econ 219b psychology and economics: applications (lecture 6)€¦ · outline 1 reference...
TRANSCRIPT
![Page 1: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/1.jpg)
Econ 219B
Psychology and Economics: Applications
(Lecture 6)
Stefano DellaVigna
February 27, 2019
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 1 / 105
![Page 2: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/2.jpg)
Outline
1 Reference Dependence: Full Prospect Theory
2 Reference Dependence: Insurance
3 Reference Dependence: Finance
4 Reference Points: Forward vs. Backward Looking
5 Reference Dependence: Domestic Violence
6 Reference Dependence: Endowment Effect
7 Reference Dependence-KR: Effort
8 Social Preferences Wave I: Altruism
9 Workplace Effort: Altruism
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 2 / 105
![Page 3: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/3.jpg)
Reference Dependence: Full Prospect Theory
Section 1
Reference Dependence: Full Prospect Theory
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 3 / 105
![Page 4: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/4.jpg)
Reference Dependence: Full Prospect Theory
Introduction
Two key features of evidence so far1 Focus not on Risk
Much of the laboratory evidence on prospect theory is on risktakingYet, field evidence considered so far (mostly) does not directlyinvolve riskHouse Sale, Merger Offer, Effort, Labor Supply, Job SearchNow consider explicitly settings with risk: insurance andfinancial choices
2 Focus on Loss Aversion exclusivelyNow examine settings where probability weighting plays roleDiminishing sensitivity also in finance
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 4 / 105
![Page 5: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/5.jpg)
Reference Dependence: Insurance
Section 2
Reference Dependence: Insurance
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 5 / 105
![Page 6: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/6.jpg)
Reference Dependence: Insurance Sydnor (2010)
Introduction
Sydnor (AEJ Applied, 2010) on deductible choice in the lifeinsurance industry
Menu Choice as identification strategy as in DellaVigna andMalmendier (2006)
Slides courtesy of Justin Sydnor
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 6 / 105
![Page 7: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/7.jpg)
Dataset50,000 Homeowners-Insurance Policies
12% were new customers Single western stateOne recent year (post 2000)Observe
Policy characteristics including deductible1000, 500, 250, 100
Full available deductible-premium menuClaims filed and payouts by company
![Page 8: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/8.jpg)
Summary Statistics
VariableFull
Sample 1000 500 250 100
Insured home value 206,917 266,461 205,026 180,895 164,485(91,178) (127,773) (81,834) (65,089) (53,808)
8.4 5.1 5.8 13.5 12.8(7.1) (5.6) (5.2) (7.0) (6.7)
53.7 50.1 50.5 59.8 66.6(15.8) (14.5) (14.9) (15.9) (15.5)
0.042 0.025 0.043 0.049 0.047(0.22) (0.17) (0.22) (0.23) (0.21)
Yearly premium paid 719.80 798.60 715.60 687.19 709.78(312.76) (405.78) (300.39) (267.82) (269.34)
N 49,992 8,525 23,782 17,536 149Percent of sample 100% 17.05% 47.57% 35.08% 0.30%
Chosen Deductible
Number of years insured by the company
Average age of H.H. members
Number of paid claims in sample year (claim rate)
* Means with standard errors in parentheses.
![Page 9: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/9.jpg)
Deductible PricingXi = matrix of policy characteristicsf(Xi) = “base premium”
Approx. linear in home valuePremium for deductible D
PiD = δD f(Xi)
Premium differencesΔPi = Δδ f(Xi)
⇒Premium differences depend on base premiums (insured home value).
![Page 10: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/10.jpg)
Premium-Deductible Menu
Available Deductible
Full Sample 1000 500 250 100
1000 $615.82 $798.63 $615.78 $528.26 $467.38(292.59) (405.78) (262.78) (214.40) (191.51)
500 +99.91 +130.89 +99.85 +85.14 +75.75(45.82) (64.85) (40.65) (31.71) (25.80)
250 +86.59 +113.44 +86.54 +73.79 +65.65(39.71) (56.20) (35.23) (27.48) (22.36)
100 +133.22 +174.53 +133.14 +113.52 +101.00(61.09) (86.47) (54.20) (42.28) (82.57)
Chosen Deductible
Risk Neutral Claim Rates?
100/500 = 20%
87/250 = 35%
133/150 = 89%
* Means with standard deviations in parentheses
![Page 11: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/11.jpg)
Potential Savings with 1000 Ded
Chosen DeductibleNumber of claims
per policy
Increase in out-of-pocket payments per claim with a
$1000 deductible
Increase in out-of-pocket payments per policy with a
$1000 deductible
Reduction in yearly premium per policy with
$1000 deductible
Savings per policy with $1000 deductible
$500 0.043 469.86 19.93 99.85 79.93 N=23,782 (47.6%) (.0014) (2.91) (0.67) (0.26) (0.71)
$250 0.049 651.61 31.98 158.93 126.95 N=17,536 (35.1%) (.0018) (6.59) (1.20) (0.45) (1.28)
Average forgone expected savings for all low-deductible customers: $99.88
Claim rate?Value of lower deductible? Additional
premium? Potential savings?
