F07.07: Behavioral Economics
Aims
Behavioral economics takes the
limitations of the rational choice model seriously. Economic actors are often boundedly
rational and not merely motivated by their material self-interest. Cognitive limitations
preclude that actors use the laws of statistics to process information and act on them
optimally. Actors tend to use heuristics and display systematic biases. They are
over-confident in their judgements, overvalue information that is readily available, and
read information in a self-serving manner. In evaluating outcomes decision makers are
sensitive to context. They weigh losses more heavily than gains and their attitude towards
risk varies accordingly. They tend to be myopic and fall prey to procrastination. People
care about equity and fairness. They evaluate their position relative to others, are
disposed to be reciprocal, and follow social norms.
In this
course we survey the evidence, from both field data and experiments. We will see how
behavioral economics combines insight from economics and psychology to develop more
realistic and more relevant models of behavior. We discuss applications in various field,
including game theory, industrial organization, labor economics, macroeconomics, finance,
and law and economics.
Credits
6 ECTS
Time Schedule
- See NAKE course program
- There will be 12 weeks of 2 hour lectures in total.
Prerequisites
For each lecture of the course, there are one or two core
papers (see below). At the beginning of the course each core paper (apart from the first
one) will be allocated to a student, and this student will give a brief presentation of
that core paper in class.
All students are required to read the core papers before the
lecture and write a brief (max ½ page) referee report on the paper (no summary!). In the
report you formulate one or more comments (“I think … is not plausible,
reasonable, valid, important, …”) and you can also formulate clarrifying
questions (“I do not understand why, how, …”). You send the reports to me
before the lecture, and I will make a selection of questions and comments that will be
discussed in class.
So, each week we have 2 one-hour lectures, in which the core
paper is presented by a student (15 minutes), discussed in class (20 minutes), put in
perspective by the lecturer (10 minutes).
Examination
weekly reports: 25 percent
paper: 50 percent
Course Outline
1. Introduction
2. Judgment I. Heuristics
3. Judgment II. Overconfidence and self-serving biases
4. Reference dependence choice I. Prospect theory, endowment
effect
5. Reference dependence choice II. Sunk costs, mental
accounting
6. Choice over time I. Overview
7. Choice over time II. Applications
8. Behavioral game theory I. Iterated dominance
9. Behavioral game theory II. Social preferences
10. Behavioral game theory
III. Learning
11-12. Selection of additional concepts, methods, applications:
Evolution of preferences, Intrinsic motivation, Neuroeconomics, Culture, Hedonics and
happiness, Peer pressure
Literature
Items indicated
with A or B are core material for that lecture and will be presented and discussed in
class. Items indicated with + contain supplementary material.
1.
Introduction
A. Rabin, M.
(1996), Psychology and Economics, Journal of
Economic Literature 34, 11-46.
2. Judgment I.
Heuristics
A. Tversky, A., and
Kahneman, D. (1974), Judgement under Uncertainty. Heuristics and Biases, Science
185, 124-1131.
B Camerer,
C., (1995), Individual Decision Making, Part I. Judgement, in: A. Roth and J. Kagel, eds.,
Handbook of Experimental Economics, Princeton: Princeton University Press.
+ Kamin, K., and
Rachlinski, J. (1995), Ex Post ? Ex Ante: Determining Liability in Hindsight, Law and Human Behavior 19, 89-104.
+ De Bondt, Werner, and
Richard Thaler (1985), “Does the Stock Market Overreact?”, Journal of Finance 40, 793- 808.
3.
Judgment II. Overconfidence and self-serving bias
A. Babcock, L., and Loewenstein,
G. (1997), Explaining Bargaining Impasses: the Role of Self-Serving Biases, Journal of
Economic Perspectives 11, 109-126. Reprinted in Advances in Behavioral Economics,
C. Camerer, G. Loewenstein, M. Rabin 2004.
B. Malmendier, U., and Tate, G.
(2004), CEO Overconfidence and Corporate Investment, forthcoming Journal of Finance.
+ Camerer, C., and Lovallo,
D., (1999), Overconfidence and Excess Entry AER.
+ Barber, B., and Odean, T.
(2001), Boys Will Be Boys: Gender, Overconfidence, and Common Stock Investment, QJE.
4.
Reference dependence choice I. Prospect theory, endowment effect
A. Kahneman, D., and Tversky, A.
(1979), Prospect Theory: An Analysis of Decision Under Risk, Econometrica 47, 263-291.
B. Kahneman, D., Knetsch, J., and
Thaler, R. (1990), Experimental Tests of the Endowment Effect and the Coase Theorem, Journal
of Political Economy.
+
Camerer, C. Babcock, L., Loewenstein, G., Thaler, R. (1997)
Labor supply of New York City Cabdrivers: One day at a time, Quarterly Journal of Economics, 407- 42.
