Essays in Behavioral Economics in the Context of Strategic Interaction

The traditional theoretical concept in game theory, Nash equilibrium, makes strong assumptions about people's rationality and the accuracy of their expectations about others' behavior. As a result, it often provides a poor description of actual behavior. Behavioral Economics seeks to improve the descriptive power of Economics by identifying and studying, often through experiments, actual patterns of behavior and reasoning.

In the first chapter of my dissertation, I study experimentally behavior in oneshot normal-form games. These games allow us to minimize learning and cultural context and to study behavior based mostly on reasoning. In this way, they could provide useful insights into real-life interactions in which people engage without prior experience or clear cultural norms, such as the first spectrum rights auctions or school-matching schemes.

I use a new approach to investigating behavior in one-shot normal-form games. Using subjects' play as well as their stated beliefs about their opponent's play, I study two fundamental dimensions of behavior. The first dimension is whether subjects are naive (do not consider what their opponent might do) or strategic (consider what their opponent might do). The second dimension is whether subjects' behavior is better captured by risk neutrality or by risk aversion.

In treatment A, subjects (graduate students at OSU) play the games without interference from belief elicitation (beliefs are elicited after all games have been played). I find that (i) only a small minority of subjects is naive, and (ii) the majority of subjects is risk averse. However, these results are not robust to changing the games or the subject population (from graduate to undergraduate students).

Some interesting comparative statics emerge by manipulating treatment A (keeping the games and the subject population fixed). Most notably, when subjects are explicitly prompted to form (and state) beliefs while playing the games (treatment B), then (iii) naive subjects all but disappear, and (iv) the proportion of risk averse subjects decreases dramatically relative to treatment A. A possible explanation for the latter is that seemingly risk averse behavior is actually driven by ambiguity aversion (i.e. by a lack of confidence in one's beliefs rather than by curvature in the utility function). In this case, giving subjects a structured way to think about the games in treatment B may be reducing ambiguity, thus increasing subjects' willingness to take risks. If simply having a structured way to think about a decision situation reduces ambiguity, this has far-reaching implications for behavior under uncertainty.

The second chapter of my dissertation, which is based on joint work with Dan Levin and James Peck, investigates experimentally behavior in a dynamic investment game in which players receive two-dimensional signals (a common-value signal about the market return and a private cost of investing) and timing of investment is endogenous. This game involves two key forces: on the one hand, there is an opportunity to wait and observe investment activity by others; on the other hand, there is a cost to waiting. How these forces play out may have implications for important real world situations. For example, at the end of a recession firms may invest straight away, thus putting an abrupt end to the recession; alternatively, they may wait to observe investment by other firms, thus prolonging the recession. In an experiment with small (two-player) markets, investment is higher and profits are lower than in Nash equilibrium. The study separately considers whether a subject draws inferences from the other subject's investment, in hindsight, and whether a subject has the foresight to delay profitable investment and learn from market activity. In contrast to Nash equilibrium, cursed equilibrium, and level-k model predictions, behavior remains the same across the experimental treatments. Maximum likelihood estimates are inconsistent with belief-based theories, but are consistent with the notion that subjects use simple rules of thumb, based on insights about the game.