This project focuses on two cognitive abilities that are likely to play a key role for departures from rationality when people make strategic decisions under situations of incomplete information. The first is the decision maker's ability to adjust his or her beliefs as he gets new information in a way that is statistically correct -- in other words, the ability to perform Bayesian updating. The second is the ability to carefully think through possible relevant scenarios before making a decision, an ability that the researchers term 'contingent reasoning'.
The study uses decision making experiments to study the role of Bayesian updating and contingent reasoning in a series of environments; second price private value auctions, an array of common value auctions, versions of the 'Acquiring a Company' game that have studied by other research teams, and endogenous timing investment games. The researchers use a specially designed individual choice task to classify participants based on their use of Bayesian updating and contingent reasoning. These research subjects then participate in a series of strategically equivalent games to see how behavior in market environments depends on cognitive characteristics.
The results apply to a wide range of environments. The requirements for contingent reasoning in any real-world situation depend on a wide variety of factors. Understanding how contingent reasoning affects decisions will allow us to choose those factors in order to encourage people to make the best possible decisions for reaching their chosen goals.
This project supported laboratory experiments conducted to investigate three important issues in behavioral economics; (a) the effect of private information to impede ‘herding, or following along with group actions, (b) the capacity of agents in a common value setting to correct for a ‘winner’s curse’ or a tendency to overbid for an item of uncertain value, and (c) the extent to which identifiable features of an agent’s past play or underlying character predict their propensity to cooperate. In our experiment on endogenous-timing herding games, we find that subjects respond to their private information and the market activity of others in a sensible way. However, subjects do not respond to more subtle features of the games that significantly affect payoffs, such as the number of subjects in a market and the correlation of investment costs across subjects. In our common-value auction experiments, we devise decision tasks that provide measures of subjects’ Bayesian updating skills and ability to draw insights. Each of these skills is shown to help subjects correct for the winner’s curse in common-value auctions. In addition, subjects are better at correcting for the winner’s curse in auction formats that cater better to bounded rationality. In our experiments on indefinitely repeated games, we find that certain ``aspects’’ of players’ behavior are stable across different repeated games and help predict the frequency of cooperation across repeated games. We also ?nd some evidence of systematic relationships between behavior in indefinitely repeated games and individual characteristics. The two individual characteristics that stand out are patience and gender. However, overall, the number of systematic relationships is surprisingly small.
