This post is password protected. To view it please enter your password below:

Password:

This post is password protected. To view it please enter your password below:

Password:

DEFINITION

“The idea that beliefs about probability show systematic biases is somewhat older than experimental psychology.
Throughout his “Essai Philosophique sur les Probabilités,” Laplace (1796) was concerned with errors of judgment  and even included a chapter concerning “illusions in the estimation of probabilities.” It is here that we find  the first published account of what is now widely known as the gambler’s fallacy—the belief that, for random  events, runs of a particular outcome (e.g., heads on the toss of a coin) will be balanced by a tendency for the opposite outcome (e.g., tails). (Peter Ayton and Ilan Fisher, below)

For a simple description of the phenomenon see also  wikipedia :

<<Gambler’s fallacy arises out of a belief in the law of small numbers, or the erroneous belief that small samples must be representative of the larger population. According to the fallacy, “streaks” must eventually even out in order to be representative.   Amos Tversky and Daniel Kahneman first proposed that the gambler’s fallacy is a cognitive bias produced by a psychological heuristic called the representativeness heuristic, which states that people evaluate the probability of a certain event by assessing how similar it is to events they have experienced before, and how similar the events surrounding those two processes are. According to this view, “after observing a long run of red on the roulette wheel, for example, most people erroneously believe that black will result in a more representative sequence than the occurrence of an additional red”,  so people expect that a short run of random outcomes should share properties of a longer run, specifically in that deviations from average should balance out. When people are asked to make up a random-looking sequence of coin tosses, they tend to make sequences where the proportion of heads to tails stays closer to 0.5 in any short segment than would be predicted by chance (insensitivity to sample size);Kahneman and Tversky interpret this to mean that people believe short sequences of random events should be representative of longer ones.The representativeness heuristic is also cited behind the related phenomenon of the clustering illusion, according to which people see streaks of random events as being non-random when such streaks are actually much more likely to occur in small samples than people expect.

Readings:

Tversky and Kahnemann Belief in the law of small numbers  (advanced)

Rabin Rabin-Small Numbers  (advanced)

EXPERIMENTS

Charles T. Clotfelter, Philip J. Cook , in their paper “G ambler’s Fallacy in Lottery Play”  (NBER Working Paper No. 3769, Issued in July 1991) provide evidence on the time pattern of lottery participation to see whether actual behavior is consistent with this fallacy. Using data from the Maryland daily numbers game, we find a clear and consistent tendency for the amount of money bet on a particular number to fall sharply immediately after it is drawn, and then gradually to recover to its former level over the course of several months. This pattern is consistent with the hypothesis that lottery players are in fact subject to the gambler’s fallacy.

One further empirical studio confirming the fallacy is presented in

“The Gambler’s Fallacy and the Hot Hand: Empirical Data from Casinos” by Rachel Croson and James Sundali

The Gambler’s Fallacy by Charles T. Clotfelter and  Philip J. Cook

Gambler’s Fallacy and Hot Hand  by Hayton and Fisher

see also Scott Plous, “The Law of Small Numbers”,  The Psychology of Judgement and decision making , page 112-115

see also more papers at the page on Expected Utility  (back)

Grand Roulette

Roulette Experiments:

Red and Black Lottery

Is expected utility theory normative for medical decision making?

• Thinking
• Lottery Simulation

 Basic requirements to better understand the topics of the course

Introduction to The Course (suggested)

Addendum to the Introduction (suggested)

MIT OpenCourseWare: Lectures on Behavioral Economics (advanced)

Khan Academy: Expected Value (suggested)

Khan Academy : The Law of Large Numbers (suggested)

 Readings on Expected Utility theory (suggested)

The dual model account of reasoning

Kahnemann Nobel Lecture (compulsory)

Camerer Neuroeconomics (advanced)

Evans: Dual Process Account of Reasoning (suggested)

Perceptive illusions

Prospect Theory 

   Kahneman and Tversky Prospect Theory: (advanced)

Introduction (p.263) ;  ”Certainty, Probability and Possibility”, pp.265-269; 3 Theory, pp.274-279; “The weighting Function”, pp. 280-281.

