The preference reversal phenomenon: Response mode,markets and incentives

Summary This paper addresses the apparent conflict between the results of experiments on individual choice and judgement and the results of market experiments. Data are reported for experiments designed to analyze the effects of (a) economic incentives, repetition, feedback and information and (b) choice and valuation response modes on (c) subjects' decisions in paired market and nonmarket environments. Causes of divergent market and nonmarket behavior are identified in the context of the preference reversal phenomenon (PRP). Study of the PRP is extended to two types of market environments. The PRP is observed on the first repetition in a market setting (second price auction) with immediate feedback, both with and without financial incentives. However, after five repetitions of the auction, the subjects' bids are generally consistent with their choices and the asymmetry between the rates of predicted and unpredicted reversals disappears. An individual pricing task using the BDM mechanism yields similar results on the first repetition but results which differ from the second price auction on the fifth repetition. Choice tasks produce lower rates of reversals than do pricing tasks in both market and individual decision making settings.We are grateful for financial support from the National Science Foundation (grant no. SES-8820552) and the California Institute of Technology. Research facilities were provided by the Economic Science Laboratory at the University of Arizona. Valuable computer programming was provided by Sean Coates and Shawn LaMaster. We thank Professor Jeffrey Dubin for his help in setting up the software for the generalized Tobit model, and Professors Joyce Berg, Graham Loomes, and Charles R. Plott for helpful comments.     

An experimental investigation of overdissipation in the all pay auction

Pervasive overbidding represents a well-documented feature of all-pay auctions. Aggregate bids exceed Nash predictions in laboratory experiments, and individuals often submit bids that guarantee negative profits. This paper examines three factors that may reduce pervasive overbidding: (a) repetition (experience), (b) reputation (strangers vs. partners), and (c) active participation. Reputation and repetition reduce aggregate overdissipation, but they eliminate it only in conjunction with active participation.     

EXPERIMENTAL EVIDENCE ON ENGLISH AUCTIONS: ORAL OUTCRY VERSUS CLOCK

This paper tests experimentally, in a common value setting, the equivalence between the Japanese English auction (or clock auction) and an oral outcry auction where bidders are allowed to call their own bids. We find that (i) bidding behaviour is different in each type of auction, but also that (ii) this difference in bidding behaviour does not affect significantly the auction prices. This lends some support to the equivalence between these two types of auction. The winner's curse is present: overbidding led to higher than expected prices (under Nash bidding strategies) in both types of auction. Although interesting and encouraging, the results clearly indicate that further research is necessary, particularly with a modified experimental design.     

Bidding behavior and experience in internet auctions

We study the role of experience in internet art auctions by analyzing repeated bidding by the same bidder in a unique longitudinal field dataset. Our results show that experience significantly lowers the level of bids suggesting that bidders change their bidding behavior throughout time. Participating in more than ten auctions brings down average bids by up to 26%. We further test several possible explanations for the observed learning behavior and show that the change in bidding strategy is a result of a change in within-auction behavior that is generated with experience. Our results are robust to concerns of endogenous participation as well as bidder fixed effects.     

Large market games with demand uncertainty

We consider a market game with a continuum of consumers, where the measure of each type is stochastic. Nature selects the set of active consumers, who make bids and offers on ?−1 spot market trading posts. Existence of type-symmetric Nash equilibrium is proven. When facing price uncertainty, best responses are unique, and a Nash equilibrium to the sell-all game is typically not a Nash equilibrium to the original game. Under plausible circumstances, consumers strictly prefer to be on one side of the market.     

Does money impede convergence?

Inspired by Clower’s conjecture that the necessity of trading through money in monetised economies might hinder convergence to competitive equilibrium, and hence, for example, cause unemployment, we experimentally investigate behaviour in markets where trading has to be done through money. In order to evaluate the properties of these markets, we compare their behaviour to behaviour in markets without money, where money cannot intervene. As the trading mechanism might be a compounding factor, we investigate two kinds of market mechanism: the double auction, where bids, asks and trades take place in continuous time throughout a trading period; and the clearing house, where bids and asks are placed once in a trading period, and which are then cleared by an aggregating device. We thus have four treatments, the pairwise combinations of non-monetised/monetised trading with double auction/clearing house. We find that: convergence is faster under non-monetised trading, implying that the necessity of using money to facilitate trade hinders convergence; that monetised trading is noisier than non-monetised trading; and that the volume of trade and realised surpluses are higher with the double auction than the clearing house. As far as efficiency is concerned, monetised trading lowers both informational and allocational efficiency, and while the double auction outperforms the clearing house in terms of allocational efficiency, the clearing house is marginally better than the double auction in terms of informational efficiency when trade is through money. Crucially we confirm the conjecture that inspired these experiments: that the necessity to use money in trading hinders convergence to competitive equilibrium, lowers realised trades and surpluses, and hence may cause unemployment.     

