[go: up one dir, main page]
More Web Proxy on the site http://driver.im/ Skip to main content
Springer Nature Link
Log in

The preference reversal phenomenon: Response mode, markets and incentives

  • Research Articles
  • Published:
Economic Theory Aims and scope Submit manuscript

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.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Subscribe and save

Springer+ Basic
£29.99 /Month
  • Get 10 units per month
  • Download Article/Chapter or eBook
  • 1 Unit = 1 Article or 1 Chapter
  • Cancel anytime
Subscribe now

Buy Now

Price includes VAT (United Kingdom)

Instant access to the full article PDF.

Institutional subscriptions

Similar content being viewed by others

References

  1. Allais, M.: Le compartement de l'homme rationnel devant le risque; critique des postulates et axioms de l'ecole americaine. Econometrica21, 503–46 (1953)

    Google Scholar 

  2. Beach, L., Phillips, L.: Subjective probability inferred from estimates and bets. J. Exp. Psychol.75, 354–59 (1967)

    Google Scholar 

  3. Beach, L., Wise, J.: Subjective probability revision and subsequent decisions. J. Exp. Psychol.81, 561–65 (1969)

    Google Scholar 

  4. Beach, L. et al.: Probability learning: response proportions and verbal estimates. J. Exp. Psychol.86, 165–70 (1970)

    Google Scholar 

  5. Becker, G., DeGroot, M., Marshak, J.: Measuring utility by a single-response sequential method. Behav. Sci.9, 226–32 (1964)

    Google Scholar 

  6. Berg, J., Dickhaut, J., O'Brien, J.: Preference reversal and arbitrage. In: Smith, V. (ed.) Research in experimental economics, vol. 3. Greenwich: JAI Press 1985

    Google Scholar 

  7. Bostic, R., Herrnstein, R., Luce, D.: The effect on the preference-reversal phenomenon of using choice indifference. J. Econ. Behav. Organiz.13, 193–222 (1990)

    Google Scholar 

  8. Braunstein, Y., Schotter, A.: Economic search: an experimental study. Econ. Inquiry19, 1–25 (1981)

    Google Scholar 

  9. Braunstein, Y., Schotter, A.: Labor market search: an experimental study. Econ. Inquiry20, 133–44 (1982)

    Google Scholar 

  10. Camerer, C.: Do biases in probability judgement matter in markets? Experimental evidence. Amer. Econ. Rev.77, 981–97 (1987)

    Google Scholar 

  11. Camerer, C.: Does the basketball market believe in the ‘hot hand’? Amer. Econ. Rev.79, 1257–61 (1989)

    Google Scholar 

  12. Camerer, C.: An experimental test of several generalized utility theories. J. Risk Uncert.2, 61–104 (1989)

    Google Scholar 

  13. Camerer, C.: The rationality of prices and volume in experimental markets. Organiz. Behav. Human Dec. Proc.51, 237–72 (1992)

    Google Scholar 

  14. Casey, J.: Reversal of the preference reversal phenomenon. Organiz. Behav. Human Dec. Proc.48, 221–51 (1991)

    Google Scholar 

  15. Chu, Y., Chu, R.: The subsidence of preference reversals in simplified and marketlike experimental settingsa note. Amer. Econ. Rev.80, 902–11 (1990)

    Google Scholar 

  16. Cox, J., Epstein, S.: Preference reversals without the independence axiom. Amer. Econ. Rev.79, 408–26 (1989)

    Google Scholar 

  17. Cox, J., Oaxaca, R.: Laboratory experiments with a finite horizon job-search model. J. Risk Uncert.2, 301–29 (1989)

    Google Scholar 

  18. Cox, J., Oaxaca, R.: Tests for a reservation wage effect. In Geweke, J. (ed.) Decision making under risk and uncertaintynew models and empirical findings. Dordrecht: Kluwer Academic Publishers 1992

    Google Scholar 

  19. Cox, J., Oaxaca, R.: Direct tests of the reservation wage property. Econ. J.102, 1423–32 (1992)

    Google Scholar 

  20. Cox, J., Smith, V., Walker, J.: Theory and individual behavior of first-price auctions. J. Risk Uncert.1, 61–99 (1988)

    Google Scholar 

  21. DuCharme, W.: Response bias explanation of conservative human inference. J. Exp. Psychol.85, 66–74 (1970)

    Google Scholar 

  22. Edwards, W.: Conservatism in human information processing. In: Kleinmuntz, B. (ed.) Formal representation of human judgement. New York 1968