•1.     Introduction. Decision Theory primer; Allais and Ellsberg paradoxes; Descriptive theories.

•  Required Readings:
• Dehling : St Petersburg  paradox
• Plous, ch 7 and 8
•  Tversky and Kahneman “Rational Choice and the framing of decisions”  The Journal of Business, vol.59, n.4 pp. s251-s278

•2.     Cognition. Dual Process of reasoning; judgment and decision making.

•  Required Readings: Kahneman, “Maps of Bounded Rationality” (Nobel Prize Lecture)

•3     Prospect Theory. Value function; Endowment Effect; Mental Accounting

•  Required Readings: Plous, chs. 9

•4.     Behavioral Law and Economics

• a. Required Readings:
• Jolls “Behavioral Law and Economics” 2004

•5.     Heuristics and Bias (Law of small numbers. Anchoring. Availability. Conjunction Fallacy. Base-rate Fallacy. Regression to the mean)

• a. Required Readings: Plous, chs. 10-15
• b. Suggested Readings, Plous, chs. 17-18

•6.     Overconfidence and Behavioral Finance

•  Required Readings:
•  Barberis and Thaler: A Survey of Behavioral Finance, par. 1,2,3, pp. 1053-1075

Reference reading material

Dehling Daniel Bernoulli  and the St.Petersburg Paradox , Niew Archief voor Wiskunde, 3 nov. 1997

Download Dehling StPetersburg

Nicolas Barberis and Richard Thaler: “A Survey of Behavioral Finance”, Handbook of the Economics of Finance, Volume 1, Part B, pp. 1053-1075, 2003 – Elsevier;-)

 Download Barberis Thaler

Christine Jolls,  Behavioral Law and Economics  Working Paper  12879 , NBER, 2007

Download Jolls Behavioral Law and Economics

Tversky and Kahneman “Rational Choice and the framing of decisions” The Journal of Business, vol.59,n.4 pp. s251-s278

Download Tversky and  Kahneman Rational Choice

Daniel Kahneman, ” Maps of bounded rationality: A perspective on intuitive judgment and choice” , Nobel Prize Lecture, 20028-O

Download Kahnemann Nobel Lecture

Scott Plous, The Pshychology of Judgment and decision Making, McGraw-Hill ,1993:-|

George A. Quattrone and Amos Tversky “Contrasting rational and psychological analyses of political choice” , The American Political Science Review, Vol. 82, No. 3 (Sep., 1988), pp. 719-736 1988

Download Quattrone Tversky

Educational goals    This course is intended to allow students to become familiar with  the literature in  behavioral economics and political  decision making . While this approach is based on the experimental data about human reasoning (provided by cognitive psychology) , students will be driven to test experimentally properties and assumptions on human decisions.Major goals will be that of enabling students to gain in-depth understanding of the major aspects of  behavioral decision-making under uncertainty, and applications to economics, politics and finance, as well as to apply effectively the theories to ongoing debates, in order to raise their interest in carrying out research in this field.

Teaching method  In-class lectures, computer-aided exercises and test sets, tutorials,

Assessment Method  Computer-aided written and oral exam

Criteria for deciding on subject of final paper  Exam grade, one-on-one colloquium

Preparatory courses   Microeconomics , Elementary Statistics

Students are supposed to be familiar with the basic issues in Risk and Decision Making. One possible suggested reference  reading on this matter is chapter “Risk and Decision Making”, in  ”Markets, Games, and Strategic Behavior: Recipes for Interactive Learning” by Charles Holt. Downloadable at  http://harbaugh.uoregon.edu/Readings/expbooknsf.pdf

More information (on construction)  on  “Cattedre on Line” website

 Exams June 2013