Cognitive biases in expectation formation : lab evidence on preferences for redistribution, financial forecasting, and subscription traps

Abstract

Chapter 1: Bringing existing inequality in South Africa (high) and Switzerland (low) to the lab, we study how people’s preferences for redistribution change with the level of income inequality, income mobility, uncertainty of initial income positions, source of income (random or based on real-effort). We find that uncertainty and overconfidence undermine demand for redistribution. The effect magnifies with larger income disparity (South Africa). It further induces a reverse POUM effect: since wealth ambitions of rich aspirants are better preserved under low than under high mobility, demand for redistribution grows with the degree of mobility. These results combined propose an inequality trap: today’s inequality favors income overestimation, winding up less demand for redistribution with less mobility, which propels advanced inequality tomorrow.

Chapter 2: Learning-to-Forecast experiments have been found to replicate price volatility of demand-driven markets quite accurately. Yet, the scope of prior studies neither exceeded 50 periods nor limited severely decision time, and thereby neglected two central features of financial markets: long runtime and time pressure. This work studies whether “bubble and crash” dynamics persist in the long run (150 periods) and how decision time (6 vs. 25 seconds) influences market volatility? We observe converging prices to the fundamental value with increasing market length. Parallel to the change in dynamics, we identify a switch from trendextrapolating to rather adaptive strategies in the low time pressure condition. Increasing time pressure in contrast, limits trend-chasing behavior and aggregated coordination right from the beginning. Both seems to exert a stabilizing effect on prices.

Chapter 3: This paper explores a novel menu effect in the context of subscriptions. Providers typically capitalize on arranging offers such that the longer, but costlier option is chosen over its cheaper alternative. We find that sizing the shorter subscription down to single use raises its attraction. This suspects that the presence of single-use prompts rational evaluation based on a realistic estimate to use the subscription again. Alternatives in the former case, both time spans, are instead decoded into the same category - referred to pigeonholing - with the consequence that other comparative criteria come to the fore. Two-dimensional models present in most behavioral theories fail to explain this type of preference reversal. Inspired by the intuition of transaction utility and the availability heuristic we propose a generalization of salience theory to capture the effect of pigeonholing.