* Means with standard errors in parentheses
![Page 12: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/12.jpg)
Back of the Envelope
BOE 1: Buy house at 30, retire at 65, 3% interest rate ⇒ $6,300 expected
With 5% Poisson claim rate, only 0.06% chance of losing money
BOE 2: (Very partial equilibrium) 80% of 60 million homeowners could expect to save $100 a year with “high” deductibles ⇒ $4.8 billion per year
![Page 13: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/13.jpg)
Consumer Inertia?Percent of Customers Holding each Deductible Level
0
10
20
30
40
50
60
70
80
90
0-3 3-7 7-11 11-15 15+
Number of Years Insured with Company
%
1000
500
250100
![Page 14: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/14.jpg)
Chosen DeductibleNumber of claims
per policy
Increase in out-of-pocket payments per claim with a $1000 deductible
Increase in out-of-pocket payments per policy with a $1000 deductible
Reduction in yearly premium per policy with
$1000 deductible
Savings per policy with $1000 deductible
$500 0.037 475.05 17.16 94.53 77.37 N = 3,424 (54.6%) (.0035) (7.96) (1.66) (0.55) (1.74)
$250 0.057 641.20 35.68 154.90 119.21 N = 367 (5.9%) (.0127) (43.78) (8.05) (2.73) (8.43)
Average forgone expected savings for all low-deductible customers: $81.42
Look Only at New Customers
![Page 15: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/15.jpg)
Bounding Risk Aversion
1)ln()(,1)1(
)()1(
==≠−
=−
ρρρ
ρ
forxxuandforxxu
Assume CRRA form for u :
)1()(
)1()1(
)()1(
)()1(
)1()( )1()1()1()1(
ρπ
ρπ
ρπ
ρπ
ρρρρ
−−
−+−−−
=−
−−+
−−− −−−−
HHHLLL PwDPwPwDPw
Indifferent between contracts iff:
![Page 16: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/16.jpg)
CRRA Bounds
Chosen Deductible W min ρ max ρ
$1,000 256,900 - infinity 794 N = 2,474 (39.5%) {113,565} (9.242)
$500 190,317 397 1,055 N = 3,424 (54.6%) {64,634} (3.679) (8.794)
$250 166,007 780 2,467 N = 367 (5.9%) {57,613} (20.380) (59.130)
Measure of Lifetime Wealth (W): (Insured Home Value)
![Page 17: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/17.jpg)
Interpreting Magnitude
50-50 gamble: Lose $1,000/ Gain $10 million
99.8% of low-ded customers would rejectRabin (2000), Rabin & Thaler (2001)
Labor-supply calibrations, consumption-savings behavior ⇒ ρ < 10
Gourinchas and Parker (2002) -- 0.5 to 1.4Chetty (2005) -- < 2
![Page 18: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/18.jpg)
Model of Deductible Choice
Choice between (PL,DL) and (PH,DH)π = probability of lossEU of contract:
U(P,D,π) = πu(w-P-D) + (1- π)u(w-P)
PT value:V(P,D,π) = v(-P) + w(π)v(-D)
Prefer (PL,DL) to (PH,DH)v(-PL) – v(-PH) < w(π)[v(- DH) – v(- DL)]
Prospect Theory
![Page 19: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/19.jpg)
No loss aversion in buyingNovemsky and Kahneman (2005) (Also Kahneman, Knetsch & Thaler (1991))
Endowment effect experimentsCoefficient of loss aversion = 1 for “transaction money”
Köszegi and Rabin (forthcoming QJE, 2005)Expected payments
Marginal value of deductible payment > premium payment (2 times)
![Page 20: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/20.jpg)
So we have:
Prefer (PL,DL) to (PH,DH):
Which leads to:
Linear value function:
)]()()[()()( LHHL DvDvwPvPv −−−<−−− π
][)( ββββ λπ LHHL DDwPP −<−
DwPWTP Δ=Δ= λπ )(
= 4 to 6 times EV
![Page 21: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/21.jpg)
Choices: Observed vs. Model
Chosen Deductible 1000 500 250 100 1000 500 250 100
$1,000 87.39% 11.88% 0.73% 0.00% 100.00% 0.00% 0.00% 0.00% N = 2,474 (39.5%)
$500 18.78% 59.43% 21.79% 0.00% 100.00% 0.00% 0.00% 0.00% N = 3,424 (54.6%)
$250 3.00% 44.41% 52.59% 0.00% 100.00% 0.00% 0.00% 0.00% N = 367 (5.9%)
$100 33.33% 66.67% 0.00% 0.00% 100.00% 0.00% 0.00% 0.00% N = 3 (0.1%)
Predicted Deductible Choice from Prospect Theory NLIB Specification:
λ = 2.25, γ = 0.69, β = 0.88
Predicted Deductible Choice from EU(W) CRRA Utility:
ρ = 10, W = Insured Home Value
![Page 22: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/22.jpg)
Alternative ExplanationsMisestimated probabilities
≈ 20% for single-digit CRRAOlder (age) new customers just as likely
Liquidity constraintsSales agent effects
Hard sell?Not giving menu? ($500?, data patterns)Misleading about claim rates?
Menu effects
![Page 23: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/23.jpg)
Reference Dependence: Insurance Barseghyan et al. (2013)
Barseghyan et al. (2013)
Barseghyan, Molinari, O’Donoghue, and Teitelbaum (AER2013)
Micro data for same person on 4,170 households for 2005 or2006 on
home insuranceauto collision insuranceauto comprehensive insurance
Estimate a model of reference-dependent preferences withKoszegi-Rabin reference points
Separate role of loss aversion, curvature of value function, andprobability weighting
Key to identification: variation in probability of claim:home insurance � 0.084auto collision insurance � 0.069auto comprehensive insurance � 0.021
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 30 / 105
![Page 24: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/24.jpg)
Reference Dependence: Insurance Barseghyan et al. (2013)
Predicted Claim Probabilities
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 31 / 105
![Page 25: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/25.jpg)
Reference Dependence: Insurance Barseghyan et al. (2013)
Summary
This allows for better identification of probability weightingfunction
Main result: Strong evidence from probability weighting,implausible to obtain with standard risk aversion
Share of probability weighting function
With probability weighting, realistic demand for low-deductibleinsurance
Follow-up work: distinguish probability weighting fromprobability distortion
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 32 / 105
![Page 26: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/26.jpg)
Reference Dependence: Insurance Barseghyan et al. (2013)
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 33 / 105
![Page 27: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/27.jpg)
Reference Dependence: Insurance Barseghyan et al. (2013)
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 34 / 105
![Page 28: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/28.jpg)
Reference Dependence: Finance
Section 3
Reference Dependence: Finance
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 35 / 105
![Page 29: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/29.jpg)
Reference Dependence: Finance
Background
Equity premium (Mehra and Prescott, 1985)
Stocks not so riskyDo not covary much with GDP growthBUT equity premium 3.9% over bond returns (US, 1871-1993)
Need very high risk aversion: RRA ≥ 20
Benartzi and Thaler (QJE 1995): Loss aversion + narrowframing solve puzzle
Loss aversion from (nominal) losses � Deter from stocksNarrow framing: Evaluate returns from stocks every n months
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 36 / 105
![Page 30: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/30.jpg)
Reference Dependence: Finance Benartzi and Thaler (1995)
Narrow Framing
More frequent evaluation � Losses more likely � Fewer stockholdings
Calibrate model with λ (loss aversion) 2.25 and full prospecttheory specification � Horizon n at which investors areindifferent between stocks and bonds
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 37 / 105
![Page 31: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/31.jpg)
Reference Dependence: Finance Benartzi and Thaler (1995)
Narrow Framing
If evaluate every year, indifferent between stocks and bonds
(Similar results with piecewise linear utility)
Alternative way to see results: Equity premium implied asfunction on n
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 38 / 105
![Page 32: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/32.jpg)
Reference Dependence: Finance Barberis’s Finance Work
Reference Dependence and Finance
Nick Barberis’s work in Handbook of Behavioral Economics
Slides courtesy of Nick
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 39 / 105
![Page 33: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/33.jpg)
Prospect theory applications
[1]
• the cross-section of stock returns
– one-period models
– new prediction: the pricing of skewness
– probability weighting plays the most critical role
[2]
• the aggregate stock market
– multi-period models
– try to address the equity premium, non-participation,volatility, and predictability puzzles
– loss aversion plays a key role; but probability weight-ing also matters
[3]
• trading behavior (and the cross-section, revisited)
– multi-period models
– try to address the disposition effect and other trad-ing phenomena
– all aspects of prospect theory play a role
13
![Page 34: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/34.jpg)
Prospect theory applications, ctd.
