Testing the Role of Contextual Deliberation in the Compromise Effect

Many phenomena of preference construction demonstrate a violation of the rationality premise in classical economic theories. One of the most well-known examples of preference construction is the compromise effect. This puzzling anomaly can be rationalized by contextual deliberation (i.e., endogenous information retrieval/acquisition that can partially resolve utility uncertainty before choice). In this research, we investigate the empirical validity of this explanation by performing falsification tests for its necessary predictions and identifying it from other potential accounts. We conduct five experiments with more than 1,000 participants and show that the compromise effect can be positively mediated by response time and cannot be eliminated by context information, but it can be moderated by manipulating the level of deliberation (i.e., time constraint, preference articulation, task order). These findings are consistent with the predictions of the theory of contextual deliberation. We also show that, on average, contextual deliberation (as proxied by response time) can uniquely account for about half of the total compromise effect. This paper was accepted by Yan Chen, behavioral economics and decision analysis

Information Validates the Prior: A Theorem on Bayesian Updating and Applications

We develop a result on expected posteriors for Bayesians with heterogenous priors, dubbed information validates the prior (IVP). Under familiar ordering requirements, Anne expects a (Blackwell) more informative experiment to bring Bob’s posterior mean closer to Anne’s prior mean. We apply the result in two contexts of games of asymmetric information: voluntary testing or certification, and costly signaling or falsification. IVP can be used to determine how an agent’s behavior responds to additional exogenous or endogenous information. We discuss economic implications. (JEL C11, D82, D84)

Minimal functional alignment of ventromedial prefrontal cortex intracranial EEG signals during naturalistic viewing

The ventromedial prefrontal cortex (vmPFC) has been thought to play an important role in processing endogenous information such as generating subjective affective meaning. Unlike sensory cortex, which processes exogenous information about the external world similarly across individuals, prior work has posited that vmPFC activity may be idiosyncratic to each individual, even when exposed to the same external stimulus. In this study, we recorded local field potentials (LFPs) from intracranial stereo electrodes implanted in patients with intractable epilepsy while they watched an emotionally engaging television show episode and evaluated temporal synchronization of these signals across participants in auditory cortex and vmPFC. Overall, we observed markedly lower intersubject synchronization of signals recorded from electrodes implanted in vmPFC compared to auditory cortex. A subset of patients, however, appeared to share similar vmPFC states during the more emotionally salient scenes. This work suggests that the vmPFC is involved in processing affective responses to ongoing experience in a state-like manner, but the specific states and temporal sequences are idiosyncratic to each individual, even when viewing the same television episode.

Expectations with Endogenous Information Acquisition: An Experimental Investigation

We use a survey experiment to generate direct evidence on how people acquire and process information. Participants can buy different information signals that could help them forecast future national home prices. We elicit their valuations and exogenously vary the cost of information. Participants put substantial value on their preferred signal and, when acquired, incorporate the signal in their beliefs. However, they disagree on which signal to buy. As a result, making information cheaper does not decrease the cross-sectional dispersion of expectations. We provide a model with costly acquisition and processing of information, which can match most of our empirical results.

Supplier Competition and Cost Reduction with Endogenous Information Asymmetry

Problem definition: We consider a buyer sourcing from multiple competing suppliers who exert cost-reduction efforts before procurement contracts are awarded. Academic/practical relevance: The supply chain is subject to the classic hold-up problem—as the lack of a contract commitment hinders suppliers’ incentives to make investment upfront—complicated with supplier competition. Methodology: With deterministic cost-reduction outcomes, suppliers will not exert any effort if this effort is observable, and a pure-strategy equilibrium does not exist if the effort is unobservable. We analyze the mixed-strategy equilibrium with unobservable supplier effort, in which suppliers randomize their efforts and the buyer designs an optimal procurement mechanism. Results: We show that the optimal procurement mechanism can be implemented by a conventional single-price reverse auction with a random reserve price. The mixed strategy of supplier effort generates endogenous information asymmetry on supplier costs that provides suppliers with information rent, which sustains their efforts. The endogenous information asymmetry improves effort efficiency (by inducing positive supplier effort), yet introduces trade inefficiency (by causing the possible failure of trade between the parties). Although increasing supplier competition (measured by the number of suppliers) hurts the effort efficiency, it improves trade efficiency. As a result, the buyer is always better off introducing supplier competition by including more than one supplier in the supply base. However, the desired supply base size (number of suppliers) depends on the product revenue: For high-margin goods, the optimal size is achieved with two suppliers, whereas for low-margin goods, a larger supply base is better for the buyer. We show that the result based on deterministic cost reduction can be established as a limit of the case when uncertainty in cost reduction exists and shrinks to null. Managerial implications: Our study helps to understand the impact of supplier competition when supply-chain parties deliberately make their actions unpredictable to avoid being held up. The findings provide managerial guidance on procurement auction and supply base designs.

Consumer Imperfect Information and Endogenous Price Rigidity

This paper studies the propagation of monetary shocks in an economy featuring a strategic microfoundation for price rigidities. Following an aggregate shock to money, most consumers are initially uninformed. The market for goods is decentralized. Firms are better off delaying the adjustment of prices until enough consumers learn. At the same time, consumers learn from firms that have adjusted prices. The implied endogenous information diffusion follows a Bernoulli differential equation, implying a nonlinear path of learning. Nonlinear learning implies hump-shaped dynamics of output and inflation. A quantitative exercise suggests that these dynamics can be sizable and persistent. (JEL D11, D21, D40, D82, E23, E31)

Neural network models for DMT-induced visual hallucinations

The regulatory role of the serotonergic system on conscious perception can be investigated perturbatorily with psychedelic drugs such as N,N-Dimethyltryptamine. There is increasing evidence that the serotonergic system gates prior (endogenous) and sensory (exogenous) information in the construction of a conscious experience. Using two generative deep neural networks as examples, we discuss how such models have the potential to be, firstly, an important medium to illustrate phenomenological visual effects of psychedelics—besides paintings, verbal reports and psychometric testing—and, secondly, their utility to conceptualize biological mechanisms of gating the influence of exogenous and endogenous information on visual perception.

Asset Pricing Implications of Short-Sale Constraints in Imperfectly Competitive Markets

We study the impact of short-sale constraints on market prices and liquidity in imperfectly competitive markets in which market makers have market power. In contrast to the existing literature, we show that because competition is imperfect, short-sale constraints decrease bid prices, increase ask prices, and drive up bid-ask spread volatility, with or without information asymmetry. If market makers are risk neutral, then short-sale constraints do not affect ask prices or ask depths. In addition, the impact of short-sale constraints can increase with market transparency. Our main results are unaffected by endogenous information acquisition or reduced information revelation because of short-sale constraints. This paper was accepted by Gustavo Manso, finance.