Friday, January 1, 2016

Happy new year to you all!

The new year starts with big meetings where you can look at two of my students, Sandro Ambuehl and Shengwu Li (whom I'll write about tomorrow).

Sandro is a great behavioral/experimental economist with a strong theory background (he has a nice theoretical matching paper on unraveling, probably the nicest theoretical treatment on unraveling there is) and interest in financial education.

Sandro's JM paper "An Offer You Can't Refuse? Incentives Change How We Think" starts with the common (well, at least among non-economists) intuition that offering substantial payments can constitute “undue inducement” and "coercion" that may harm the agent. This quite vague intuition that has no empirical evidence is the foundation for nearly universal laws that prohibit living organ sales (such as kidneys) as well as incentives that can be paid to participants in experiments, egg donors, surrogate mothers etc. Despite the large economic consequences of such laws, economists have been rather silent on the subject (apart from iterating loudly and clearly that markets are efficient). Empirically, given the universality of laws against payments for organ donation, economists certainly appear not to have had a large impact, at least so far.

Sandro points out that incentives may not only direct affect choices, but also people's beliefs about the consequences of various choices. He theoretically shows how incentives affect the information acquisition process and points out that larger incentives will lead people look more for information about the upside of the transaction and less about the downside. As a result it can be that a person offered higher incentives will have different posteriors than a person offered low incentives about how bad it is to participate. Specifically, it may be that for many prices the "high incentives" person is happy to take the offer given her posteriors than the person who gathered information under low incentives. As a result it appears as if people try to persuade themselves to participate when incentives are high: while this may "feel" irrational, it can be perfectly Bayesian.

Sandro runs an experiment to test whether he finds such effects. To think of a relevant domain, Sandro picks a transaction with visceral consequences, which many people may do "just for the money" and where people have uncertainty how they will feel about doing it: His has people eat insects.

He finds that participants offered high incentives skew their information gathering as predicted. Furthermore, participants given high incentives are more willing to eat insects at many prices. Finally, Sandro shows in a more stylized experiment that incentives cause participants to skew their beliefs in a way that is consistent with Bayes law.

Sandro's paper points out that it is important to understand the reason behind the nearly universal laws: is it because of the (erroneous) belief that incentives affecting beliefs is "irrational", because people who receive high incentives become optimistic about the transaction above and beyond what is warranted by Bayesian updating, or for other reasons? Different reasons have different policy implications about whether we will see a change in these laws, and what should be done to minimize harm (the chance to update in a non-Bayesian way).

Sandro's paper attracts a lot of attention: Tyler Cowen on marginalrevolution wrote in November in "Incentives change how we think" about his paper "I found this to be the most interesting job market paper of the year..." Cass Sunstein tweeted: "Brilliant & original paper on some effects of incentives on how we think..." and Jeff Guo wrote about his paper in "The secret to why money is so good at changing people’s minds" in the Washington Post on December 11.

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