Note:
• prospect theory models capture a very intuitive idea
– that, when they invest, people think explicitly abouthow much money they could make, or lose
• one difficulty is defining the “gains” and “losses” peo-ple think about
– gains and losses in total wealth, financial wealth,stock market holdings, individual stocks?
– annual gains and losses?
– is a gain a return that exceeds zero, or one thatexceeds the risk-free rate or the investor’s expecta-tion?
• in the absence of a full theory of how gains and lossesare defined, we try specifications that appear plausible
– e.g. focus on annual gains and losses in financialwealth
14
![Page 35: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/35.jpg)
The cross-section
Barberis and Huang (2008), “Stocks as Lotteries...”
• single period model; a risk-free asset and J risky assetswith multivariate Normal payoffs
• investors have identical expectations about securitypayoffs
• investors have identical CPT preferences
– defined over gains/losses in wealth (i.e. no narrowframing)
– reference point is initial wealth scaled up by therisk-free rate, so utility defined over W = W1 −W0Rf
– full specification is:
V (W ) =∫ 0−∞ v(W ) dπ(P (W ))−
∫ ∞0 v(W ) dπ(1−P (W ))
(continuous distribution version of Tversky andKahneman, 1992)
Then:
• the CAPM holds!
– i.e. prospect theory gives the same prediction asthe EU model
– see also De Giorgi, Hens, and Levy (2011)
15
![Page 36: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/36.jpg)
The cross-section, ctd.
• to make more interesting predictions, break away fromthe multivariate Normal assumption
– introduce a small, independent, positively skewedsecurity into the economy
• obtain a novel prediction: the new security earns anegative excess return
– skewness itself is priced, in contrast to concave EUmodel where only coskewness with market matters
• equilibrium involves heterogeneous holdings
(assume short-sale constraints for now)
– some investors hold a large, undiversified positionin the new security
– others hold no position in it at all
– heterogeneous holdings arise from non-unique globaloptima, not from heterogeneous preferences
• since the new security contributes skewness to theportfolios of some investors, it is valuable, and so earnsa low average return
16
![Page 37: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/37.jpg)
The cross-section, ctd.
0 0.02 0.04 0.06 0.08 0.1 0.12 0.14 0.1610
8
6
4
2
0
2
4
6
810–3
x
Util
ity
Figure 3. A Heterogeneous Holdings Equilibrium
Notes: The figure shows the utility that an investor with cumulative prospect theory preferences derives from adding a position in a positively skewed security to his current holdings of a Normally distributed market portfolio. The skewed security is highly skewed. The variable x is the fraction of wealth allocated to the skewed security relative to the frac-tion of wealth allocated to the market portfolio. The two lines correspond to different mean returns on the skewed security.
17
![Page 38: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/38.jpg)
The cross-section, ctd.
Applications
• low average return on IPOs
– IPO returns are highly positively skewed
– Green and Hwang (2012) show that IPOs predictedto be more positively skewed have lower long-termreturns
• low average return of distressed stocks, bankrupt stocks,OTC stocks (Eraker and Ready, 2015)
• low average return of out-of-the-money options on in-dividual stocks
– Boyer and Vorkink (2014) find that stock optionspredicted to be more positively skewed have lowerreturns
• low average return of out-of-the-money index calls andindex puts, and the variance premium (Baele et al.,2019)
• low average return on stocks with high idiosyncraticvolatility (Ang et al., 2006; Boyer, Mitton, Vorkink,2010)
• diversification discount (Mitton and Vorkink, 2010)
21
![Page 39: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/39.jpg)
The aggregate stock market
Can prospect theory help us understand empirical factsabout the aggregate stock market?
• Benartzi and Thaler (1995) propose that prospect the-ory can help explain the equity premium puzzle
• specific finding:
– the prospect theory values of the historical distri-bution of annual U.S. stock returns and of the his-torical distribution of annual U.S. bond returns areapproximately equal
• interpretation: the high equity premium makes thestock market competitive with the bond market inthe eyes of prospect theory investors
– without it, the stock market would be unappealing,due to loss aversion
• loss aversion and annual evaluation play importantroles here
– “myopic loss aversion”
24
![Page 40: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/40.jpg)
The aggregate stock market, ctd.
• Benartzi and Thaler (1995) do not incorporate theirideas into an equilibrium model with endogenouslydetermined prices
• Barberis, Huang, and Santos (2001) take up this task
– construct a model where the representative agentderives utility from consumption and from gainsand losses in financial wealth
• Barberis and Huang (2009) address the same chal-lenge using a different modeling approach
– see also Andries (2013) and Pagel (2013)
25
![Page 41: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/41.jpg)
The aggregate stock market, ctd.
