OPTIMAL AGING AND DEATH: UNDERSTANDING THE PRESTON CURVE

Does prosperity lead to greater longevity? If so, what is the strength of the income channel? To address these questions we develop a life cycle model in which households are subject to physiological aging. In modeling aging we draw on recent research in the fields of biology and medicine. The speed of the aging process, and thus the age of death, are endogenously determined by optimal health investments. A calibrated version of the model accounts well for the observed nonlinear cross‐country link between longevity and income, also known as the Preston curve.     

EXPLAINING GIFT‐EXCHANGE—THE LIMITS OF GOOD INTENTIONS

This paper explores the limitations of intention‐based social preferences as an explanation of gift‐exchange between a firm and a worker. In a framework with one self‐interested and one reciprocal player, gift‐giving never arises in equilibrium. Instead, any equilibrium in a large class of multistage games must involve mutually unkind behavior of both players. Besides gift‐exchange, this class of games also includes moral hazard models and the rotten kid framework. Even though equilibrium behavior may appear positively reciprocal in some of these games, the self‐interested player never benefits from reciprocity. We discuss the relation of these results to the theoretical and empirical literature on gift‐exchange in employment relations.     

IMAGE AND MISREPORTING

In this paper we analyze how image utility can lead to misreporting of private information in contexts where truthful reports maximize monetary outcomes. In a controlled experiment, subjects go through a series of quiz questions and subsequently report a performance measure. We vary whether reports are made to an audience or not. In an additional feedback treatment, reports are also stated to an audience and afterwards the experimenter publicly verifies whether reports were correct. We find that in the audience treatment, stated reports are significantly higher relative to the private treatment as well as the feedback treatment. Our findings suggest that overconfident appearance might be a consequence of social approval seeking.     

SELECTIVE ATTENTION AND LEARNING

What do we notice and how does this affect what we learn and come to believe? I present a model of an agent who learns to make forecasts on the basis of readily available information, but is selective as to which information he attends to: he chooses whether to attend as a function of current beliefs about whether such information is predictive. If the agent does not attend to some piece of information, it cannot be recalled at a later date. He uses Bayes' rule to update his beliefs given attended‐to information, but does not attempt to fill in missing information. The model demonstrates how selective attention may lead the agent to persistently fail to recognize important empirical regularities, make systematically biased forecasts, and hold incorrect beliefs about the statistical relationship between variables. In addition, it identifies factors that make such errors more likely or persistent. The model is applied to shed light on stereotyping and discrimination, persistent learning failures and disagreement, and the process of discovery.     

REFERENCE POINTS,SOCIAL NORMS,AND FAIRNESS IN CONTRACT RENEGOTIATIONS

How does an ex‐ante contract affect behavior in an ex‐post renegotiation game? We address this question in a canonical buyer–seller relationship with renegotiation. Our paper provides causal experimental evidence that an initial contract has a highly significant and economically important impact on renegotiation behavior that goes beyond the effect of contracts on bargaining threat points. We compare situations in which an initial contract is renegotiated to strategically equivalent bargaining situations in which no ex‐ante contract was written. The ex‐ante contract causes sellers to ask for markups that are 45% lower than in strategically equivalent bargaining situations without an initial contract. Moreover, buyers are more likely to reject given markups in renegotiations than in negotiations. These effects do not depend on whether the contract was written under competitive or monopolistic conditions. Our results provide strong evidence supporting the hypothesis that contracts serve as reference points that shape and coordinate the expectations of the contracting parties.     

JEEA‐FBBVA Lecture 2012: USE AND ABUSE OF AUTHORITY: A BEHAVIORAL FOUNDATION OF THE EMPLOYMENT RELATION

Employment contracts give a principal the authority to decide flexibly which task his agent should execute. However, there is a tradeoff, first pointed out by Simon (1951, Econometrica, 19, 293–302), between flexibility and employer moral hazard. An employment contract allows the principal to adjust the task quickly to the realization of the state of the world, but he may also abuse this flexibility to exploit the agent. We capture this tradeoff in an experimental design and show that principals exhibit a strong preference for the employment contract. However, selfish principals exploit agents in one‐shot interactions, inducing the latter to resist entering into employment contracts. This resistance to employment contracts vanishes if fairness preferences in combination with reputation opportunities keep principals from abusing their power, leading to the widespread, endogenous formation of efficient long‐run employment relations. Our results inform the theory of the firm by showing how behavioral forces shape an important transaction cost of integration—the abuse of authority—and by providing an empirical basis for assessing differences between the Marxian and the Coasian view of the firm, as well as Alchian and Demsetz's (1972, American Economic Review, 62, 777–795) critique of the Coasian approach.     

