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The literature suggests that probability weighting and choice set dependence influence risky choices. However, their relative importance remains an open question. We present a joint test that uses binary choices between lotteries provoking Common Consequence and Common Ratio Allais Paradoxes and manipulates their joint payoff distribution. We show non-parametrically that probability weighting and choice set dependence both play a role at describing aggregate choices. To parsimoniously account for heterogeneity, we also estimate a structural model using a finite mixture approach. The model uncovers substantial heterogeneity and classifies subjects into three types: 38% Prospect Theory types whose choices are predominantly driven by probability weighting, 34% Salience Theory types whose choices are predominantly driven by choice set dependence, and 28% Expected Utility Theory types. The model predicts type-specific differences in the frequency of preference reversals out-of-sample, i.e., in choices with a different context than the ones used for estimating the model. Moreover, the out-of-sample predictions indicate that the choice context shapes the influence of choice set dependence.

We propose a task for eliciting attitudes toward risk that is close to real-world risky decisions which typically involve gains and losses. The task consists of accepting or rejecting gambles that provide a gain with probability $$p$$ and a loss with probability $$1-p$$ . We employ finite mixture models to uncover heterogeneity in risk preferences and find that (i) behavior is heterogeneous, with one half of the subjects behaving as expected utility maximizers, (ii) for the others, reference-dependent models perform better than those where subjects derive utility from final outcomes, (iii) models with sign-dependent decision weights perform better than those without, and (iv) there is no evidence for loss aversion. The procedure is sufficiently simple so that it can be easily used in field or lab experiments where risk elicitation is not the main experiment.

Various theories of social behavior propose that individuals condition actions that involve a moral value by following each other’s behavior. The theoretical and experimental instruments employed to evaluate this conditioning, often focus only on the diffusion of actions with negative moral value (e.g. dishonesty, norm violation, tax evasion). In this paper, we develop and execute a laboratory experiment to study the diffusion of actions with both, positive and negative moral values. We use a lying dilemma to study the diffusion of honesty and dishonesty in a simultaneous and a sequential move sequence. The results indicate that dishonesty is more contagious than honesty. While individuals switch from truth telling to lying when they observe another lying, they do not switch from lying to truth-telling when they observe another telling the truth.

This paper studies the evolution of overconfidence over a cohort&rsquo, s working life. To do this, the paper incorporates subjective assessments into a continuous time human capital accumulation model with a finite horizon. The main finding is that the processes of human capital accumulation, skill depreciation, and subjective assessments imply that overconfidence first increases and then decreases over the cohort&rsquo, s working life. In the absence of skill depreciation, overconfidence monotonically increases over the cohort&rsquo, s working life. The model generates four additional testable predictions. First, everything else equal, overconfidence peaks earlier in activities where skill depreciation is higher. Second, overconfidence is lower in activities where the distribution of income is more dispersed. Third, for a minority of individuals, overconfidence decreases over their working life. Fourth, overconfidence is lower with a higher market discount rate. The paper provides two applications of the model. It shows the model can help make sense of field data on overconfidence, experience, and trading activity in financial markets. The model can also explain experimental data on the evolution of overconfidence among poker and chess players.

This chapter reviews how worker overconfidence affects labor markets. Evidence from psychology and economics shows that in many situations, most people tend to overestimate their absolute skills, overplace themselves relative to others, and overestimate the precision of their knowledge. The chapter starts by reviewing evidence for overconfidence and for how overconfidence affects economic choices. Next, it reviews economic explanations for overconfidence. After that, it discusses research on the impact of worker overconfidence on labor markets where wages are determined by bargaining between workers and firms. Here, three key questions are addressed. First, how does worker overconfidence affect effort provision for a fixed compensation scheme? Second, how should firms design compensation schemes when workers are overconfident? In particular, will a compensation scheme offered to an overconfident worker have higher- or lower-powered incentives than that offered to a worker with accurate self-perception? Third, can worker overconfidence lead to a Pareto improvement? The chapter continues by reviewing research on the impact of worker overconfidence on labor markets where workers can move between firms and where neither firms nor workers have discretion over wage setting. The chapter concludes with a summary of its main findings and a discussion of avenues for future research.

Beliefs about relative skill matter for risky decisions such as market entry, career choices, and financial investments. Yet in most laboratory experiments risk is exogenously given and beliefs about relative skill play no role. We use a laboratory experiment without strategy confounds to isolate the impact of beliefs about relative skill on risky choices. We find that low (high) skill individuals are more (less) willing to take risks on gambles where the probabilities depend on relative skill than on gambles with exogenously given probabilities. This happens because low (high) skill individuals overestimate (underestimate) their relative skill. Consequently, the wrong people may engage in risky activities where performance is based on relative skill while the right people may be crowded out.

