Mark Dean, New York University
"Status Quo Bias in Large and Small Choice Sets"
Dean introduces models of status quo bias based on the
concept of decision avoidance, by which a decisionmaker may select the status quo in order
to avoid a difficult decision. These models capture the experimental finding that the
status quo is more frequently chosen in larger choice sets. This phenomenon violates the
predictions of current preference-based models of status quo bias that assume a
decisionmaker with a fixed status quo will make consistent choices. Using laboratory
experiments, Dean shows that subjects in large choice sets do exhibit behavior in line
with decision avoidance, while in small choice sets, preference-based models offer a
better explanation of behavior. These findings raise questions for advocated policies of
"benign paternalism." Nicholas Barberis, Yale University and
NBER
"A Model of Casino Gambling"
Casino gambling is a hugely popular activity around the world, but
there are still very few models of why people go to casinos or of how they behave when
they get there. In this paper, Barberis shows that prospect theory can offer a rich
theory of gambling, one that captures many features of actual gambling behavior. First, he
demonstrates that, for a wide range of parameter values, a prospect theory agent would be
willing to gamble in a casino, even if the casino only offers bets with zero or negative
expected value. Second, he shows that prospect theory predicts a plausible time
inconsistency: at the moment he enters a casino, a prospect theory agent plans to follow
one particular gambling strategy; but after he enters, he wants to switch to a different
strategy. The model therefore predicts heterogeneity in gambling behavior: how a gambler
behaves depends on whether he is aware of this time-inconsistency; and, if he is aware of
it, on whether he is able to commit, in advance, to his initial plan of action.
Shimon Kogan, University of Texas, Anthony M. Kwasnic,
Pennsylvania State University, and Roberto Wseber, Carnegie Mellon
University
"Coordination in the Presence of Asset
Markets"
Kogan and his co-authors explore how final prices and security
holdings in an asset market influence and forecast behavior and outcomes in an affiliated
coordination game. The researchers vary the incentives from the market relative to payoffs
from the game, the number of players in a group, and whether traders' payoffs are
influenced by outcomes in their own or another group. Markets lead to significantly less
efficient group outcomes across all treatments, even when the market produces little or no
distortion of incentives in the game. At the same time, the authors find that asset
markets are informative about group outcomes and thereby reduce "wasted input."
Their experiment therefore may shed light on how financial markets themselves contribute
to economic crises.
Marianne Bertrand, University of Chicago and NBER, and Adair
Morse, University of Chicago
"Information Disclosure, Cognitive Biases and Payday Borrowing"
If people face cognitive limitations or biases that lead to financial
mistakes, how can lawmakers possibly help? One approach is to remove the option of the bad
decision; another approach is to increase financial education, such that individuals can
reason through choices when they arise. A third, less discussed, approach is to mandate
disclosure of information in a form that enables people to overcome limitations or biases
at the point of the decision. This third approach is the topic of the paper by Bertrand
and Morse. They study whether and what information can be disclosed to payday loan
borrowers to lower their use of high-cost debt. Their information comes from a field
experiment at a national chain of payday lenders. They find that information that helps
people think less narrowly (over time) about the cost of payday borrowing, and in
particular information that reinforces the adding-up effect over pay cycles of the dollar
fees incurred on a payday loan, reduces the take-up of payday loans. They also find
substantial heterogeneity in the effectiveness of information disclosure across categories
of borrowers: information disclosure appears more effective among more self-controlled
individuals, individuals with some college education (but not a college degree) and
individuals whose average borrowing-to-income ratio is low. Overall, their results suggest
that consumer information regulations based on a deeper understanding of cognitive biases
might be an effective policy tool when it comes to payday borrowing, and possibly other
financial products.
Wei Xiong, Princeton University and NBER, and Jialin Yu,
Columbia University
"The Chinese Warrants Bubble"
In 2005-8, over a dozen put warrants traded in China went so deep out
of the money that they were certain to expire worthless. Nonetheless, these warrants
attracted a speculative frenzy: for each warrant, billions of Yuan traded with an average
daily turnover rate close to 300 percent, and at substantially inflated prices. The
publicly observable underlying stock prices make the zero-warrant fundamentals common
knowledge to all market participants. This warrants bubble thus presents a unique
opportunity for studying bubble mechanisms, which previously had only been available in
laboratory environments. Xiong and Yu find evidence supporting the resale
option theory of bubbles: investors overpay for a warrant hoping to resell it at an even
higher price to a greater fool.
Uday Rajan, University of Michigan, Amit Seru,
University of Chicago, and Vikrant Vig, London Business School
"The Failure of Models That Predict
Failure: Distance, Incentives, and Defaults"
Using data on securitized subprime mortgages issued in the period
1997-2006, Rajan and his co-authors demonstrate that, as the degree of
securitization increases, interest rates on new loans rely increasingly on hard
information about borrowers. As a result, a statistical default model fitted in a low
securitization period breaks down in the high securitization period in a systematic
manner: it under-predicts defaults among borrowers for whom soft information is more
valuable (that is, borrowers with low documentation, low FICO scores, and high
loan-to-value ratios). The researchers rationalize these findings in a theoretical model
that highlights a reduction in lenders' incentives to collect soft information as
securitization becomes common, resulting in worse loans being issued to borrowers with
similar hard information characteristics. These results partly explain why statistical
default models severely underestimated defaults during the subprime mortgage crisis, and
imply that these models are subject to a Lucas critique. Regulations that rely on such
models to assess default risk therefore may be undermined by the actions of market
participants. |