EXPONENTIAL‐GROWTH BIAS AND LIFECYCLE CONSUMPTION

Exponential‐growth bias (EGB) is the tendency for individuals to partially neglect compounding of exponential growth. We develop a model wherein biased agents misperceive the intertemporal budget constraint, and derive conditions for overconsumption and dynamic inconsistency. We construct an incentivized measure of EGB in a US‐representative population and find substantial bias, with approximately one third of subjects estimated as the fully biased type. The magnitude of the bias is negatively associated with asset accumulation, and does not respond to a simple graphical intervention.     

THE POLITICAL ECONOMY OF REGULATION IN MARKETS WITH NAÏVE CONSUMERS

In a model of a competitive industry selling base goods and add‐ons, we investigate the conditions under which citizen‐consumers will support policies that eliminate behavioral inefficiencies induced by naïve consumers. Unregulated competitive markets have two effects: they produce deadweight losses, and they redistribute income away from biased consumers. Both unbiased and naïve consumers believe that they benefit from this redistribution (the naïve consumers are wrong), so support for efficiency‐improving regulation is limited. Extending our model to consumers with partial sophistication about their naïveté, we predict patterns of regulation consistent with the form and timing of the Credit Card Accountability Responsibility and Disclosure (CARD) Act of 2009.     

PREDICTING LOTTO NUMBERS: A NATURAL EXPERIMENT ON THE GAMBLER'S FALLACY AND THE HOT‐HAND FALLACY

We investigate the “law of small numbers” using a data set on lotto gambling that allows us to measure players' reactions to draws. While most players pick the same set of numbers week after week, we find that those who do change, react on average as predicted by the law of small numbers as formalized in recent behavioral theory. In particular, players tend to bet less on numbers that have been drawn in the preceding week, as suggested by the “gambler's fallacy”, and bet more on a number if it was frequently drawn in the recent past, consistent with the “hot‐hand fallacy”.     

NORMS MAKE PREFERENCES SOCIAL

We explore the idea that prosocial behavior in experimental games is driven by social norms imported into the laboratory. Under this view, differences in behavior across subjects is driven by heterogeneity in sensitivity to social norms. We introduce an incentivized method of eliciting individual norm‐sensitivity, and we show how it relates to play in public goods, trust, dictator, and ultimatum games. We show how our observations can be rationalized in a stylized model of norm‐dependent preferences under reasonable assumptions about the nature of social norms. Then we directly elicit norms in these games to test the robustness of our interpretation.     

OPTIMAL AND NEAR OPTIMAL CONTROL OF A TWO-PART-TYPE STOCHASTIC MANUFACTURING SYSTEM WITH DYNAMIC SETUPS

This paper deals with a manufacturing system consisting of a single machine subject to random failures and repairs. The machine can produce two types of parts. When the production is switched from one part type to the other, a random setup time is incurred at a constant cost rate. The objective is to track the demand, while keeping the work-in-process as close as possible to zero for both products. The problem is formulated as an optimal stochastic control problem. The optimal policy is obtained numerically by discretizing the continuous time continuous state opti-mality conditions using a Markov chain approximation technique. The discretized optimality conditions are shown to correspond to an infinite horizon, discrete time, discrete state dynamic programming problem. The optimal setup policy is shown to have two different structures depending on the parameters of the system. A heuristic policy is proposed to approximate the optimal setup policy. Simulation results show that the heuristic policy is a very good approximation for sufficiently reliable systems.     

A MODEL OF NONBELIEF IN THE LAW OF LARGE NUMBERS

People believe that, even in very large samples, proportions of binary signals might depart significantly from the population mean. We model this “nonbelief in the Law of Large Numbers” by assuming that a person believes that proportions in any given sample might be determined by a rate different than the true rate. In prediction, a nonbeliever expects the distribution of signals will have fat tails. In inference, a nonbeliever remains uncertain and influenced by priors even after observing an arbitrarily large sample. We explore implications for beliefs and behavior in a variety of economic settings.     

CONVERGENCE: AN EXPERIMENTAL STUDY OF TEACHING AND LEARNING IN REPEATED GAMES

Nash equilibrium can be interpreted as a steady state where players hold correct beliefs about the other players’ behavior and act rationally. We experimentally examine the process that leads to this steady state. Our results indicate that some players emerge as teachers—those subjects who, by their actions, try to influence the beliefs of their opponent and lead the way to a more favorable outcome—and that the presence of teachers appears to facilitate convergence to Nash equilibrium. In addition to our experiments, we examine games, with different properties, from other experiments and show that teaching plays an important role in these games. We also report results from treatments in which teaching is made more difficult. In these treatments, convergence rates go down and any convergence that does occur is delayed.     