This article analyzes the impact of entrepreneurial optimism on the market for new issues. We find that the existence of optimists generates a new reason for entrepreneurs to own equity in their firms. We show that optimism is a natural explanation for why some new issues are underpriced and others overpriced. We also show that the impact of optimism on entrepreneurs' equity holdings depends on the number of optimists, absolute risk aversion, and cash flow variance. Optimism makes entrepreneurs worse off. In contrast, optimism can make outside investors better off when entrepreneurs signal firm value by retaining shares and underpricing.

We apply the cognitive hierarchy model of Camerer et al. (Q J Econ 119(3):861-898, 2004)-where players have different levels of reasoning-to Huck et al. (Games Econ Behav 38:240-264, 2002) discrete version of Hamilton and Slutsky (Games Econ Behav 2:29-46, 1990) action commitment game-a duopoly with endogenous timing of entry. We show that, for an empirically reasonable average number of thinking steps, the model rules out Stackelberg equilibria, generates Cournot outcomes including delay, and outcomes where the first mover commits to a quantity higher than Cournot but lower than Stackelberg leader. We show that a cognitive hierarchy model with quantal responses can explain the most important features of the experimental data on the action commitment game in (2002). In order to gauge the success of the model in fitting the data, we compare it to a noisy Nash model. We find that the cognitive hierarchy model with quantal responses fits the data better than the noisy Nash model.

This paper explores the role of inequity aversion as an explanation for observed behavior in experimental Cournot oligopolies. We show that inequity aversion can change the nature of the strategic interaction: quantities are strategic substitutes for sufficiently asymmetric output levels but strategic complements otherwise. We find that inequity aversion can explain why: (i) some experiments result in higher than Cournot–Nash production levels while others result in lower, (ii) collusion often occurs with only two players whereas with three or more players market outcomes are very close to Cournot–Nash, and (iii) players often achieve equal profits in asymmetric Cournot oligopoly.

We explore the role of trade costs for the home bias in trade. In a series of Cournot duopoly experiments with a home and an export market, we compare output choices when firms face different levels of trade costs. We find that there is two-way trade in identical products and that firms hold the majority market share in their home market. The resulting home bias turns out to be, however, stronger than that predicted by theory, and it even occurs without trade costs. Tacit collusion contributes to the home bias observed in our experiment but does not offer a full explanation for the phenomenon.

We analyze the impact of overconfidence on the timing of entry in markets, profits, and welfare using an extension of Hamilton and Slutsky’s (1990) quantity commitment game. Players have private information about costs, one player is overconfident, and the other one rational. We find that for slight levels of overconfidence and intermediate cost asymmetries there is a unique cost-dependent equilibrium where the overconfident player has a higher ex-ante probability of being the Stackelberg leader. Overconfidence lowers the profit of the rational player but can increase that of the overconfident player. Consumer rents increase with overconfidence while producer rents decrease which leads to an ambiguous welfare effect.

In a controlled laboratory experiment we use one sample of college students and one of mature executives to investigate how positive skew influences risky choices. In reduced-form regressions we find that both students and executives make riskier choices when lotteries display positive skew. We estimate decision models to explore three explanations for skew seeking choices: risk-loving (convex utility), optimism (concave probability weighting) and likelihood insensitivity (inverse s-shape probability weighting). We find no role for love for risk as neither students nor executives have convex utility. Both optimism and likelihood insensitivity play a part in skew seeking choices. Likelihood insensitivity is larger for students than for executives. Executives have more concave utility and are more optimistic than students, but this is found to be largely due to them being older.

I extend Spence's signaling model by assuming that some workers are overconfident--they underestimate their marginal cost of acquiring education--and some are underconfident. Firms cannot observe workers' productive abilities and beliefs but know the fractions of high-ability, overconfident, and underconfident workers. I find that biased beliefs lower the wage spread and compress the wages of unbiased workers. I show that gender differences in self-confidence can contribute to the gender pay gap. If education raises productivity, men are overconfident, and women underconfident, then women will, on average, earn less than men. Finally, I show that biased beliefs can improve welfare.

This paper studies the impact of firm cost and market size asymmetries on merger decisions. I consider a model where a small and a large country compete in a third (world) market. Each of the two countries has two firms (with potentially different costs) that supply the domestic market and export to the third market. Merger decisions in the two countries are modeled as a simultaneously move game. The paper finds that firms in the large country have more incentives to merge than firms in the small country. In contrast, the government of the large country has more incentives to block a merger than the government of the small country. Thus, the model predicts that conflicts of interest between governments and firms concerning national mergers are more likely in large countries than in small ones.