RETESTING THE UNCERTAINTY EFFECT USING LOTTERIES WITH REAL PRODUCTS AND MONEY

In the current study, several experiments re‐examine the uncertainty effect using lotteries that include real products, monetary outcomes and electronic gift cards in a between‐subjects design. The study also takes the selling position into consideration, in addition to the buying position considered by all previous works on the uncertainty effect. The results indicate that for all types of lotteries, the bids are higher than the bids for the worst possible realization. These findings are consistent with the internality axiom and do not support the uncertainty effect.     

Reputation and Reciprocity: Consequences for the Labour Relation

Recent evidence highlights the importance of social norms in many economic relations. However, many of these relationships are long term and provide repeated game incentives for performance. We experimentally investigate interaction effects of reciprocity and repeated game incentives in two treatments (one-shot and repeated) of a gift-exchange game. In both treatments we observe reciprocity, which is strengthened in the repeated game. A detailed analysis shows that, in the repeated game, some subjects imitate reciprocity. Thus, reciprocity and repeated game incentives reinforce each other. Observed behaviour is robust against experience. We conclude that long-term interaction is a "reciprocity-compatible" contract enforcement device.
JEL classification : J 30; C 91     

The all-pay auction with complete information

Summary In a (first price) all-pay auction, bidders simultaneously submit bids for an item. All players forfeit their bids, and the high bidder receives the item. This auction is widely used in economics to model rent seeking, R&D races, political contests, and job promotion tournaments. We fully characterize equilibrium for this class of games, and show that the set of equilibria is much larger than has been recognized in the literature. When there are more than two players, for instance, we show that even when the auction is symmetric there exists a continuum of asymmetric equilibria. Moreover, for economically important configurations of valuations, there is no revenue equivalence across the equilibria; asymmetric equilibria imply higher expected revenues than the symmetric equilibrium.We are grateful to Jacques Crémer, Chuangyin Dang, Jürgen Dennert, Chaim Fershtman, Martin Hellwig, Arthur Robson, Heinrich Ursprung, Eric van Damme, Ton Vorst, and the referees for helpful comments. We benefitted from presentations at the World Congress of the Econometric Society in Barcelona, the European Meeting on the Economics of Information at Tilburg University, the Midwest Mathematical Economics Meetings at the University of Illinois, and seminars at Texas A&M University, The Pennsylvania State University, Tilburg University and the University of Montreal. Baye is grateful for support from the CentER for Economic Research at Tilburg University and the Tinbergen Institute where earlier versions of this paper were completed. Kovenock acknowledges support from Erasmus Universiteit Rotterdam, the Tinbergen Institute, the Center for Economic Studies at the University of Munich, the Institut d'Analisi Economica CSIC at the Universitat Autonoma de Barcelona, the Krannert School of Management, and the Jay N. Ross Young Faculty Scholar Award.     

Bid rotation and collusion in repeated auctions

This paper studies bidder collusion with communication in repeated auctions when no side transfer is possible. It presents a simple dynamic bid rotation scheme which coordinates bids based on communication history and enables intertemporal transfer of bidders’ payoffs. The paper derives a sufficient condition for such a dynamic scheme to be an equilibrium and characterizes the equilibrium payoffs in a general environment with affiliated signals and private or interdependent values. With IPV, it is shown that this dynamic scheme yields a strictly higher payoff to the bidders than any static collusion scheme which coordinates bids based only on the current reported signals.     

Strategy-proof assignment on the full preference domain

We consider the problem of efficiently allocating several indivisible objects between agents who are to receive at most one object and whose preferences are private information. We examine this standard “assignment” problem from the perspective of mechanism design giving up the usual assumption of linear preferences and instead using a full preference domain (with indifferences permitted). We characterize two classes of mechanisms: (i) Bi-polar Serially Dictatorial Rules by Essential Single-Valuedness, Pareto Indifference, Strategy-Proofness and Non-Bossiness; and (ii) all selections from Bi-polar Serially Dictatorial Rules by Single-Valuedness, Efficiency, Strategy-Proofness and Weak Non-Bossiness. We compare the outcomes from the (Bi-polar) Serially Dictatorial Rules with the outcomes obtained using a market based approach, namely the “core” of the market. We show that all strongly efficient outcomes in the core can be generated using Serially Dictatorial Rules. Moreover, we argue that Serially Dictatorial Rules have an advantage over the market based approach in that they yield strongly efficient solutions for all preference profiles, making it possible to use randomization to restore equity. When preferences are private information, this type of ex ante equity cannot be implemented using the market based approach.     

Costless discrimination and unequal achievements in an experimental tournament

We investigate the emergence of discrimination in an experiment where individuals affiliated to different groups compete for a monetary prize, submitting independent bids to an auctioneer. The auctioneer receives perfect information about the bids (there is no statistical discrimination), and she has no monetary incentive to favor the members of her own group (the bidders are symmetric). We observe nonetheless some discrimination by auctioneers, who tend to assign the prize more frequently to a member of their own group when two or more players put forward the highest bid. Out-group bidders react to this bias and reduce significantly their bids, causing an average decay of their earnings throughout the game, with cumulative effects that generate unequal outcomes. Because the initial bias is costless, such mechanism can survive even in a competitive market, providing a rationale for the long-run persistence of discrimination.     