• Barberis, Huang, and Santos (2001) consider an econ-omy with three assets: risk-free (Rf,t), stock market(RS,t+1), non-financial asset (RN,t+1)
• representative agent maximizes:
E0
∞∑t=0
⎡⎢⎢⎢⎣ρ
t C1−γt
1− γ+ b0ρ
t+1C−γt v(GS,t+1)
⎤⎥⎥⎥⎦
GS,t+1 = St(RS,t+1 −Rf,t)
v(x) =
⎧⎪⎪⎨⎪⎪⎩
xλx
forx ≥ 0x < 0
, λ > 1
– here, GS is the annual gain or loss in financialwealth, measured relative to the risk-free rate
i.e. BtRf,t + StRS,t+1 − (Bt + St)Rf,t
where Bt and St are risk-free and stock marketholdings
– v(·) captures loss aversion; concavity/convexity andprobability weighting are ignored for now
• for “reasonable” parameters, the model generates alarge equity premium
26
![Page 42: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/42.jpg)
The aggregate stock market, ctd.
The role of narrow framing
• Barberis, Huang, and Santos (2001) assume a mildlevel of narrow framing
– gains and losses in financial wealth
• loss aversion over total wealth fluctuations may notproduce as large an equity premium
– nor generate non-participation in the stock market(Barberis, Huang, Thaler, 2006)
• a stronger level of narrow framing can also be assumed
The role of probability weighting
• De Giorgi and Legg (2012) bring probability weightingand concavity/convexity into the Barberis and Huang(2009) framework
– they show that probability weighting can signifi-cantly increase the equity premium
– because the aggregate market is negatively skewed
28
![Page 43: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/43.jpg)
The aggregate stock market, ctd.
Note:
• we are using frameworks in which investors derive util-ity from fluctuations in financial wealth, not just con-sumption
• we can justify this in terms of “mental accounting”
– to try to ensure good future consumption outcomes,investors track wealth fluctuations on a regular ba-sis
– an increase in wealth is “good news” and becomesassociated with a positive utility burst
– a decrease in wealth is “bad news” and becomesassociated with a negative utility burst
30
![Page 44: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/44.jpg)
II. Disposition effect (CC)
• Odean (1998) studies the trading activity, from 1987-
1993, of 10,000 households with accounts at a large
discount brokerage firm
• whenever an investor sells shares of a stock, classify
each of the stocks in her portfolio on that day as one
of:
– “realized gain”, “realized loss”, “paper gain”, or
“paper loss”
• add up total number of realized gains and losses and
paper gains and losses over all accounts over the sam-
ple, and compute:
PGR =no. of realized gains
no. of realized gains + no. of paper gains
PLR =no. of realized losses
no. of realized losses + no. of paper losses
(e.g. PGR is “proportion of gains realized”)
• the disposition effect is the finding that PGR > PLR
– specifically, 0.148 = PGR > PLR = 0.098
21
![Page 45: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/45.jpg)
II. Disposition effect (CC), ctd.
The most obvious potential explanations fail to capture
important features of the data
• e.g. informed trading
– the subsequent return of winners that people sell
is higher than that of losers they hold on to
• e.g. taxes, rebalancing, transaction costs
Two non-standard hypotheses have gained prominence
• an irrational belief in mean-reversion
• an explanation based on prospect theory and narrow
framing
At first glance, prospect theory and narrow framing do
seem to generate a disposition effect
• in a formal model, however, Barberis and Xiong (2005)
find that prospect theory often predicts the opposite
of the disposition effect
22
![Page 46: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/46.jpg)
II. Disposition effect (CC), ctd.
• consider a simple portfolio choice setting
– T + 1 dates: t = 0, 1, . . . , T
– a risk-free asset, gross return Rf each period
– a risky asset with an i.i.d binomial distribution
across periods:
Rt,t+1 =
⎧⎪⎪⎪⎪⎨⎪⎪⎪⎪⎩
Ru > Rf with probability 12
Rd < Rf with probability 12
, i.i.d.
• the investor has prospect theory preferences defined
over her “gain/loss”
– simplest definition of gain/loss is trading profit be-
tween 0 and T, i.e. WT −W0
– we use WT −W0RTf
– call W0RTf the “reference” wealth level
23
![Page 47: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/47.jpg)
II. Disposition effect (CC), ctd.
Does prospect theory predict a disposition effect?
• construct a simulated dataset of how 10,000 prospect
theory investors trade NS stocks over T periods
– simulate a T -period path through the binomial tree
for 10, 000×NS stocks
– for each path, earlier analysis tells us how the in-
vestor trades along the path
• now follow Odean’s (1998) exact methodology for com-
puting PGR and PLR
– if PGR > PLR, there is a disposition effect
• parameter values:
– set (P0,W0) = (40, 40) for each stock
– set Rf = 1 and σ = 0.3
– set (α, λ) = (0.88, 2.25)
– Barber and Odean (2000) report NS = 4
– range of values of µ and T
29
![Page 48: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/48.jpg)
Table 2: For a given (µ, T ) pair, we construct an artificial dataset of how 10,000investors with prospect theory preferences, each of whom owns NS stocks, eachof which have expected return µ, would trade those stocks over T periods. Foreach (µ, T ) pair, we use the artifical dataset to compute PGR and PLR, wherePGR is the proportion of gains realized by all investors over the entire tradingperiod, and PLR is the proportion of losses realized. The table reports PGR/PLRfor each (µ, T ) pair. Boldface type identifies cases where the disposition effectfails (PGR < PLR). A hyphen indicates that the expected return is so low thatthe investor does not buy any stock at all.
µ T = 2 T = 4 T = 6 T = 12
1.03 - - - .55/.50
1.04 - - .54/.52 .54/.52
1.05 - - .54/.52 .59/.45
1.06 - .70/.25 .54/.52 .58/.47
1.07 - .70/.25 .54/.52 .57/.49
1.08 - .70/.25 .48/.58 .47/.60
1.09 - .43/.70 .48/.58 .46/.61
1.10 0.0/1.0 .43/.70 .48/.58 .36/.69
1.11 0.0/1.0 .43/.70 .49/.58 .37/.68
1.12 0.0/1.0 .28/.77 .23/.81 .40/.66
1.13 0.0/1.0 .28/.77 .24/.83 .25/.78
41
![Page 49: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/49.jpg)
II. Disposition effect (CC), ctd.
What is the investor’s strategy at time 1?
