Non-Standard Preferences and Financial Decision Making

Project Start: 01/2014
Status: Completed
Researchers: Sascha Baghestanian, Paul Gortner, Matthias Heinz, Heiner Schumacher, Joel van der Weele
Category: Corporate Finance, Transparency Lab
Funded by: LOEWE

Working Paper No. 67

Topic and Objectives

In many settings of the financial world, “social preferences” relating to trustworthiness, willingness to cooperate and feelings of envy or guilt may play an important role. Yet these motivations are barely incorporated into models of financial markets and economic transactions. In this project, we investigate both theoretically and experimentally how such preferences influence job market signaling, financial advice, conformity in risk taking and asset market equilibrium.

In a first subproject, we investigate the role of peer effects and social influences in financial markets. Nowadays, technology allows traders to actively seek each other's influence. The online trading platform eToro allows its members not only to engage in financial trading, but also to follow other members’ activity. Indeed, every trade is made public on their website and tied to a profile name. Such social trading platforms are growing rapidly, and the biggest ones have millions of members. We are particularly interested in the impact of social influence on an essential function of markets, namely that both parties can trade assets to mutually insure each other. The more traders take advantage of that opportunity, the better markets perform their function to mitigate and diversify risks.

The study is conducted in a laboratory, as using field data to achieve a clean statistical identification of social influence is difficult for individual behavior. The experimental markets are computerized, student subjects trade with each other and are paid according to their earnings in the market. The degree of social influence in our experiments varies between four different conditions. Traders in the first condition have no information about each other. In the second condition, subjects observe the portfolios of others while they are trading. Either the highest, or the lowest performer is publicly announced in the third and fourth condition. Apart from these manipulations, subjects are not allowed to communicate with each other.

Key Findings

  • The availability of information about others leads to less risky portfolios. By the end of the experiment, subjects who have information about others bear on average 36 percent less risk. Thus, the results show that peer information can actually improve risk sharing, which opens a new and positive perspective on peer effects that are typically associated with instability and market bubbles.
  • The way the decisions of others are presented is important. Publishing only information about the best performers leads to more risk taking in our experiment and more variability in payoffs for participants. By contrast, highlighting those hurt by risk taking leads to better diversification.

Working Paper No. 120

Topic and Objectives

A second sub-project deals with the role of signaling in labor markets. In a market with asymmetric information, the informed party may be able to credibly signal advantageous type information by taking some costly action. This mechanism is particularly important in labor markets where employers know less about an applicant’s capabilities and preferences than the applicant herself. However, what exactly does an applicant’s vita reveal about her? In the theoretical and empirical literature on job market signaling, the object of asymmetric information is the agent’s productivity – her value to the employer – and the costly signal is her education. In practice, productivity may comprise attributes like cognitive ability, general knowledge as well as behavioral characteristics such as the agent’s intrinsic motivation to pursue the employer’s goals or to cooperate with other employees. Such characteristics may be important for the employer, in particular, if the scope for monitoring or providing monetary incentives is limited. Nevertheless, so far there exists no analysis about whether and how an applicants’ vita signals these characteristics to employers.

We conduct two experiments. In study 1, we collect student subjects’ current résumés and measure their behavior in a standard linear public goods game (PGG). In study 2, we ask human resource managers from different firms and industries to predict the behavior of study 1 subjects in the PGG based on their résumés. To elicit beliefs in an incentive-compatible manner, their payoff increases in the precision of their predictions. By randomly varying the informational content of the résumés, we can identify the signaling value of study 1 subjects’ extracurricular activities with respect to the willingness to cooperate.

Key Findings

  • An applicant’s vita is quite informative about her behavior and employers use résumé content effectively to predict it.
  • The subjects’ willingness to cooperate increases with their degree of social engagement.
  • Differences in behavior are not caused by differing beliefs. On average, subjects’ beliefs about opponents’ behavior equal the mean contribution.
  • We do not find any significant behavioral differences for subjects engaged in student or sports associations. Other items on the résumé such as age, gender, field of studies or the industry in which a subject collected professional experience are usually not informative about contributions in the PGG.
  • Employers largely anticipate the relative behavioral differences. If résumé content includes extracurricular activities, socially engaged subjects are expected to contribute around 30 percent more in the PGG than all other subjects. In contrast, the intensity of engagement in student associations has no effect on beliefs.
  • The results from the two studies taken together demonstrate that intensive social engagement credibly signals the willingness to cooperate. In line with signaling theory, producing the signal is costly as activities in the third and fourth quartile of the social intensity distribution almost always involve working in positions with a high degree of commitment and responsibility for other people.

Related Working Papers

No. Author/s Title Year Research Area Keywords
67 Sascha Baghestanian, Paul Gortner, Joel van der Weele Peer Effects and Risk Sharing in Experimental Asset Markets 2014 Corporate Finance, Transparency Lab peer effects, laboratory experiments, risk taking, asset markets

 

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