+ Odean, T. (1998), Are Investors
Reluctant to Realize their Losses, AER.
5.
Reference dependence choice II. Sunk costs, mental accounting
A. Potters, J., and
Offerman, T. (2000), Does Auctioning of Entry Licenses Induce Collusion? An Experimental
Study, CentER Discussion Paper 2000-53.
B. Bernartzi,
Shlomo, and Richard Thaler (1995), Myopic Loss Aversion and the Equity Premium Puzzle, Quarterly Journal of Economics 110, 75- 92.
+ Eyster, E., (2002), Rationalizing the Past: A
Taste for Consistency, Working Paper LSE.
6. Choice over time I.
Overview
A+B. Frederick, S., Loewenstein, G., O’Donoghue, T.
(2004), Time Discounting and Time Preference. A Critical Review, forthcoming Journal of
Economic Literature.
7. Choice
over time II. Applications
A. Laibson, D., (1997), Golden Eggs and Hyperbolic
Discounting, Quarterly Journal of Economics.
B. DellaVigna, S., and Malmendier, U. (2003),
Overestimating Selfcontrol: Evidence from the Health Club Industry, working paper
Stanford.
8.
Behavioral game theory I. Iterated dominance
A. Camerer, C. (2003), Iterated Reasoning in Dominance
Solvable Games, Chapter 5 in Behavioral Game Theory.
B. Goeree, J., and Holt, C. (2001), Ten Little
Treasures of Game Theory and Ten Intuitive Contradictions, American Economic Review.
9.
Behavioral game theory II. Social preferences
A. Rabin, M. (1993), Incorporating Fairness into
Game Theory and Economics, AER.
B Fehr, E., and Schmidt, K. (1999), A
Theory of Fairness, Competition, and Cooperation, Quarterly
Journal of Economics 114, 817-868.
+ Brown, M., Falk, A., Fehr, E.
(2005), Contractual Incompleteness and the Nature of Market Transactions, forthcoming Econometrica.
10.
Behavioral game theory III. Learning
A+B. Camerer,
C., (2003), Learning, Chapter 3 in Behavioral Game Theory.
+ Offerman, T.,
Potters, J., and Sonnemans, J. (2002), Imitation and belief learning in an oligopoly
experiment, Review of Economic Studies.
11-12. Evolution of preferences, Intrinsic
motivation, Neuroeconomics, Culture, Hedonics and happiness, Peer pressure
General background reading
on Behavioral Economics
There still are no text books on Behavioral Economics. There
are a couple of volumes:
Baron, J.,
(2000), Thinking and Deciding, 3rd ed, Cambridge University Press.
[Introductory textbook with a psychological perspective on judgment and decisionmaking
mainly targeted at non-psychology graduates and researchers.]
Camerer,
C. (2003), Behavioral Game Theory, Princeton:
Princeton University Press. [Superb overview of experimental studies on games, including
recent theoretical developments.]
Gigerenzer,
G., and Selten, R. (eds.), Bounded Rationality. The Adaptive Toolbox, MIT Press.
[An interesting collection original papers outlining an approach to bounded rationality
that moves a further away from the standard rational choice model than much other work in
BE does.]
Roth, A. and
Kagel, J. (eds.) (1995), Handbook of Experimental Economics, Princeton University
Press. [Excellent book. Six chapters with thorough overviews of experimental research in
different fields.]
Shleifer,
A. (2000), Inefficient Markets. An Introduction to Behavioral Finance, Oxford
University Press.
Edited books (collections of
previously published papers)
Camerer, C., Loewenstein, G., Rabin, M.,
(eds.) (2004), Advances in Behavioral Economics, Princeton University Press. [Good
selection of quality papers in BE, most of them previously published.]
Kahneman, D.,
Tversky, A. (eds.) (2000), Choices, Values, and Frames, Cambridge University Press.
[Selection of 42 excellent papers, many of them classics.]
Kahneman, D., Slovic, P.,
Tversky, A. (eds.) (1982), Judgment under
uncertainty: Heuristics and Biases,
Cambridge University Press.
Loewenstein, G., Read, D., Baumeister, R. (eds.) (2003), Time and Decision. Economic and Psychological
Perspectives onIntertemporal choice, Russell Sage.
Sunstein, C., (ed.) (2000), Behavioral Law and Economics, Cambridge University Press. [Selection
of papers where BE is applied to issues in Law and Economics, Apart from the (very nice)
introduction, all previously published.]
Thaler, R.
(1992), The Winner’s Curse. Paradoxes and Anomalies of Economic Life,
Princeton University Press. [Very nice, accessible, brief overviews of behavioral
economics in a variety of fields. Individual chapters were previously published as a
column on Anomalies in the Journal of Economic Perspectives]
Thaler, R. (ed.)
(1993), Advances in Behavioral Finance, Russell Sage (collection of the very best
early papers in Behavioral Finance).