Collaborative Research: Substantive and Procedural Rationality in Decisions Under Uncertainty

New York University, New York NY

Investigators

Abstract

This project aims to generate and analyze data for understanding choice under uncertainty in the laboratory. In contrast to earlier work, the purpose is not to uncover violations of particular theories, but rather to provide a positive account of choice under uncertainty in a rich choice environment that allows for a general characterization of the patterns of individual behavior. To characterize an individual's decision-making under uncertainty, it is necessary to generate many observations per subject over a wide range of choice sets. An innovative graphical interface was developed for this purpose, where subjects see on a computer screen a geometrical representation of a portfolio choice problem involving two (or three) risky assets. Subjects choose portfolios through a simple 'point-and-click.' This intuitive and user-friendly interface allows for the quick and efficient elicitation of many decisions per subject under a wide range of choice scenarios. Preliminary findings with these data suggest that subjects' behavior is consistent in the sense that choices "maximize" a consistent set of preferences; it is emphasized that this test does not rely on any particular theory of choice under uncertainty, but is rather a more fundamental test of rationality. The next task is to characterize the (consistent) patterns in choice behavior. This is done in two ways. First, as a descriptive exercise, it is useful to study whether subjects use identifiable heuristics ("rules of thumb") to make their decisions. Inspection of the data generated by the two-asset experiment suggests that there are indeed common heuristics that govern many subjects' choices. Second, in order to connect this heuristic approach in making choices to substantive rationality, a type mixture model (TMM) is estimated. The TMM predicts an individual's choice of heuristics by assuming that the individual is attempting to imperfectly maximize his underlying (consistent) preferences. Preliminary results with the two-asset model suggest that the TMM is effective in describing subjects' behaviors. An analogous methodology will be applied to studying choice over three risky assets and to the study of choice under ambiguity, that is, choice when the "true" probabilities are not known. This project will develop the necessary tools, both methodological and analytical, for providing a comprehensive individual-level analysis of decision-making under uncertainty. Two distinctive features of the broader project are the new experimental design, and the application of the tools of the theory of consumer demand to individual decision-making in the laboratory. Broader Impact: Decisions under uncertainty enter every realm of economic decision-making, so fundamental contributions to this area will have broad-reaching implications. Further, the experimental platform and analytical techniques that have been developed and will be refined through this project can be applied to many types of individual choice problems. More elaborate versions of the experimental method currently under development will allow for interaction between subjects. All experiments and programs for analysis will be made publicly available through the web.