Psychology in Economics

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Psychology in Economics Finance

• or, why people would leave a tip at a restaurant
  even if they know that under no circumstances
  will they ever be back?

2
Richard Thaler quote

• Many economic models portray agents as
  unboundedly unprincipled, unscrupulous, dishonest
  with no regard for others (except possibly family
  members and friends).

3
What real world says us?

• The inter-temporal preferences
• Self-control problem
• Status quo bias
• Loss aversion
• Self-serving bias
• Overconfidence and misperception

4
Would you rather receive 15 today or 16 in 1
month?

• How much money would I need to give you in one
  month to make you indifferent to receiving 15
  today? What about in 1 year? What about in 10
  years?
• Thaler presented these questions to subjects and
  found median answers of 20, 50 and 100.
• At first these answers may seem somewhat
  reasonable, however, they actually imply huge
  discount rates 345 over one month, 120 over a
  1-year horizon and 19 over a 10-year horizon.
• Subjects greatly prefer the present to the
  future.

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The inter-temporal preferences

• Would you prefer 100 today or 110 tomorrow?
• Would you prefer 100 thirty days from now or
  110 thirty-one days from now?
• The inter-temporal preferences (short run
  impatience, long run patience) are often modeled
  as a discount rates that vary with horizon.

6
Implications for Education

• Mullainathan linked the problem of inter-temporal
  preferences to the access to education in
  developing countries.

7
Hints in teaching

• End of course exam looks very attractive at the
  beginning of course, but hard and time consuming
  at the end. So, spare your students make
  evaluations frequently.
• Encourage students to start essays/course
  works/master thesis's as early as possible.
• Give evenly spaced deadlines rather then one big
  deadline at the end.

8
Status quo bias

• Samuelson and Zeckhauser first documented a
  variety of phenomena known as the status quo bias
  the idea that people often make automatic,
  non-conscious choices.
• Madrian Shea studied a firm that altered the
  choice context for employee participation in
  their retirement plan. When they join the firm
  employees are given a form that they must fill
  out in order to participate in the savings plan.
  Though the plan is quite lucrative, participation
  is low. Standard economic models might suggest
  that the subsidy ought to be raised. This firm
  instead changed a very simple feature of its
  program.

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Status quo bias

• Prior to the change, new employees received a
  form that said something to the effect of Check
  this box if you would like to participate in a
  401(k). Indicate how much youd like to
  contribute. After the change, however, new
  employees received a form that said something to
  the effect of Check this box if you would like
  to not to have 3 of your pay check put into a
  401(k).
• How hard is it to check off a box?
• When the default option is to not contribute,
  only 38 of those contributed. When the default
  option was contribution, 86 contributed.
  Moreover, even several years later those exposed
  to a contribution default still show much higher
  contribution rates.

10
Hints in teaching
11
Loss aversion

• Loss aversion is a tendency for people to weight
  losses significantly more heavily than gains.
  Empirical estimates of loss aversion are about 2,
  that is losses hurt twice as much as gains yield
  pleasure.
• Taking into account Madrian Shea work and loss
  aversion behavior Thaler Benartzi developed a
  prescriptive savings plan called Save More
  Tomorrow that increased average saving rates from
  3.6 to 11.6 in 28 months.

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Save More Tomorrow

• Employees are approached about increasing their
  savings a considerable time before actual
  increase. (inter-temporal discounting !!!)
• Increase of savings occurs every time when
  employee receives pay raise. (risk aversion !!!)
• Status quo bias work toward keeping people in the
  plan increasing savings every time they receive
  pay raise.

13
Sell More Tomorrow

• Using the approach from SMT plan, Benartzi
  developed a prescriptive plan of diversification
  of employees savings plans.

14
Teaching hints

• Loss aversion implies that penalties hurt more
  than encouragements benefit.
• It doesnt mean that we should build all the
  teaching system on punishment, but we can benefit
  from this feature.
• For example, in my evaluation scheme class
  attendance gives certain number of points.
  However, I do not give points for presence in the
  classroom rather I deduct points for every
  absence.

15
Orange Revolution

• I will try to use loss aversion phenomena to
  explain the rise of Orange Revolution.

16
Overconfidence

• 90 of all drivers consider themselves to be
  above average drivers.
• More generally, people think that they are above
  average on many traits.
• When investing, people often choose the company
  that they know more about, even if they have no
  real private information that would provide some
  investment advantage.

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Misperception

• Behavioral finance literature collected many
  evidences that fashion, fads and misperception of
  news by so-called noise traders may push prices
  far from their fundamental values.
• Often it is assumed (Friedman, Fama) that
  sophisticated traders who have special
  information might trade against noise traders and
  drive prices back to fundamental values.
• However, when the proportion of noise traders or
  their misperception of news is significant,
  prices can diverge dramatically from their
  fundamental values.

18
My research

• Following De Long, Shleifer, Summers and Waldmann
  (1990) we consider and empirically test an asset
  market model with two types of trader described
  above, where noise trades misperception in time t
  is measured by the normal random variable
• ,
• Where indicates the average behavior of
  noise traders.
• Negative and positive represents bear and
  bull speculation respectively. The model allows
  asset prices to deviate from fundamental values
  considerably even without fundamental risk and
  the source of such deviations depends essentially
  on the number of noise trader.

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My research

• Using results from Shiller, as a proxy for the
  number of noise traders, we use publicity
  measured by number of publicly available news
  releases. The amount of available information
  causes number of noise traders to change, and
  because of unpredictability of noise trader that
  implies changes in price and riskiness of assets.
• In our study we use weekly data on prices and
  number of news releases available at Lexis-Nexis
  Academic web site for 16 selected components of
  SP500.

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My research

• We estimated panel regressions obtained from the
  model. This allowed us to estimate measures of
  average noise trades misperception and .
  The main results obtained are summarized in the
  following statements
• Conditional volatility and publicity do not
  show significant relationship.
• The average noise traders misperception
  does not significantly differ from zero, however,
  in the period of market growth and
  in the period of market fall.
•  On average the dispersion of noise traders
  misperception is greater in the period
  of market fall.

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Why people leave a tip in restaurants?

• Because of fairness !!!
• This is the best hint for teaching !!!

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Thank You!