The Effects of Personality Traits on Wages: A Matching Approach

I use the National Longitudinal Survey of Youth 1979 to estimate the effects of adolescent measurements of self‐esteem and locus of control on adult wages using propensity score matching. An adolescent possessing high self‐esteem will experience between 8.5 and 9.2 per cent higher wages as an adult. This result is statistically significant and robust to the addition of cognitive skill and family background characteristics. When cognitive skill and family background characteristics are controlled for, locus of control as an adolescent is insignificant in explaining adult wages. This result is contrary to findings in the literature.     

CATEGORIZE THEN CHOOSE: BOUNDEDLY RATIONAL CHOICE AND WELFARE

We propose a boundedly rational model of choice where agents categorize alternatives before choosing. The model explains some behavioral anomalies, and it is fully characterized by a property of choice data: a categorizer can never exhibit certain patterns of “revealed preference reversals”. This model offers clues on the problem of making welfare judgements in the presence of boundedly rational agents.     

MEASURING SELF‐CONTROL PROBLEMS: A STRUCTURAL ESTIMATION

Abstract We adopt a two‐stage Method of Simulated Moments to estimate the preference parameters in a life‐cycle consumption‐saving model augmented with temptation disutility. Our approach estimates the parameters from the comparison between simulated moments with empirical moments observed in the US Survey of Consumer Finances; to identify the parameters we consider moments from liquid and illiquid asset holdings at different ages. We find evidence of a small but significantly positive degree of temptation. The temptation model predicts consumption choices similar to the model with standard preferences, and holdings of liquid and illiquid assets closer to those observed in the empirical data.     

PREFERENCES FOR REDISTRIBUTION AND PERCEPTION OF FAIRNESS: AN EXPERIMENTAL STUDY

We conduct a laboratory experiment to study how demand for redistribution of income depends on self‐interest, insurance motives, and social concerns relating to inequality and efficiency. Our choice environments feature large groups of subjects and real‐world framing, and differ with respect to the source of inequality (earned or arbitrary), the cost of taxation to the decision maker, the dead‐weight loss of taxation, uncertainty about own pretax income, and whether the decision maker is affected by redistribution. We estimate utility weights for the different sources of demand for redistribution, with the potential to inform modeling in macroeconomics and political economy     

FORGETTING WE FORGET: OVERCONFIDENCE AND MEMORY

Do individuals have unbiased beliefs, or are they over‐ or underconfident? Overconfident individuals may fail to prepare optimally for the future, and economists who infer preferences from behavior under the assumption of unbiased beliefs will make mistaken inferences. This paper documents overconfidence in a new domain, prospective memory, using an experimental design that is more robust to potential confounds than previous research. Subjects chose between smaller automatic payments and larger payments they had to remember to claim at a six‐month delay. In a large sample of college and MBA students at two different universities, subjects make choices that imply a forecast of a 76% claim rate, but only 53% of subjects actually claimed the payment.     

PROPERTY RIGHTS AND THE EFFICIENCY OF BARGAINING

We show that efficient bargaining is impossible for a wide class of economic settings and property rights. These settings are characterized by (i) the existence of “adverse efficient opt‐out types”, whose participation does not change the efficient allocation and who, when they opt out, are the worst type other agents can face, and (ii) non‐existence of the “marginal core”, and its multivaluedness with a positive probability. We also examine the optimal allocation of property rights within a given class that satisfies (i), such as simple property rights, liability rules, and dual‐chooser rules. We characterize property rights that minimize the expected subsidy required to implement efficiency. With two agents, simple property rights that are optimal in this way maximize the expected surplus at the status quo allocation, but this no longer holds with more agents. We also study “second‐best” budget‐balanced bargaining under a liability rule. The optimal “second‐best” liability rule may differ from, but is often close to, the expectation of the victim's harm, which would be optimal if there were no bargaining. However, liability rules that are close to a simple property right result in a lower expected surplus than the simple property right they are near.     

THE EFFECTS OF VARIABLE AND FIXED TRANSACTION COSTS ON OPTIMAL INVESTMENT DECISIONS

This paper studies the impact of variable and fixed transaction costs on investment decisions under conditions of risk. The decision model is first formulated as a mixed-integer nonlinear program. The following subjects are then examined: the structure of the investment frontier facing the investor and the effects of transaction costs on this frontier, the impact of transaction costs on the investor's optimal investment strategy, and the conditions for the equilibrium structure of risky asset prices and risk-return relationships. The main finding is that the relaxation of the assumption of the absence of transaction costs eliminates some of the most unattractive implications of the classic capital asset pricing model (CAPM) while preserving the more attractive implications of this model. Also, our model provides explanations for some discrepancies between the theoretical CAPM and empirical findings and, therefore, is a step toward narrowing the gap between theory and practice.