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We study an alternating-offer bargaining model with arbitration. Our model has two key features. First, there is a deadline in bargaining. Second, whenever the bargaining deadline is reached, an arbitrator uses final-offer arbitration to determine the outcome. We find that if players are sufficiently patient, they will always reject opponents’ offers during bargaining, and thus, the game always moves to arbitration. Our result is in sharp contrast to the usual prediction in the literature that the threat of going to final-offer arbitration encourages players to reach negotiated agreements before arbitration. Our result is due to the so-called gambling effect of final-offer arbitration that we discover.

We conduct a large scale randomized field experiment to study whether providing recipients – 42,454 Chinese households in a rural area – with information on the costs of a real decision they make can help to improve the quality of their choices. The decisions are of high financial impact, as the objects of deliberation – air conditioners – have upfront prices exceeding the average monthly salary of a household. Besides providing nominal cost information, we conduct two additional treatments, where we either present the same information by making the real opportunity costs salient, or by administering the information via a quiz. The former aims at facilitating the comparison of effective costs, while the latter aims at enhancing attention and cognitive involvement. We find that providing cost information substantially affects the choices made, and reduces the decision mistakes, in particular in the two additional treatments.

Existing literature in economics and psychology has documented that individuals care about their social image. However, most of the existing evidence is based on laboratory experiments, where the concern for social image is artificially induced. We hand-collect a unique data set on restaurant tipping and use the mode of payment to discriminate between social-image-concern and other possible motivations for tipping in a naturally occurring environment. The social-image-concern hypothesis predicts that consumers will tip more frequently when paying by cash, relative to paying by a credit card, because their tipping behavior can be publicly observed and enables them to foster a positive social image. We find that both the probability of tipping and the dollar value of the tip is significantly higher when paying by cash, which is consistent with the social-image-concern hypothesis.

This paper experimentally tests the Fox-Tversky (1995) source preference hypothesis as axiomatized in Chew and Sagi (2008) where people may have preference between equally distributed risks depending on the underlying sources of uncertainty. We study two forms of source preference. One is based on familiarity of risks arising from the trailing digit of stock prices in the home city exchange. Another is based on the trailing digit of the market index of the home city versus that of a foreign city. We find a familiarity-based source preference in portfolios comprising strictly dominated bets associated with more familiar stocks and in valuation of bets elicited using an ascending-price auction. Complementarily, we find a home bias in terms of Shanghai (Hong Kong) subjects preferring to bet on the trailing digit of the Shanghai Stock Exchange Index (Hang Seng Index) even though the same bets based on Dow Jones Industrial Average would pay more. Taken together, our study suggests that home bias is driven mainly by source preference rather than ambiguity aversion.

We experimentally investigate the effect of timing of implementation of decisions on trust and trustworthiness. In the “Now” treatment, a standard trust game is run and subjects receive payment in the same date of the experiment. In the “Later” treatment, subjects make decisions in the same date as the now treatment, while the decisions are implemented (and hence payment) in a week. The later treatment captures a key feature of social interactions where decisions are often implemented in the future rather than immediately. Consistent with our model, we find that both trust and trustworthiness are lower in the later treatment. Our result thus suggests that individuals who discount utility from altruism to a larger extent than utility from monetary payoff will have less incentive to trust or be trustworthy when the decision is implemented with a delay.

Does morality in business affect investors’ choice of stocks? Building on the source preference literature, we propose a novel measure of moral stock preference and offer a nested model relating it to social preference, attention to corporate social responsibility (CSR), and belief bias. We investigate moral stock preference experimentally in terms of sin stock aversion (SSA) and virtue stock affinity (VSA) and arrive at three main findings: (1) SSA and VSA are both observed, with the effect of SSA being stronger, (2) SSA/VSA is positively correlated with social preference, with the effect of altruistic giving being stronger than that of trust or trustworthiness, and (3) SSA/VSA is correlated with belief bias, the effect of which is stronger than that of social preference. The asymmetry between SSA and VSA – avoiding “bad” matters more than doing “good” – points to moral loss aversion based on a disproportionate avoidance of sin stocks compared to favoring virtue stocks. Together, our findings demonstrate the validity of our model, with social preference, attention to CSR, and belief bias working in tandem to capture the decision maker’s moral stock preference.