This paper analyzes the implications of worker overestimation of productivity for firms in which incentives take the form of tournaments. Each worker overestimates his productivity but is aware of the bias in his opponent’s self-assessment. The manager of the firm, on the other hand, correctly assesses workers’ productivities and self-beliefs when setting tournament prizes. The paper shows that, under a variety of circumstances, firms make higher profits when workers have positive self-image than if workers do not. By contrast, workers’ welfare declines due to their own misguided choices.

This paper suggests a mechanism that describes individuals' positive self-image in subjective assessments of their relative abilities. The mechanism assumes individuals have heterogeneous production functions that determine ability as a function of multiple skills; make skill-enhancing investments with the goal of maximizing their ability; and make ability comparisons using their own production function. Within this framework, the paper provides conditions under which there is positive self-image. Positive self-image is increasing in the ease of the task, the number of different skills needed for the task, and the variability of production technologies in the population.

We propose a task for eliciting attitudes towards risk that is close to real world risky decisions which typically involve gains and losses. The task consists of accepting or rejecting gambles that provide a gain with probability p and a loss with probability 1 − p. We employ finite mixture models to uncover heterogeneity in risk preferences and find that (i) behavior is heterogeneous, with slightly less than one half of the subjects behaving as expected utility maximizers, (ii) for the others, reference-dependent models perform better than those where subjects derive utility from final outcomes, (iii) models with sign dependent decision weights perform better than those without, and (iv) there is no evidence for loss aversion. The procedure is sufficiently simple so that it can be easily used in field or lab experiments where risk elicitation is not the main experiment.

We use a laboratory experiment to study how perceptions of skill influence teamwork. Our design is based on Gervais and Goldstein (2007) theory of teams. Team output is increasing in skill and in effort, skill and effort are complements, and workers' effort choices are complements. An overconfident agent thinks that his skill is higher than it actually is. We find that the presence of overconfi-dent workers in teams is beneficial for firms since it raises effort provision and team output. We also find that overconfidence leads to a Pareto improvement in workers' payoffs. In contrast, underconfidence is detrimental to firms as well as workers.

This paper uses a field survey to investigate the quality of individuals’ beliefs of relative performance in tournaments. We consider two field settings, poker and chess, which differ in the degree to which luck is a factor and also in the information that players have about the ability of the competition. We find that poker players’ forecasts of relative performance are random guesses with an overestimation bias. Chess players also overestimate their relative performance but make informed guesses. We find support for the “unskilled and unaware hypothesis” in chess: high-skilled chess players make better forecasts than low-skilled chess players. Finally, we find that chess players’ forecasts of relative performance are not efficient.

In a controlled laboratory experiment we use one sample of students and one of mature individuals participating in an executive education entrepreneurship seminar to examine how positive skew influences risky choices. Both groups are found to respond positively to skew. We estimate decision models to explore three explanations for the preference for skew: risk-loving (convex utility), optimism (concave probability weighting), and likelihood insensitivity (inverse s-shape probability weighting). Somewhat surprisingly, decision making by students and executives is not much different. Both students and executives have concave utility, are optimists, and display likelihood insensitivity. Executives have more concave utility and are more optimistic, but this is found to be largely due to them being older. This change in behavior with age may be part of the explanation why older people are more likely to enter into entrepreneurship.

Research in psychology suggests that some individuals are more sensitive to positive than to negative information while others are more sensitive to negative rather than positive information. I take these cognitive positive–negative asymmetries in information processing to a Bayesian decision-theory model and explore its consequences in terms of decisions and payoffs. I show that in monotone decision problems economic agents with more positive-responsive information structures are always better off, ex ante, when they face problems where payoffs are relatively more sensitive to the action chosen when the state of nature is favorable.

The prediction of asymmetric equilibria with Stackelberg outcomes is clearly the most frequent result in the endogenous timing literature. Several experiments have tried to validate this prediction empirically, but failed to find support for it. In contrast, these experiments find that simultaneous-move outcomes are modal and that behavior in endogenous timing games is quite heterogeneous. This paper generalizes Hamilton and Slutsky’s (Hamilton, J., Slutsky, S., 1990. Endogenous timing in duopoly games: Stackelberg or Cournot equilibria. Games and Economic Behavior 2, 29–46) endogenous timing games by assuming that players are averse to inequality in payoffs. I explore the theoretical implications of inequity aversion and compare them to the empirical evidence. I find that this explanation is able to organize most of the experimental evidence on endogenous timing games. However, inequity aversion is not able to explain delay in Hamilton and Slutsky’s endogenous timing games.

