then in one large warm bath
• Hot hand feels colder and the cold hand feels
  hotter
• Loss-aversion -v(-x) v(x) for x0 (KT 79)
• Or v(x) first-order risk-aversion aka focussing
  illusion?
• Requires theory of mental accounting
• What gains/losses are grouped together?
• When are mental accounts closed/opened?
• Conjecture time, space, cognitive boundaries
  matter
• Example Last-race-of-the-day effect (bets switch
  to longshots to break even, McGlothlin 1956)

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Reference-dependence modelling

• Where does r come from? MORE TBA HERE
• Default Usually status quo or pre-experiment
  condition
• Koszegi-Rabin 05 Reference point r is based on
  recent expectationspersonal equilibrium in
  which choices optimize ref-dependent utility
  given r, and r is fulfilled
• Utility from u(c)µ(c-r) ?µ(r-c)
• Exhibits multiple equilibria,Giffen good effects,
  endowment effect (sensitive to how much one
  owns an object, e.g. PZ end-of-trial or J List
  effects)

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Prospect theory value function Note kink at
zero and diminishing marginal sensitivity
(concave for x0, convex for x 9
Endowment effects (KKT JPE 90)
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KKT mugs experiment (JPE 90)
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Plott-Zeiler review
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Data from young (PCC) and old (80 yr olds) using
PZ instructions (Kovalchik et al JEBO in press 04)
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Plott-Zeiler (AER 05) results replication (top)
vs mugs-first (bottom)
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Status quo bias and defaults in organ donation
(Johnson-Goldstein Sci 03)
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Loss-aversion in savings decisions (note few
points with actual utility Camerer 03 (slopes .86 , .33 - ratio 2.63)
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Disposition effects in housing (Genesove and
Mayer, 2001)

• Why is housing important?
• It's big
• Residential real estate value is close to stock
  market value.
• Its likely that limited rationality persists
• most people buy houses rarely (don't learn from
  experience).
• Very emotional ("I fell in love with that
  house").
• House purchases are "big, rare" decisions --
  mating, kids, education, jobs
• Advice market may not correct errors
• buyer and seller agents typically paid a fixed
  of price (Steve Levitt study shows agents sell
  their own houses more slowly and get more ).
• Claim
• People hate selling their houses at a "loss" from
  nominal not inflation-adjusted! original
  purchase price.

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Boston condo slump in nominal prices
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G-M econometric model
Model Listing price L_ist depends on hedonic
terms and mLoss_ist (m0 is no disposition
effect) but measured LOSS_ist excludes
unobserved quality v_i so the error term ?_it
contains true error and unobserved quality v_i
causes upward bias in measurement of m
Intuitively If a house has a great unobserved
quality v_i, the purchase price P0_is will be
too high relative to the regression. The model
will think that somebody who refused to cut their
price is being loss-averse whereas they are
really just pricing to capture the unobserved
component of value.
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Results m is significant, smaller for investors
(not owner-occupants less attachment?)
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Cab driver income targeting (Camerer et al QJE
97)
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Cab driver instrumental variables (IV) showing
experience effect
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Anchored valuation Valuations for listening to
poetry framed as labor (top) or leisure (bottom)
(Ariely, Loewenstein, Prelec QJE 03 and working
paperhttp//sds.hss.cmu.edu/faculty/Loewenstein/do
wnloads/Sawyersubmitted.pdf
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Arbitrary valuations

• Stock prices?
• Wages (what are different jobs really worth?)
• Depends on value to firm (hard to measure)
• compensating differentials/disutility (hard to
  measure)
• Exotic new products
• Housing (SF? Pittsburgh tend to buy too much
  house Simonsohn and Loewenstein 03)
• Exec comp'n (govt e.g. 150k for senator, vs
  CEO's, 38.5 million Britney Spears)

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What econ. would happen if valuations are
arbitrary?