We experimentally investigate the memory recall bias of overconfident (underconfident) individuals after receiving feedback on their overconfidence (underconfidence). Our study differs from the literature by identifying the recall pattern conditional on subjects’ overconfidence/underconfidence. We obtain the following results. First, overconfident (underconfident) subjects exhibit overconfident (underconfident) recall despite receiving feedback on their overconfidence (underconfidence). Second, awareness of one’s overconfidence or underconfidence does not eliminate memory recall bias. Third, the primacy effect is stronger than the recency effect. Overall, our results suggest that memory recall bias is mainly due to motivated beliefs of sophisticated decision makers rather than naïve decision-making.

This study investigates the effect of the COVID-19 pandemic on people’s preferences including social preference in terms of trust and trustworthiness, risk attitude, and time preference. We compare the preferences of subjects in two sets of online experiments with samples drawn from provinces across mainland China before and after the COVID-19 pandemic. We test two competing hypotheses regarding social preference. First, we examine whether the outbreak as a collective threat induces more pro-social behavior by enhancing ingroup cohesion and cooperation. Second, we test whether the pandemic leads to a reduction in pro-social behavior due to the expectation that the related economic downturn will have a negative impact on income. We find that after the outbreak, the subjects overall are less trusting (8% lower) and more trustworthy (6% higher). We also find that the subjects are more risk averse and less patient after the outbreak, which is consistent with the idea that the fear generated by the pandemic induces risk aversion and impatience. Finally, using two large mobility datasets derived from anonymized mobile phone records, we show that people’s preferences are not affected by social distancing.

We conduct a horse race of preferences to compare the predictive power and net effects of 15 types of preferences, such as attention, ambiguity aversion, loss aversion, probability overweighting, time preference, confidence, self-control, trust, and strategic reasoning, on actual investment decisions and outcomes. We estimate the net effects of the preferences by considering the correlations between the preferences. We find that for share of wealth invested in the stock market, the effect of confidence (Kyle and Wang, 1997) is stronger than that of risk aversion, which is stronger than the effects of self-control (Heidhues and Koszegi, 2010), loss aversion (Tversky and Kahneman, 1992), and ambiguity aversion (Dow and Werlang, 1992). For holding lottery-like stock, the effect of attention (Sims, 2003) is stronger than that of the discount rate, which is stronger than that of probability overweighting (Barberis and Huang, 2008). For share of lottery-like stock, the effect of strategic reasoning (Nagel, 1995) is stronger than that of probability overweighting. For wealth level, self-control has the strongest net effect.

We conduct an online experiment to investigate the effect of the COVID-19 outbreak on people’s expectation about the macroeconomy, including economic growth rate, inflation rate, unemployment rate, and their consumption, income, saving, and investment. We find that ambiguity aversion and time preference affect macroeconomic expectations. Ambiguity averse subjects are more pessimistic about the Covid-19 outbreak’s impact on the economic growth rate and are more likely to reduce their consumption. Subjects with a lower discount factor have more optimistic expectations, as they are less likely to expect lower economic growth, lower income, lower investment, higher inflation, and higher unemployment.

We conduct a field experiment to investigate the memory recall bias of real-life investors who are asked to recall their best performing stock (BPS) and worst performing stock (WPS). We find that investors are more likely to remember BPS than forgetting, while such pattern is not observed for WPS. Further, investors with higher discount rate are more likely to forget BPS and WPS. Investors who pay more attention to stock prices are more likely to forget WPS. The proportion of investors who forget WPS and remember BPS is higher than the proportion of investors who forget BPS and remember WPS. Investors who are more sensitive to loss are less likely to exhibit the asymmetric recall of forgetting WPS and remembering BPS. Investors who are more worried about investment performance, or more risk averse are more likely to exhibit memory bias of remembering WPS and forgetting BPS. Experience in investment play an important role that the less experienced investors are more likely to forget WPS than BPS, while more experienced investors do not exhibit this bias. We propose a theory of investor's memory recall preference to account for the findings.

It is well established that human behaviors are susceptible to others' opinions. However, optimal decision theory mandates choices be made upon the estimated validities of different information sources and little is known about whether and how people could wean themselves off social conformity bias, especially when the social signals are uninformative. Here, we asked subjects to participate in a probabilistic urn guessing task based on their private information as well as observed choices from their partners. Specifically, we manipulated the information validity of these two sources such that only the private evidence was informative. Across trials, social conformity declined, manifested by the increased influence of the private evidence but steady effect of social information. Correspondingly, we found dorsomedial prefrontal cortex (dmPFC) was involved in detecting the conflict of private and social information and conforming to social signal whereas striatum was responsible for selectively updating the influence of private (but not social) evidence contingent on its inferred validity. Furthermore, functional coupling between striatum and dmPFC predicted the resistance toward the influence of social information. Together, these results may provide a mechanistic account of how the conformity bias toward uninformative social information can be remedied.