• we focus on situations in which the expected risky
asset return is not too low
• after a gain at time 1, the investor takes a position
such that, after a poor time 2 return, she ends up
with a small gain
– since v(·) is only mildly concave over gains, she
gambles to the edge of the concave region, but no
further
• after a loss at time 1, the investor takes a position
such that, after a good time 2 return, she again ends
up with a small gain
– since v(·) is convex over gains, she gambles to the
edge of the convex region, but not much beyond
31
![Page 50: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/50.jpg)
II. Disposition effect (CC), ctd.
So why does the disposition effect fail?
• for the investor to buy the stock at all at time 0, in
spite of her loss aversion, it must have a relatively high
expected return
– this implies that the time 1 gain is larger than the
time 1 loss in magnitude
– it also implies that, after a gain, the investor gam-
bles to the edge of the concave region
• but it takes a larger position to gamble to the edge of
the concave region after a gain, than it does to gamble
to the edge of the convex region, after a loss
⇒ the investor takes more risk after a gain, than after
a loss, contrary to the disposition effect
32
![Page 51: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/51.jpg)
Trading behavior, ctd.
• an alternative gain-loss utility approach can generatethe disposition effect more reliably
– one based on “realization utility”
– the idea that investors derive utility directly fromrealized gains and losses (Shefrin and Statman,1985)
• e.g. if you buy a stock at $40 and sell it at $60
– you get a jolt of positive utility at the moment ofsale, based on the size of the realized gain
• what is the source of realization utility?
– people often think about their investing history asa series of investing episodes
– and view selling a stock at a gain as a “good”episode
⇒ when an investor sells an asset at a gain, hefeels a burst of pleasure because he is creating apositive new investing episode
35
![Page 52: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/52.jpg)
Trading behavior, ctd.
• Barberis and Xiong (2012), “Realization Utility,” studylinear realization utility, coupled with time discount-ing
Assets
• a risk-free asset, with net return of zero
• N risky assets, “stocks”; stock i has price process
dSi,t
Si,t= μdt + σdZi,t
– μ and σ are the same for all stocks
The Investor
• at each time t, he either allocates all of his wealth tothe risk-free asset, or all of his wealth to one of the Nstocks
– time t wealth is Wt
• if he is holding stock at time t, let Bt be the cost basisof the position
• if he sells stock at time t, he pays a transaction costkWt
36
![Page 53: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/53.jpg)
Trading behavior, ctd.
Key assumption:
• if, at time t, the investor switches his wealth from astock to the risk-free asset or to another stock, hereceives realization utility of
u((1− k)Wt −Bt)
• he also faces the possibility of a random liquidity shock
– the shock arrives according to a Poisson processwith parameter ρ
– when a shock hits, the investor sells his asset hold-ings and exits the asset markets
• the investor maximizes the discounted sum of expectedfuture realization utility flows
– δ is the time discount rate
– we take u(x) = x
37
![Page 54: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/54.jpg)
Trading behavior, ctd.
Solution
• if the expected return on stocks is low, the individualinvests in the risk-free asset forever
• if the expected return on stocks is high enough, hebuys a stock at time 0
– and sells it only if its value rises a certain percent-age amount above purchase price
– he then immediately reinvests in another stock,and so on
38
![Page 55: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/55.jpg)
Trading behavior, ctd.
• applications:
– the disposition effect
but also:
– “excessive trading”
– the underperformance of individual investors evenbefore transaction costs
– the greater turnover in bull markets
– the greater selling propensity above historical highs
– the negative premium to volatility in the cross-section
– the fact that overpriced assets are also heavily traded
39
![Page 56: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/56.jpg)
Reference Points: Forward- vs. Backward-Looking
Section 4
Reference Points: Forward- vs.
Backward-Looking
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 56 / 105
![Page 57: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/57.jpg)
Reference Points: Forward- vs. Backward-Looking
So Far: Backward-Looking Reference Point
Most papers so far assume assume a backward-looking referencepoint
Salient past outcomes
Purchase price of homePurchase price of sharesAmount withheld in taxesRecent earnings
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 57 / 105
![Page 58: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/58.jpg)
Reference Points: Forward- vs. Backward-Looking
So Far: Backward-Looking Reference Point
Status quo
Ownership in endowment effect
Cultural norm
52-week high for mergersRound numbers (as running goals)Number of strokes in a put
For bunching and shifting test, reference point needs to be
DeterministicClear to the researcher
For other predictions, such as in job search, exact level lesscritical
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 58 / 105
![Page 59: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/59.jpg)
Reference Points: Forward- vs. Backward-Looking
What About Forward-Looking?
Koszegi and Rabin (QJE 2006; AER 2007): forward-lookingreference points
Reference point is expectations of future outcomesReference point is stochasticSolve with Personal Equilibria
Motivations:
Motivation 1: It often makes sense for people to compareoutcomes to expectationsMotivation 2: Reference point does not need to be assumed
Evidence so far:
Reference point for police arbitrationReference point for watching sports games
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 59 / 105
![Page 60: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/60.jpg)
Reference Points: Forward- vs. Backward-Looking
Forward-Looking Reference Point
Drawbacks of forward-looking reference points:
Stochastic � Lose sharpest tests of reference dependence(bunching and shifting)(Reference point is often taken as expectation, rather than fulldistribution, to simplify)Often multiplicity of equilibria
Next, cover papers designed to test reference points asexpectations:
Endowment effectEffort
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 60 / 105
![Page 61: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/61.jpg)
Reference Points: Forward- vs. Backward-Looking
Future Research
Future research: Would be great to see papers with referencepoint r
r = αr0 + (1− α) rf
r0 backward-looking / status quo reference pointrf forward-looking reference pointWhat weight on each component?
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 61 / 105
![Page 62: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/62.jpg)
Reference Dependence: Domestic Violence
Section 5
Reference Dependence: Domestic Violence
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 62 / 105
![Page 63: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/63.jpg)
Reference Dependence: Domestic Violence
Introduction
Consider a man in conflicted relationship with the spouse
What is the effect of an event such as the local (American)football team losing or winning a game?