• Perfect competition? pricemarginal
  costanchoring influences quantity, not price
  expect large Q variations for similar products
• Attempts to influence the anchor (QVC home
  shopping, etc., "for you just 59.95).
• Advertising!!!
• If social comparison/imitation is an anchor,
  expect geographical, temporal, social clustering
  (see this in law medical practice)
• E.g., CEO pay linked to pay of Directors on
  Board's comp'n committee. Geographical
  differences in housing prices, London,Tokyo, NYC,
  SF.
• Interindustry wage differentials for the same
  work (Stanford contracts out janitorial service
  so it doesn't have to pay as much cf. airline
  security personnel??)
• Sports salaries 100k/yr Miami Dolphins 1972 vs
  10million/yr modern football
• Huge rise in CEO comp'n from 1990 (42 times
  worker wage) to 2000 (531 times) big
  differentials between US and Europe
• Consumers who are most anchorable or
  influenceable will be most faddish -- children
  and toys!!? (McDonald's happy meal etc)

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Is too much choice bad?

• Jams study (Iyengar-Lepper)
• 6 jams 40 stopped, 30 purchased
• 24 jams 60 stopped, 3 purchased
• Assignment study
• Short list 74 did the extra credit assignment
• Long list 60 did the extra credit assignment
• Participation in 401(k) goes down 2 for every 10
  extra funds
• Shoe salesman Never show more than 3 pairs of
  shoes
• Medical
• 65 of nonpatients said they would want to be in
  charge of medical treatmentbut only12 of
  ex-cancer patients said they would
• Camerer conjecture The curse of the composite
• Paraphrased personals ad I want a man with the
  good looks of Brad Pitt, the compassion of Denzel
  Washington
• Is there too much mate choice in big cities?

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Choice-aversion

• How to model too much choice?
• Anticipated regret from making a mistake
• grass is greener/buyers remorse
• Direct disutility for too-large choice set (e.g.
  too complex)
• Policy question
• Markets are good at expanding choicewhat is a
  good institution for limiting choice?
• Example Bottled water in supermarkets
• Limit useless substitution? What is the right
  amount?
• Pro-govt example Swedish privatized social
  security
• Offered hundreds of funds
• Default fund is low-fee global index (not too
  popular)
• Most popular fund is local tech, down 80 1st yr

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Capuchins obey law of demand (K. Chen et al 05)
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Monkey loss-aversion

• (a,b,c) means display a, then pay b or c
• One stochastic dominance
• Two reference-dependence (risky)
• Three reference-dependence (riskless)

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Experimental markets prob judgment

• 1. Abstract stimuli vs natural events??
• pro can precisely control information of
  individuals
• can conpute a Bayesian prediction
• con maybe be fundamentally different mechanisms
  than for concrete events...
• 2. Do markets eliminate biases?
• Yes specialization
• Market is a dollar-weighted average opinion
• Uninformed traders follow informed ones
• Bankruptcy
• No Short-selling constraints
• Confidence (and trade size) uncorrelated with
  information
• Camerer (1987) Experience reduces pricing biases
  but increases allocation biases
• Contingent claims markets
• Markets enforce correct prices..BUT probability
  judgment influences allocations and volume of
  trade (example Iowa political markets)

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IIlusions of transparency

• Curse of knowledge
• Difficult to recover coarse partition from
  fine-grained one
• Piaget example New PhDs teaching
• EA Poe, telltale heart
• Computer manuals
• The tapper study (tapping out songs with
  a pencil)
• Hindsight bias
• Recollection of P_t(X) at t1 biased by whether
  X occurred
• I should have known!
• You should have known (ignored warning
  signs)
• -- juries in legal cases (securities cases)
• implications for principal-agent relations?
• Spotlight effect (Tom Gilovich et al)
• Eating/movies alone
• Wearing a Barry Manilow t-shirt
• ? psychology Shows how much we think others are
  attending when theyre not