We experimentally investigate memory recall bias of overconfident/underconfident individuals after feedback on their overconfidence/underconfidence. Our study differs from the previous literature by identifying the recall pattern conditional on subject's preference for overconfidence/underconfidence. We show that overconfident (underconfident) subjects exhibit overconfident (underconfident) recall despite they have received feedback about their overconfidence (underconfidence). We find that about 71% of memory recall bias are due to preference for motivated belief. Our result provides evidence that awareness of one's overconfidence/underconfidence will not eliminate motivated biases, and individuals choose to misremember according to their preference rather than necessarily misremembering bad news more than good news.

This paper proposes a new method to identify gambler’s fallacy (GF) and hot-hand fallacy (HHF). In the classical method, subjects are classified as exhibiting GF/HHF even they are just randomizing/indifferent between options. In our method, subjects play the game twice and we vary the payoff between different options, and their probability beliefs are elicited. We experimentally test three competing theories of GF and HHF: probability bias, randomized choice, and bounded rationality. We find that the classical method substantially overestimates the proportion of subjects exhibiting GF and HHF due to wrongly classifying randomized and mistaken choices as exhibiting these biases. About 7% (18%) of subjects exhibit true GF (HHF), while the classical method suggests about 51% (48%). We show that probability bias, randomized choice, and bounded rationality accounts for 31%, 41%, and 20% of behavioral GF, while the shares are 40%, 26%, and 18% for behavioral HHF.

This paper experimentally investigates whether firms should use both prosocial incentives and monetary incentives to motivate workers. We conduct a real-effort experiment on a data entry job. It is found that prosocial incentives will likely reduce work quality. When worker’s compensation does not include prosocial incentives, making the compensation conditional on the quality of work performed greatly enhanced the work quality. However, when worker’s compensation includes prosocial incentive, making the compensation conditional on the work quality no longer improve work quality. This suggests that prosocial incentive induces some workers to work less professionally.

Arad and Rubinstein (2012, AER) proposed the 11&ndash, 20 money request game as an alternative to the P beauty contest game for measuring the depth of thinking. In this paper, we show theoretically that in the Nash equilibrium of the 11&ndash, 20 game players are more likely to choose high numbers if they are risk-averse rather than risk neutral. Hence, the depth of thinking measured in the 11&ndash, 20 game is biased by risk aversion. Based on a lab experiment, we confirm this hypothesis empirically.

In a Bayesian persuasion setting, a sender persuades a receiver to take an action by designing and committing to disclose information about the receiver’s payoff of taking the action. We propose a model that incorporates reciprocity into the Bayesian persuasion setting, using the approach of Falk and Fischbacher. The introduction of reciprocal concerns leads to a number of novel predictions. First, the receiver’s response changes continuously in the realized signals. Second, when the prior belief is more favorable, the receiver is more difficult to be persuaded, implying that the sender’s optimal persuasion strategy involves more informative disclosure. These predictions are supported by experimental data.

We propose a two-step procedure to measure the depth of thinking. We apply this method to the P beauty contest game. By comparing the numbers submitted in the two-steps, we can identify the depth of thinking more accurately than the classical method. We show that the classical method has the fundamental problem that it cannot distinguish if a submitted number is due to strategic reasoning or not. Using our method, we find that 81% of subjects do not have strategic reasoning while the classical method would suggest only 12%. Our procedure can cleanly identify whether the individual has strategic reasoning and differentiate between the depth of thinking and random choice, and hence provide a much more accurate estimation on the depth of thinking.

Unlike in the standard jury voting experiment, the voting environment in practice has no explicit signal structure. Voters then need to conceptualize the information structure in order to update their beliefs based on “pivotal reasoning”. This paper investigates whether voters can play a strategic voting under a “detail-free” environment. We obtain non-parametric predictions in terms of the differences in voting behaviors under majority and unanimity rule. Our experimental results suggest that voters can still play the strategic voting as in the existing experiments.

Recent studies, mostly from prosocial settings, suggest that monetary rewards may crowd out effort exertion by economic agents. We design a field experiment with data entry workers to investigate the extent of such crowding-out effects in a labor market. Using simple variations in the job description of a task, we induce a natural work setting under the work frame and emphasize social preference under the social frame. We find that crowding out of labor participation critically depends on framing—whereas small monetary rewards reduce the participation rate under the social frame, the participation rate is nondecreasing in the wage rate under the work frame. Moreover, among the workers who participate in the task, those who receive a positive wage perform a considerably higher amount of work than those who are paid zero wage under either frame. Thus, there is weak evidence of crowding out only when the task is explicitly given a prosocial flavor and not under a regular work setting. Furthermore, emphasizing social preference in the labor market in such a way reduces the overall labor supply and seems to have an adverse effect on the quality of work. Data, as supplemental material, are available at http://dx.doi.org/10.1287/mnsc.2013.1807 . This paper was accepted by John List, behavioral economics.