  23. Ellsberg, D.: Risk, ambiguity, and the savage axioms. Q. J. Econ.75, 643–69 (1961)

    Google Scholar 

  24. Fischhoff, B.: Hindsight not equal to foresightthe: effect of outcome knowledge on judgement under uncertainty. J. Exp. Psychol.1, 228–99 (1975)

    Google Scholar 

  25. Forsythe, R., Nelson, F., Neumann, G., Wright, J.: The Iowa presidential stock marketa field experiment. In: Isaac, M. (ed.). Research in experimental economics, vol. 4. Greenwich: JAI Press 1991

    Google Scholar 

  26. Forsythe, R., Palfrey, T., Plott, C.: Asset valuation in an experimental market. Econometrica50, 537–67 (1982)

    Google Scholar 

  27. Gigerenzer, G.: How to make cognitive illusions disappearbeyond ‘heuristics and biases’. Eur. Rev. Soc. Psychol.2, 83–115 (1991)

    Google Scholar 

  28. Gode, D., Sunder, S.: Allocative efficiency of markets with zero-intelligence tradersmarket as a partial substitute for individual rationality. J. Polit. Econ.101, 119–37 (1993)

    Google Scholar 

  29. Goldstein, W., Einhorn, H.: Expression theory and the preference reversal phenomena. Psychol. Rev.94, 236–54 (1987)

    Google Scholar 

  30. Grether, D.: Bayes rule as a descriptive modelthe representativeness heuristic. Q. J. Econ.95, 537–57 (1980)

    Google Scholar 

  31. Grether, D., Plott, C.: Economic theory of choice and the preference reversal phenomenon. Amer. Econ. Rev.69, 623–38 (1979)

    Google Scholar 

  32. Hamm, R.: The conditions of occurrence of the preference reversal phenomenon. Tech. Report, Center for Research on Judgement and Policy, University of Colorado, 1984

  33. Holt, C.: Preference reversals and the independence axiom. Amer. Econ. Rev.76, 508–14 (1986)

    Google Scholar 

  34. Howells, W.: Uncertainty from internal and external sourcesa clear case of overconfidence. J. Exp. Psychol.89, 240–43 (1971)

    Google Scholar 

  35. Howells, W.: Compounding uncertainty from internal sources. J. Exp. Psychol.95, 6–13 (1972)

    Google Scholar 

  36. Irwin, J., McClelland, G., Schulze, W.: Hypothetical and real consequences in experimental auctions for insurance against low-probability risks. J. Behav. Dec. Making5, 107–116 (1992)

    Google Scholar 

  37. Isaac, M., Plott, C.: Price controls and the behavior of auction markets: an experimental examination. Amer. Econ. Rev.71, 448–49 (1981)

    Google Scholar 

  38. Kagel, J., Levin, D.: The winner's curse and public information in common value auctions. Amer. Econ. Rev.76, 894–920 (1986)

    Google Scholar 

  39. Kahneman, D., Tversky, A.: On the psychology of prediction. Psychol. Rev.80, 237–51 (1973)

    Google Scholar 

  40. Kahneman, D., Slovic, P., Tversky, A.: In: Judgement under uncertainty: heuristics and biases. Cambridge: Cambridge University Press 1982

    Google Scholar 

  41. Karni, E., Safra, Z.: ‘Preference reversal’ and the observability of preferences by experimental methods. Econometrica55, 675–85 (1987)

    Google Scholar 

  42. Lichtenstein, S., Slovic, P.: Reversals of preference between bids and choices in gambling decisions. J. Exp. Psychol.89, 46–55 (1971)

    Google Scholar 

  43. Lichtenstein, S., Slovic, P.: Response-induced reversals of preference in gamblingan extended replication in Las Vegas. J. Exp. Psychol.101, 16–20 (1973)

    Google Scholar 

  44. Lindman, H.: Inconsistent preferences among gambles. J. Exp. Psychol.89, 390–97 (1971)

    Google Scholar 

  45. Loomes, G., Starmer, C., Sugden, R.: Preference reversalinformation-processing effect of rational nontransitive choice. Econ. J. [Conf. Suppl.]99, 140–51 (1989)

    Google Scholar 

  46. Loomes, G., Starmer, C., Sugden, R.: Observing violation of transitivity by experimental methods. Econometrica59, 425–40 (1991)

    Google Scholar 

  47. Loomes, G., Sugden, R.: Regret theoryan alternative theory of rational choice under uncertainty. Econ. J.92, 805–24 (1982)