With probability h the man loses control and becomes violent
Assume h = h (u) with h′ < 0 and u the underlying utilityDenote by p the ex-ante expectation that the team winsDenote by u(W ) and u(L) the consumption utility of a loss
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 63 / 105
![Page 64: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/64.jpg)
Reference Dependence: Domestic Violence
Introduction
Using a Koszegi-Rabin specification, then ex-post the utility from awin is
U (W |p) = u(W ) [consumption utility]
+p [0] + (1− p) η [u (W )− u (L)] [gain-loss utility]
Similarly, the utility from a loss is
U (L|p) = u(L) + (1− p) [0]− λpη [u (W )− u (L)]
Implication:
∂U (L|p) /∂p = −λη [u (W )− u (L)] < 0
The more a win is expected, the more a loss is painful � themore likely it is to trigger violenceThe (positive) effect of a gain is higher the more unexpected(lower p)
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 64 / 105
![Page 65: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/65.jpg)
Reference Dependence: Domestic Violence Card and Dahl (2011)
Testing the Predictions
Card and Dahl (QJE 2011) test these predictions using adata set of:
Domestic violence (NIBRS)Football games by StateExpected win probability from Las Vegas predicted point spread
Separate matches into
Predicted win (+3 points of spread)Predicted closePredicted loss (-3 points)
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 65 / 105
![Page 66: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/66.jpg)
Reference Dependence: Domestic Violence Card and Dahl (2011)
Testing the Predictions
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 66 / 105
![Page 67: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/67.jpg)
Reference Dependence: Domestic Violence Card and Dahl (2011)
Findings
1 Unexpected loss increases domestic violence
2 No effect of expected loss
3 No effect of unexpected win, if anything increases violence
Findings 1-2 consistent with ref. dep. and 3 partially consistent(given that violence is a function of very negative utility)
Other findings:
Effect is larger for more important gamesEffect disappears within a few hours of game end � Emotionsare transientNo effect on violence of females on males
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 67 / 105
![Page 68: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/68.jpg)
Reference Dependence: Endowment Effect
Section 6
Reference Dependence: Endowment Effect
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 68 / 105
![Page 69: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/69.jpg)
Reference Dependence: Endowment Effect Plott and Zeiler (2005)
Plott and Zeiler (AER 2005)
Plott and Zeiler (AER 2005) replicating Kahneman,Knetsch, and Thaler (JPE 1990)
Half of the subjects are given a mug and asked for WTAHalf of the subjects are shown a mug and asked for WTPFinding: WTA ' 2 ∗WTP
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 69 / 105
![Page 70: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/70.jpg)
Reference Dependence: Endowment Effect Plott and Zeiler (2005)
Model
How do we interpret it? Use reference-dependence in piece-wiselinear form
Assume only gain-loss utility, and assume piece-wise linearformulation (1)+(3)Two components of utility: utility of owning the object u (m)and (linear) utility of money pAssumption: No loss-aversion over moneyWTA: Given mug � r = {mug}, so selling mug is a lossWTP: Not given mug � r = {∅}, so getting mug is a gainAssume u {∅} = 0
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 70 / 105
![Page 71: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/71.jpg)
Reference Dependence: Endowment Effect Plott and Zeiler (2005)
This implies:
WTA: Status-Quo ∼ Selling Mug
u{mug} − u{mug} = λ [u {∅} − u{mug}] + pWTA or
pWTA = λu{mug}WTP: Status-Quo ∼ Buying Mug
u {∅} − u {∅} = u{mug} − u {∅} − pWTP or
pWTP = u{mug}It follows that
pWTA = λu{mug} = λpWTP
If loss-aversion over money,
pWTA = λ2pWTP
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 71 / 105
![Page 72: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/72.jpg)
Reference Dependence: Endowment Effect Plott and Zeiler (2005)
Results
Result WTA ' 2 ∗WTP is consistent with loss-aversion λ ' 2
Plott and Zeiler (AER 2005): The result disappears with
appropriate trainingpractice roundsincentive-compatible procedureanonymity
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 72 / 105
![Page 73: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/73.jpg)
Reference Dependence: Endowment Effect Plott and Zeiler (2005)
Interpretation 1
Endowment effect and loss-aversion interpretation are wrong
Subjects feel bad selling a ‘gift’Not enough training
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 73 / 105
![Page 74: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/74.jpg)
Reference Dependence: Endowment Effect Plott and Zeiler (2005)
Interpretation 2
In Plott-Zeiler (2005) experiment, subjects did not perceive thereference point to be the endowment
Koszegi-Rabin: Assume reference point (.5, {mug}; .5, {∅}) inboth cases
WTA:[.5 ∗ [u{mug} − u{mug}]+.5 ∗ [u{mug} − u {∅}]
]=
[.5 ∗ λ [u {∅} − u{mug}]+.5 ∗ [u {∅} − u {∅}]
]+pWTA
WTP:[.5 ∗ λ [u {∅} − u{mug}]+.5 ∗ [u {∅} − u {∅}]
]=
[.5 ∗ [u{mug} − u{mug}]+.5 ∗ [u{mug} − u {∅}]
]−pWTP
This implies no endowment effect:
pWTA = pWTP
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 74 / 105
![Page 75: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/75.jpg)
Reference Dependence: Endowment Effect Plott and Zeiler (2005)
Testing Koszegi-Rabin
Following papers: manipulate probability of exchange to testKoszegi-Rabin
Ericson and Fuster (QJE 2011): KR evidenceHeffetz and List (JEEA 2015): no KR evidence
Cerulli-Harms, Goette, and Sprenger (AEJ Micro, 2019)
Endowment effect in classroomVary probability p of forced exchange: owner must sell, buyermust buyFor probability p = 0.5, owner in KR sense is only owner withprob. 0.5, and buyer is owner with p = 0.5 � Should be noendowment effect
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 75 / 105
![Page 76: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/76.jpg)
Reference Dependence: Endowment Effect Cerulli-Harms, Goette, and Sprenger (2019)
Prediction
For p > 0.5 � Reverse endowment effect
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 76 / 105
![Page 77: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/77.jpg)
Reference Dependence: Endowment Effect Cerulli-Harms, Goette, and Sprenger (2019)
Results
What do they find? Mostly, full endowment effect, no KR
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 77 / 105
![Page 78: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/78.jpg)
Reference Dependence-KR: Effort
Section 7
Reference Dependence-KR: Effort
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 78 / 105
![Page 79: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/79.jpg)
Reference Dependence-KR: Effort Abeler et al. (2011)
Abeler, Falk, Goette, Huffman (AER 2011)
Return to our earlier real-effort set up
Individuals put in effort e, with cost c (e)
Value of effort v (e|r) affected by a reference point
Assume now that the reference point r is a la Koszegi-Rabin
� Evidence that subjects shift effort and bunch at this referencepoint?