Halevy (2007) experimentally tests the prediction of the Recursive Non-Expected Utility (RNEU) model that there is a positive correlation between degree of ambiguity aversion and degree of preference on reduction of compound lotteries ROCL. Halevy (2007) claimed that the experimental result supports the RNEU. In this study, we use Halevy’s data and conduct further analysis based on subject’s ambiguity attitude types: ambiguity neutral, ambiguity averse, and ambiguity loving. We find striking different results. First, there is no significant relationship between degree of preference on ROCL and degree of ambiguity aversion. Second, subjects who prefer simple lotteries are not more likely to be ambiguity averse than subjects who prefer compound lotteries. Third, ambiguity averse subjects are not more likely to prefer simple lottery than those who are ambiguity seeking. In sum, there is no evidence that ambiguity aversion can be well explained by preference on reduction of compound lotteries.

In classical finance theory, social preference is assumed to play no role in investor’s portfolio choice, as the optimal portfolio is formed by considering return and risk of the stocks. While it has been known that sin stocks have abnormal returns, the causality (i.e., whether it is caused by investor’s social preference) of the phenomenon remains to be investigated. This paper first uses a data set on portfolio of 78,000 retail investors to investigate the relationship between investment in sin stocks and religiosity. We find that investors underweight sin stocks, and the degree of underweighting is positively correlated with the degree of religiosity of the region where investors reside. This is the first result reported in the literature for the correlation between investors’ moral concern and holding of sin stocks. The result is robust after we control for holding in familiar stocks, lottery stocks, and demographics. Then, we conduct laboratory experiments to cleanly identify the casual relationship between concern for corporate social responsibility (CSR) and investment. The first experiment shows that investors avoid holding sin stocks despite its return dominates the non-sin stocks. The second experiment shows that the concern for CSR induces firms to adapt clean production or to outsource production process with pollution. Overall, our paper provides the first causal evidence in the literature that investor’s concern for social responsibility leads them to underweight sin stocks. Our result highlights the importance of social preference in the financial market, and its implications for asset pricing theories.

This paper investigates how communication in a particular language affects decision-making in social interactions and risk preferences. We test two competing hypotheses: the cognitive accessibility hypothesis and the expectation-based hypothesis. The cognitive accessibility hypothesis argues that communication in a particular language will activate the underlying cultural frame and affect behavior. The expectation-based hypothesis argues that different languages will induce different expectations regarding the choices of others and affect behavior. We test these two hypotheses using an extensive range of behaviors in a set of incentivized experiments with bilingual subjects in Chinese and English. We found that the subjects are more prosocial in the strategic interaction games (trust games) when the experiments are conducted in Chinese. However, no treatment effects are observed in the individual choice games on social preference. The results suggest that both hypotheses are rejected. The results are more compatible with the idea that individuals exhibit familiarity bias when communicating in a familiar language.

Previous studies have suggested that negative emotion can enhance memory accuracy. However, they were not conducted in the context of social interactions using the methodology of experimental economics. Based on the present study, we find that in such a context, individuals’ memory recall accuracy depends on the kindness of acts and who performed them, and negative emotion may lower memory accuracy. A victim of an unkind act is more likely to forget than someone who benefited from a kind act. This result supports the hypothesis that individuals may strategically manipulate their memory by forgetting an unpleasant experience. We also find that individuals who committed an unkind act tend to perceive it as less unkind as time moves on. They also tend to believe that a higher percentage of players have also committed the unkind act. Overall, the results support the hypothesis that individuals strategically manipulate their memory and beliefs to maintain self-esteem or feel less guilty.

This paper experimentally investigates preference towards different methods of control in risk taking. Participants are asked to choose between different ways for choosing which numbers to bet on for a gamble. They can choose the numbers themselves (control), let the experimenter choose (no control), or randomize. Classical economic theories predict indifference among the three methods. I found that participants exhibit strict preference for control, preference for no control, and preference for randomization. These preferences are robust as participants are willing to pay a small amount of money to implement their preferred method. Most participants believe that the winning probability under different methods is the same. This result contributes to the literature by clarifying that for most participants who exhibit preference for control, their preference is not due to illusion of control, but by source preference. Participants invest less in the risky gamble when they are not offered their preferred method.