This paper departs from the standard profit-maximizing model of firm behavior by assuming that firms are motivated in part by personal animosity–or respect–towards their competitors. A reciprocal firm responds to unkind behavior of rivals with unkind actions (negative reciprocity), while at the same time, it responds to kind behavior of rivals with kind actions (positive reciprocity). We find that collusion is easier to sustain when firms have a concern for reciprocity towards competing firms provided that they consider collusive prices to be kind and punishment prices to be unkind. Thus, reciprocity concerns among firms can have adverse welfare consequences for consumers.

This paper analyzes the impact of overconfidence on the timing of entry in markets, profits, and welfare. To do that the paper uses an endogenous timing model where (i) players have private information about costs and (ii) one player is overconfident and the other is rational. The paper shows that for moderate levels of self-confidence there is a unique cost-dependent equilibrium where the overconfident player has a higher ex-ante probability of entering the market before the rational player. In this equilibrium self-confidence reduces the profits of the rational player but can increase the profits of the overconfident player provided that cost asymmetries are small. Finally, we show that overconfidence reduces welfare, except when cost asymmetries are very small.

This paper provides a theory of corporate social responsibility in imperfectly competitive markets. We consider a two-stage game where consumers have a preference from buying goods from firms that do CSR and where firms first decide simultaneously the amount per unit sold to give to social causes and then choose quantities. We find that firms will do CSR when products are complements but might not do it when products are substitutes. We characterize how contributions to social causes depend on costs of production and on the degree of product differentiation. Finally, we show that CSR increases quantities, prices and profits.

This paper extends the standard industrial organization models of repeated interaction between firms by incorporating preferences for reciprocity. A reciprocal firm responds to unkind behavior of rivals with unkind actions (destructive reciprocity), while at the same time, it responds to kind behavior of rivals with kind actions (constructive reciprocity). The main finding of the paper is that, for plausible perceptions of fairness, preferences for reciprocity facilitate collusion in infinitely repeated market games, that is, the critical discount rate at wish collusion can be sustained tends to be lower when firms have preferences for reciprocity than when firms are selfish. The paper also finds that the best collusive outcome that can be sustained in the infinitely repeated Cournot game with reciprocal firms is worse for consumers than the best collusive outcome that can be sustained in the infinitely repeated Cournot game with selfish firms.

This paper studies how reciprocity and inequity aversion influence the behavior of firms in imperfectly competitive markets. The paper shows that if reciprocal firms compete a la Cournot, then they are able to sustain "collusive" outcomes under a positive reciprocity equilibrium. By contrast, Stackelberg warfare outcomes may emerge under a negative reciprocity equilibrium. The results for inequity aversion are similar. Cournot competition between inequity averse firms can be harmful to consumers if it leads to equilibria where firms feel compassion toward each other. However, in equilibria where inequity averse firms are envious of each other consumers are better off than if firms were selfish. The paper also shows that only under very restrictive conditions does reciprocity or inequity aversion have an impact on Bertrand competition. Finally, the paper shows that non-selfish preferences have a greater impact on equilibrium outcomes in markets with a small number of firms.

This paper incorporates egocentric comparisons into a human capital accumulation model and studies the evolution of positive self image over time. The paper shows that the process of human capital accumulation together with egocentric comparisons imply that positive self image of a cohort is first increasing and then decreasing over time. Additionally, the paper finds that positive self image: (1) peaks earlier in activities where skill depreciation is higher, (2) is smaller in activities where the distribution of income is more dispersed, (3) is not a stable characteristic of an individual, and (4) is higher for more patient individuals.

This paper analyzes the implications of worker overestimation of productivity for firms in which incentives take the form of tournaments. Each worker overestimates his productivity but is aware of the bias in his opponent's self-assessment. The manager of the firm, on the other hand, correctly assesses workers' productivities and self-beliefs when setting tournament prizes. The paper shows that, under a variety of circumstances, firms make higher profits when workers have positive self-image than if workers do not. By contrast, workers' welfare declines due to their own misguided choices.

This paper investigates the implications of individuals' mistaken beliefs of their abilities on incentives in organizations using the principal-agent model of moral hazard. The paper shows that if effort is observable, then an agent's mistaken beliefs about own ability are always favorable to the principal. However, if effort is unobservable, then an agent's mistaken beliefs about own ability can be either favorable or unfavorable to the principal. The paper provides conditions under which an agent's over estimation about own ability is favorable to the principal when effort is unobservable. Finally, the paper shows that workers' mistaken beliefs about their coworkers' abilities make interdependent incentive schemes more attractive to firms than individualistic incentive schemes.