Design to disentangle forward- versus backward-lookingreference points
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 79 / 105
![Page 80: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/80.jpg)
Reference Dependence-KR: Effort Abeler et al. (2011)
Design
Individuals put real effort
First training: for 4 minutes count as many zeros in tables ascanThen, real task:
Decide how long to work, for up to 60 minutes (smart designchoice, as higher elasticity of effort than tasks to do in fixedamount of time)With probability 1/2, paid piece rate time effort, p ∗ e, p = .2With probability 1/2, paid T eurosVary whether TLow = 3 or THi = 7
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 80 / 105
![Page 81: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/81.jpg)
Reference Dependence-KR: Effort Abeler et al. (2011)
Standard Model
maxe
T + pe
2− c (e)
−− > e∗ = c ′−1 (p/2)
Solution does not depend on target T
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 81 / 105
![Page 82: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/82.jpg)
Reference Dependence-KR: Effort Abeler et al. (2011)
Reference-Dependent Model
Reference-dependent model, with gain-loss utility: Assume referencepoint is pe with prob. 1/2, T with prob. 1/2
If pe < T , utility v (e|r) is (with prob. 1/2 paid pe, with prob.1/2 paid T ):
T + pe
2+
1
2η
[1
2(pe − pe) +
1
2λ (pe − T )
]+
+1
2η
[1
2(T − T ) +
1
2(T − pe)
]
=T + pe
2+
1
4η (λ− 1) (pe − T )
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 82 / 105
![Page 83: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/83.jpg)
Reference Dependence-KR: Effort Abeler et al. (2011)
Reference-Dependent Model
If pe > T , utility is
T + pe
2+
1
2η
[1
2(pe − pe) +
1
2(pe − T )
]
+1
2η
[1
2(T − T ) +
1
2λ (T − pe)
]
=T + pe
2− 1
4η (λ− 1) (pe − T )
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 83 / 105
![Page 84: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/84.jpg)
Reference Dependence-KR: Effort Abeler et al. (2011)
F.O.C. for Effort
The f.o.c. for effort are
p
2+
p
4η (λ− 1)− c ′ (e∗) = 0 if pe < T
p
2− p
4η (λ− 1)− c ′ (e∗) = 0 if pe > T
Thus, should see
bunching at THigher effort for higher T
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 84 / 105
![Page 85: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/85.jpg)
Reference Dependence-KR: Effort Abeler et al. (2011)
Results
KR effect on effort, though smaller than one would expect
Anchoring can be confound
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 85 / 105
![Page 86: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/86.jpg)
Reference Dependence-KR: Effort Gneezy et al. (2017)
Gneezy, Goette, Sprenger, Zimmermann (JEEA
2017)
Focus on possible confound in design of Abeler et al. paper
Subject are paid a piece rate with p = 0.5 and with p = 0.5 arepaid TReference point T is also salient choice
Remove with alternative design:
Subjects are paid $0 with prob. pSubjects are paid $14 with prob. qSubjects are paid piece rate with prob. 1− p − q = 0.5
This removes salience-based bunching at T since $0 or $14 arenot salient points
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 86 / 105
![Page 87: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/87.jpg)
Reference Dependence-KR: Effort Gneezy et al. (2017)
Gneezy et al. (JEEA 2017)
(a): Like Abeler et al. but also use ref pt L = 0, L = 14(b): Do stochastic designKey result: do not replicate Abeler et al. findingGneezy et al. The Limits of Expectations-Based Reference Dependence 871
Panel (a) Panel (b)
FIGURE 2. Average accumulated earnings across treatments. Standard error bars correspondingto C/! one robust standard error. Panel (a): Average accumulated earnings for each value of Lfrom treatments (0, 0.5, NA, L). Panel (b): Average accumulated earnings for each value of p fromtreatments (p, q, 14, 0). Observations from subtreatments (0, 0.5, NA, 0) and (0, 0.5, NA, 0)8 as wellas for subtreatments (0, 0.5, NA, 7) and (0, 0.5, NA, 7)8 are combined.
4. Results
A total of 265 subjects participated in our nine conditions. Over all treatments, subjectson average solved 39.64 tables, leading to accumulated earnings of $7.93. The averagetime subjects worked on the task was 33.30 min. Table 1 provides means and standarddeviations for all experimental conditions and Figure 2 summarizes our key findings.The key measure of effort will be Accumulated Earnings, we!. Accumulated earningsare graphed against the expected value of the manipulated payments, pH C qL, withseparate series for our two predictions.
4.1. Changing Outcomes
To test Prediction 1, we first consider treatments (0, 0.5, NA, 3) and (0, 0.5, NA, 7),the two treatments from Abeler et al. (2011). Figure 2, Panel (a) and Table 1 showthat, as predicted by theories of expectations-based reference dependence and found inAbeler et al. (2011), effort increases as we move from a fixed payment of $3 to a fixedpayment of $7. In the two envelope conditions, subjects on average stop working at
Downloaded from https://academic.oup.com/jeea/article-abstract/15/4/861/2965616by University of California, Berkeley/LBL useron 21 February 2018
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 87 / 105
![Page 88: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/88.jpg)
Reference Dependence-KR: Effort Summary
Summary on Reference Points
Much research remains to be done on reference pointdetermination
Not much support for forward-looking reference pointsEmphasis on backward-looking reference pointsCan estimate reliable speed of adjustment?Much faster in Thakral and To than in DellaVigna et al.