Previous research has argued that firm’s overconfidence is mainly due to psychological bias or miscalibration. This study tests the competing hypothesis that firm’s overconfidence is a well-motivated rational choice. Using a dataset on management earnings forecasts of 3,540 listed firms, we show that a large proportion of firms are consistently overconfident despite the fact that they receive feedbacks that their forecasts are overconfident. We identify a set of firm characteristics which can predict firm’s overconfidence well. Our results thus suggest that majority of firm’s overconfidence is not a behavioral bias or due to miscalibration. Rather, it is a rational choice.

This experimental economics study using brain imaging techniques investigates the risk-ambiguity distinction in relation to the source preference hypothesis (FoxTversky, 1995) in which identically distributed risks arising from different sources of uncertainty may engender distinct preferences for the same decision maker, contrary to classical economic thinking. The use of brain imaging enables sharper testing of the implications of different models of decision-making including Chew and Sagi's (2008) axiomatization of source preference.Using fMRI, brain activations were observed when subjects make 48 sequential binary choices among even-chance lotteries based on whether the trailing digits of a number of stock prices at market closing would be odd or even. Subsequently, subjects rate familiarity of the stock symbols.When contrasting brain activation from more familiar sources with those from less familiar ones, regions appearing to be more active include the putamen, medial frontal cortex, and superior temporal gyrus. ROI analysis showed that the activation patterns in the familiar-unfamiliar and unfamiliar-familiar contrasts are similar to those in the risk-ambiguity and ambiguity-risk contrasts reported by Hsu et al. (2005). This supports the conjecture that the risk-ambiguity distinction can be subsumed by the source preference hypothesis.Our odd-even design has the advantage of inducing the same "unambiguous" probability of half for each subject in each binary comparison. Our finding supports the implications of the Chew-Sagi model and rejects models based on global probabilistic sophistication, including rank-dependent models derived from non-additive probabilities, e.g., Choquet expected utility and cumulative prospect theory, as well as those based on multiple priors, e.g., alpha-maxmin. The finding in Hsu et al. (2005) that orbitofrontal cortex lesion patients display neither ambiguity aversion nor risk aversion offers further support to the Chew-Sagi model. Our finding also supports the Levy et al. (2007) contention of a single valuation system encompassing risk and ambiguity aversion.This is the first neuroimaging study of the source preference hypothesis using a design which can discriminate among decision models ranging from risk-based ones to those relying on multiple priors.

Purpose – This experimental economics study using brain imaging techniques investigates the risk-ambiguity distinction in relation to the source preference hypothesis (Fox & Tversky, 1995) in which identically distributed risks arising from different sources of uncertainty may engender distinct preferences for the same decision maker, contrary to classical economic thinking. The use of brain imaging enables sharper testing of the implications of different models of decision-making including Chew and Sagi's (2008) axiomatization of source preference. Methodology/approach – Using fMRI, brain activations were observed when subjects make 48 sequential binary choices among even-chance lotteries based on whether the trailing digits of a number of stock prices at market closing would be odd or even. Subsequently, subjects rate familiarity of the stock symbols. Findings – When contrasting brain activation from more familiar sources with those from less familiar ones, regions appearing to be more active include the putamen, medial frontal cortex, and superior temporal gyrus. ROI analysis showed that the activation patterns in the familiar–unfamiliar and unfamiliar–familiar contrasts are similar to those in the risk–ambiguity and ambiguity–risk contrasts reported by Hsu et al. (2005). This supports the conjecture that the risk-ambiguity distinction can be subsumed by the source preference hypothesis. Research limitations/implications – Our odd–even design has the advantage of inducing the same “unambiguous” probability of half for each subject in each binary comparison. Our finding supports the implications of the Chew–Sagi model and rejects models based on global probabilistic sophistication, including rank-dependent models derived from non-additive probabilities, e.g., Choquet expected utility and cumulative prospect theory, as well as those based on multiple priors, e.g., α-maxmin. The finding in Hsu et al. (2005) that orbitofrontal cortex lesion patients display neither ambiguity aversion nor risk aversion offers further support to the Chew–Sagi model. Our finding also supports the Levy et al. (2007) contention of a single valuation system encompassing risk and ambiguity aversion. Originality/value of chapter – This is the first neuroimaging study of the source preference hypothesis using a design which can discriminate among decision models ranging from risk-based ones to those relying on multiple priors.