    Google Scholar 

  48. Loomes, G., Sugden, R.: A rationale for preference reversal. Amer. Econ. Rev.73, 428–32 (1983)

    Google Scholar 

  49. Machina, M.: Choice under uncertaintyproblems solved and unsolved. J. Econ. Perspect.1, 121–54 (1987)

    Google Scholar 

  50. Miller, R., Plott, C.: Product quality signaling in experimental markets. Econometrica53, 837–72 (1985)

    Google Scholar 

  51. Peterson, C., DuCharme, W., Edwards, W.: Sampling distribution and probability revisions. J. Exp. Psychol.76, 236–43 (1968)

    Google Scholar 

  52. Plott, C.: Rational choice in experimental markets. In: Hogarth, R., Reder, M. (eds.) Rational choice: the contrast between economics and psychology. Chicago: University of Chicago Press 1987

    Google Scholar 

  53. Plott, C., Miller, R., Smith, V.: Intertemporal competitive equilibriuman empirical study of speculation. Q. J. Econ.91, 599–624 (1977)

    Google Scholar 

  54. Plott, C., Sunder, S.: Efficiency of experimental security markets with inside information: an application of rational expectations models. J. Polit. Econ.90, 663–98 (1982)

    Google Scholar 

  55. Plott, C., Sunder, S.: Rational expectations and aggregation of diverse information in laboratory security markets. Econometrica56, 1085–118 (1988)

    Google Scholar 

  56. Schkade, D., Johnson, E.: Cognitive processes in preference reversals. Organiz. Behav. Human Perform.44, 203–31 (1989)

    Google Scholar 

  57. Scott, W. Jr., Fark, J., Podsakoff, P.: The effects of ‘intrinsic’ and ‘extrinsic’ reinforcement contingencies on task behavior. Organiz. Behav. Human Dec. Proc.41, 405–425 (1988)

    Google Scholar 

  58. Segal, U.: Does the preference reversal phenomenon necessarily contradict the independence axiom? Amer. Econ. Rev.78, 233–36 (1988)

    Google Scholar 

  59. Slovic, P., Lichtenstein, S.: Preference reversalsa broader perspective. Amer. Econ. Rev.73, 596–605 (1983)

    Google Scholar 

  60. Slovic, P., Lichtenstein, S.: The relative importance of probabilities and payoffs in risk-taking. J. Exp. Psychol. [Monog. Suppl. part 2]78, 1–18 (1968)

    Google Scholar 

  61. Smith, V.: Markets as economizers of information: experimental examination of the Hayek hypothesis. Econ. Inquiry20, 165–79 (1982)

    Google Scholar 

  62. Smith, V.: Microeconomic systems as an experimental science. Amer. Econ. Rev.72, 923–55 (1982)

    Google Scholar 

  63. Smith, V.: Experimental methods in the political economy of exchange. Science234, 167–73 (1986)

    Google Scholar 

  64. Tversky, A.: Intransitivity of preference. Psychol. Rev.76, 31–48 (1969)

    Google Scholar 

  65. Tversky, A., Kahneman, D.: Belief in the law of small numbers. Psychol. Bull.76, 105–10 (1971)

    Google Scholar 

  66. Tversky, A., Kahneman, D.: Judgement under uncertainty: heuristics and biases. Science185, 1124–131 (1974)

    Google Scholar 

  67. Tversky, A., Slovic, P., Kahneman, D.: The causes of preference reversal. Amer. Econ. Rev.80, 204–17 (1990)

    Google Scholar 

  68. Wright, W., Abdoul-Ezz, M.: Effects of extrinsic incentives on the quality of frequency assessments. Organiz. Behav. Human Dec. Pro.41, 143–52 (1988)

    Google Scholar 

Download references

Author information

Authors and Affiliations

  1. Department of Economics, University of Arizona, 85721, Tucson, AZ, USA

    James C. Cox

  2. California Institute of Technology, 91125, Pasadena, CA, USA

    David M. Grether

Authors
  1. James C. Cox
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. David M. Grether
    View author publications

    You can also search for this author in PubMed Google Scholar

Additional information

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.

Rights and permissions

Reprints and permissions

About this article

Cite this article

Cox, J.C., Grether, D.M. The preference reversal phenomenon: Response mode, markets and incentives. Econ Theory 7, 381–405 (1996). https://doi.org/10.1007/BF01213657

Download citation

  • Received:

  • Revised:

  • Issue Date:

  • DOI: https://doi.org/10.1007/BF01213657

Keywords

Search

Navigation