Behavioral Game Theory

My holiday reading started with the book Behavioral Economics: A History by Floris Heukelom. The book provides a interesting take on how behavioral economics has grown from humble beginnings to the huge phenomenon that it now is. A nice review of the book has been written by Andreas Ortmann and so I will not delve too deeply into general comment here, other than to say I enjoyed reading the book.  But in terms of more specific comment, one theme running throughout the book is the distinction between behavioral economics and experimental economics. Heukelom makes clear that he thinks there is a very sharp distinction between these two fields. Personally I have always thought of them both as part of one big entangled blob. There are people who clearly prefer to label themselves a behavioral economist or an experimental economist but this seemed to me more a matter of personal preference than any grand design. So, what is the difference between behavioral and experime...

Prospect theory is most well known for its assumption that gains are treated differently to losses. Another crucial part of the theory, namely that probabilities are weighted, typically attracts much less attention. Recent evidence, however, is suggesting that probability weighting has a crucial role to play in many applied settings. So, what is probability weighting and why does it matter? The basic idea of probability weighting is that people tend to overestimate the likelihood of events that happen with small probability and underestimate the likelihood of events that happen with medium to large probability. In their famous paper on ' Advances in prospect theory ', Amos Tversky and Daniel Kahneman quantified this effect. They fitted experiment data to equation where  γ is a parameter to be estimated. In interpretation, p is the actual probability and  π (p)  the weighted probability. The figure below summarizes the kind of effect you get. Tversky and Kah...

Officially, Richard Thaler won the Nobel Prize in Economics because he 'has incorporated psychologically realistic assumptions into analyses of economic decision-making. By exploring the consequences of limited rationality, social preferences, and lack of self-control, he has shown how these human traits systematically affect individual decisions as well as market outcomes'.  An interesting thing about this quote is that nudge doesn't get a mention; indeed, it only just about scrapes it into the Academy's official  press release . (In the more detailed popular information document it doesn't appear until page 5 of 6.) This is in stark contrast to the popular press: the BBC leads with 'Nudge' economist wins Nobel Prize, the Telegraph leads with 'Nudge' guru wins the Nobel Prize, and so on. To read the papers you would think that Nudge is all there is to it. There is no doubt that Nudge has been a huge success and made Thaler famous (at least ...

In my last post I looked at dishonesty in the banking industry. Sticking with a similar theme, this time I will at dishonesty across different countries.        Let us start with a study by David Pascual-Ezama and a long list of co-authors on 'Context dependent cheating: Experimental evidence from 16 countries'. They asked 90 students in 16 different countries to perform a very simple task: toss a black and white coin and record the outcome. If the coin came up white the student obtained a red Lindt Lindor Truffle. If it came up black they got nothing. Crucially, the coin toss took place in private and so the student could report whatever outcome they wanted. If they wanted a chocolate then they simply had to report white. (The study contrasted three different methods of reporting - form put in a box, form given to the experimenter or verbally telling the experimenter - but I will skip those details here.)           The chart below summa...

The film 'A Good Year' starts with a ruthless financial trader called Max, played by Russell Crowe, manipulating bond markets in order to out-maneuver his competitors and make a quick, big profit. But, by the end of the film Max has decided to pack it all in and live out a more fulfilling life in rural France. Could that happen? Can someone really transition from a ruthless, selfish trader to a compassionate, loving family man in the space of a few days?         A study by Alain Cohn, Ernst Fehr and Michel Marechal, publisehd in 2014 in Nature, suggests it might be possible. They used a standard coin tossing task to measure the dishonesty of 128 employees from a large, international bank. The task works as follows: A subject is asked to toss a coin 10 times and record whether the outcome was heads or tails. Depending on the outcome the subject can win $20 per toss. The crucial thing to know is that the subject records whether or not they won for each toss and the...

Suppose you offer someone called Albert a gamble - if the toss of a coin comes up heads then you pay him £100 and if it comes up tails he pays you £100. The evidence suggests that most people will not take on that gamble. If Albert also turns down the gamble, what does that tell you about Albert's preferences?          One thing we can conclude is that Albert is risk averse. In particular, the gamble was fair because Albert's expected payoff was 0 and, by definition, if someone turns down a fair gamble then they are exhibiting risk aversion. It is hard to argue with a definition and so we can conclude that Albert is risk averse. The more interesting question is why he displays risk aversion?            The micro-economic textbook would tell us that it is because of diminishing marginal utility from money. A diagram helps explain the logic. Suppose that Albert has the utility function for money depicted below. In this specific c...

As the run-up to the UK's snap general election continues, the Conservative party appear content to talk about one thing and one thing only - strong and stable leadership for Brexit negotiations. Throughout the campaign Theresa May has been particularly keen to claim that 'every vote for me strengthens my hand in the Brexit negotiations'. This claim seems to be going down well with voters. But does it make any sense?           In bargaining theory the disagreement point is of critical importance. In the Brexit negotiations we can think of the disagreement point as the outcome if no deal is done between the UK and the EU and so the UK simply leaves the EU in March 2019 and starts from scratch. Most experts seem to agree that no deal would be bad - very bad for the UK and bad for the EU. That means that a deal is essential. It also means that the UK starts from a bad negotiating position.          To put some analysis to this conside...