The Franchising of Passenger Rail Services in Britain

Following the 1993 Railways Act, British Rail's passenger business was spilt into 25 train operating units, which have been privatised by a process of franchising. This paper will review the franchising experience to date. First, the results of 38 in-depth interviews with potential bidders for the passenger businesses will be described. Secondly, a hypothetical bidding game, based on a series of Stated Preference experiments undertaken by our sample of potential bidders, will be described. A model has been established which determines managers' preferences with respect to contract size and length, exclusivity, and the degree of regulatory control. Given assumptions concerning the degree of competition for rail franchises and bidding behaviour, some predictions are made about the likely magnitude of winning bids and these predictions are validated against actual bids.     

Are ‘true’ preferences revealed in repeated markets? An experimental demonstration of context-dependent valuations

This paper reports a new and significant experimental demonstration that market participants adjust their bids towards the price observed in previous market periods when—by design—individuals’ values should not be affiliated with the market price. This demonstration implies that market prices may not adjust as standard comparative statics predicts and emphasizes the significance of social aspects even in market contexts. Hence, the present study shows that market behaviour is not anomaly-free. Indeed, market behaviour does not reveal the underlying true preferences but rather context-dependent preferences.     

Relational Political Contribution under Common Agency

Motivated by commitment problems of contracts in lobbying, this paper studies a model of a repeated common agency where monetary transfers must be voluntary. First, we show that the optimal punishment strategy for a principal takes a two‐phase scheme, which is similar to the punishment characterized by Goldlücke and Kranz. Second, we investigate whether an outcome of standard menu auctions with binding contracts can be supported by implicit contracts. We define the environment to be more preference‐diverse if an efficient decision is less attractive to each principal. We show that the discount factor must be high to support the outcome of the standard menu auction if the environment is preference‐diversified.     

Do practice rounds affect experimental auction results?

Researchers use practice rounds to familiarize participants with experimental auction mechanisms. We find a positive correlation between practice bids and bids submitted in later rounds. We consider three explanations for this correlation: a behavioral anchoring effect, a tendency for some auction participants to be more free-spending, and misconception of the experimental auction’s demand revealing qualities.     

COURSE BIDDING AT BUSINESS SCHOOLS*

Mechanisms that rely on course bidding are widely used at business schools in order to allocate seats at oversubscribed courses. Bids play two key roles under these mechanisms: to infer student preferences and to determine who have bigger claims on course seats. We show that these two roles may easily conflict, and preferences induced from bids may significantly differ from the true preferences. Therefore, these mechanisms, which are promoted as market mechanisms, do not necessarily yield market outcomes. We introduce a Pareto‐dominant market mechanism that can be implemented by asking students for their preferences in addition to their bids over courses.     

Empirical Evidence Showing The Relationships Between Three Approaches for Pollution Control

Willingness to pay models have shown the theoretical relationships between the contingent valuation, cost of illness and the avertive behaviour approaches. In this paper, field survey data are used to compare the relationships between these three approaches and to demonstrate that contingent valuation bids exceed the sum of cost of illness and the avertive behaviour approach estimates. The estimates provide a validity check for CV bids and further support the claim that contingent valuation studies are theoretically consistent.     

Decentralized computation procurement and computational robustness in a smart market

Summary. Several `smart market' mechanisms have recently appeared in the literature. These mechanisms combine a computer network that collects bids from agents with a central computer that selects a schedule of bids to fill based upon maximization of revenue or trading surplus. Potential problems exist when this optimization involves combinatorial difficulty sufficient to overwhelm the central computer. This paper explores the use of a computation procuring clock auction to induce human agents to approximate the solutions to discrete constrained optimization problems. Economic and computational properties of the auction are studied through a series of laboratory experiments. The experiments are designed around a potential application of the auction as a secondary institution that approximates the solution to difficult computational problems that occur within the primary `smart market', and show that the auction is effective and robust in eliciting and processing suggestions for improved schedules. Received: November 5, 1996; revised version: September 30, 1997     

Sequential auctions with randomly arriving buyers

We analyze a dynamic market in which buyers compete in a sequence of private-value auctions for differentiated goods. New buyers and new objects may arrive at random times. Since objects are imperfect substitutes, buyers? values are not persistent. Instead, each buyer?s private value for a new object is a new independent draw from the same distribution.We consider the use of second-price auctions for selling these objects, and show that there exists a unique symmetric Markov equilibrium in this market. In equilibrium, buyers shade their bids down by their continuation value, which is the (endogenous) option value of participating in future auctions. We characterize this option value and show that it depends not only on the number of buyers currently present on the market and the distribution of their values, but also on anticipated market dynamics.