Need more designs that ‘reveal’ reference points
Use bunching?
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 88 / 105
![Page 89: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/89.jpg)
Social Preferences Wave I: Altruism
Section 8
Social Preferences Wave I: Altruism
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 89 / 105
![Page 90: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/90.jpg)
Social Preferences Wave I: Altruism
Pure Altruism
First set of models (since 1970s): Pure altruismSelf with payoff xs
Other with payoff xoSelf assigns weight α to Other’s utility:
U = u (xs) + αu (xo)
First used to model within-family altruism (Becker, 1981;Becker and Barro, 1986)Still very useful benchmark model
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 90 / 105
![Page 91: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/91.jpg)
Workplace Effort: Altruism
Section 9
Workplace Effort: Altruism
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 91 / 105
![Page 92: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/92.jpg)
Workplace Effort: Altruism Bandiera, Barankay, and Rasul (2005)
Bandiera-Barankay-Rasul (QJE, 2005)
Impact of relative pay versus piece rate on productivity
Standard model:
Piece rate: Worker i maximizes
maxei
pei − c (ei )
e∗iP = c ′−1 (p)
Relative pay: Worker i maximizes
maxei
pei − γ∑
j 6=i
ejI − 1
− c (ei )
e∗iRP = e∗P = c ′−1 (p)
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 92 / 105
![Page 93: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/93.jpg)
Workplace Effort: Altruism Bandiera, Barankay, and Rasul (2005)
Assume simple altruism
Simple Altruism model:
Ui = ui + α∑
j 6=i
uj
Piece rate: Worker maximizes
maxei
pei − c (ei) + α∑
j 6=i
[pej − c (ej)]
Same solution as with α = 0Relative pay: Worker i maximizes
maxei
pei−γ∑
j 6=i
ejI − 1
−c (ei )+α∑
j 6=i
pej − γ
∑
q 6=j
eqI − 1
− c (ej)
Solution
c ′ (e∗iRP) = p − αγ (I − 1) – > e∗iRP < e∗iP
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 93 / 105
![Page 94: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/94.jpg)
Workplace Effort: Altruism Bandiera, Barankay, and Rasul (2005)
Experiment Details
Test for impact of social preferences in the workplace
Does productivity increase when switching to piece rate?
Use personnel data from a fruit farm in the UK
Measure productivity as a function of compensation scheme
Timeline of quasi-field experiment:First 8 weeks of the 2002 picking season � Fruit-pickerscompensated on a relative performance scheme
Per-fruit piece rate is decreasing in the average productivity.Workers that care about others have incentive to keep theproductivity low
Next 8 weeks � Compensation switched to flat piece rate perfruitSwitch announced on the day change took place
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 94 / 105
![Page 95: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/95.jpg)
Workplace Effort: Altruism Bandiera, Barankay, and Rasul (2005)
Results: Productivity
Dramatic 50 percent increase in productivity
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 95 / 105
![Page 96: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/96.jpg)
Workplace Effort: Altruism Bandiera, Barankay, and Rasul (2005)
Results: Other
No other significant changes
Is this due to response to change in piece rate?No, piece rate went down � Incentives to work less(substitution effect)
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 96 / 105
![Page 97: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/97.jpg)
Workplace Effort: Altruism Bandiera, Barankay, and Rasul (2005)
Robustness Checks
Results robust to controls
Results are stronger the more friends are on the field
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 97 / 105
![Page 98: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/98.jpg)
Workplace Effort: Altruism Bandiera, Barankay, and Rasul (2005)
Interpretations
Two Interpretations:Social Preferences:
Work less to help othersWork even less when friends benefit, since care more for them
Repeated Game
Enforce low-effort equilibriumEquilibrium changes when switch to flat pay
Test: Observe results for tall plant where cannot observeproductivity of others (raspberries vs. strawberries)
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 98 / 105
![Page 99: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/99.jpg)
Workplace Effort: Altruism Bandiera, Barankay, and Rasul (2005)
Results: Comparison
Compare Fruit Type 1 (Strawberries) to Fruit Type 2(Raspberries)
No effect for Raspberries
� No Pure Social Preferences. However, can be reciprocity
Important to control for repeated game effects � Fieldexperiments
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 99 / 105
![Page 100: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/100.jpg)
Workplace Effort: Altruism Hjort (2014)
Hjort (QJE, 2014)
Social preferences among co-workers as function of ethnicity
Kenya flower plantTeams of 3: one supplier, two processorsPiece rate (at least initially) for two processors, and suppliergets pay for average productivity
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 100 / 105
![Page 101: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/101.jpg)
Workplace Effort: Altruism Hjort (2014)
Manipulate Team Composition
Different team ethnicity configurations of Luos and Kikuyu:
Vertically mixed teams � Work less hard to sort flowersHorizontally mixed teams � Sort fewer flowers to non-coethnicFindings strikingly aligned to predictions of model
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 101 / 105
![Page 102: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/102.jpg)
Workplace Effort: Altruism Hjort (2014)
Results
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 102 / 105
![Page 103: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/103.jpg)
Workplace Effort: Altruism Hjort (2014)
Explanations
Two further pieces of evidence:1 Period of ethnic animosity and violence2 Switch to team pay for the processors
Prediction of first change:
Exacerbate patterns
Prediction of second change:
Reduce effect in horizontally-mixed teamsNot in vertically-mixed teams
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 103 / 105
![Page 104: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/104.jpg)
Workplace Effort: Altruism Hjort (2014)
Results
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 104 / 105
![Page 105: Econ 219B Psychology and Economics: Applications (Lecture 6)€¦ · Outline 1 Reference Dependence: Full Prospect Theory 2 Reference Dependence: Insurance 3 Reference Dependence:](https://reader033.vdocument.in/reader033/viewer/2022042312/5edad41909ac2c67fa685f1e/html5/thumbnails/105.jpg)
Workplace Effort: Altruism Hjort (2014)
Next Lecture
Social Preferences
Wave I: AltruismWave II: Warm GlowWave III: Inequity AversionWave IV: Social Pressure, Social Signalling, and Social Norms
Stefano DellaVigna Econ 219B: Applications (Lecture 6) February 27, 2019 105 / 105