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A Laboratory Investigation of Networked Markets // 2007-10-02

Dan Friedman , Alessandra Cassar , Patricia Higino Schneider

Abstract

When contracts are not perfectly enforceable, can interpersonal networks improve market efficiency? We introduce exogenous networks into laboratory markets in which traders can cheat in “Distant” transactions but not in “Local” ones. Traders are anonymous outside their network, but inside it they can build a reputation. We examine network configurations that have the potential to completely overcome market failure and achieve competitive equilibrium (CE) efficiency. Our results fall short of that mark, but the networks do significantly reduce cheating and increase efficiency. Moreover, the theoretical upper bounds correctly predict the main qualitative trade patterns across our four network architectures. The networks support increased international trade volume and reduced domestic volume, and divert transactions of the highest value and lowest cost units from domestic markets to international networks.

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• A Laboratory Investigation of Networked Markets

A Laboratory Investigation of Networked Markets // 2007-10-02

Dan Friedman , Alessandra Cassar , Patricia Higino Schneider

Abstract

When contracts are not perfectly enforceable, can interpersonal networks improve market efficiency? We introduce exogenous networks into laboratory markets in which traders can cheat in “Distant” transactions but not in “Local” ones. Traders are anonymous outside their network, but inside it they can build a reputation. We examine network configurations that have the potential to completely overcome market failure and achieve competitive equilibrium (CE) efficiency. Our results fall short of that mark, but the networks do significantly reduce cheating and increase efficiency. Moreover, the theoretical upper bounds correctly predict the main qualitative trade patterns across our four network architectures. The networks support increased international trade volume and reduced domestic volume, and divert transactions of the highest value and lowest cost units from domestic markets to international networks.

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• A Laboratory Investigation of Networked Markets

A Laboratory Investigation of Networked Markets // 2006-06-02

Dan Friedman , Alessandra Cassar , Patricia Higino Schneider

Abstract

A central theoretical proposition in economics is that frictionless markets perform at 100% efficiency, and require only trivial links between buyers and sellers. Actual markets, however, face moderate to severe trading frictions, and rely on various sorts of buyer-seller links. Despite a recent ‡flurry of theoretical models and …field works relating networks to social capital with ambiguous effects on effeciency, there is as yet very little empirical knowledge about the e¤ects of networks on mar- ket performance. We gather such knowledge in a controlled laboratory setting. Beginning with a standard and highly e¢ cient real-time trading procedure (the continuous double auction), we introduce one important friction: possible cheating (e.g., a seller might ship an item of lower quality or a buyer might not pay in full). We then introduce exogenous networks of links among traders, and examine the impact on market performance, including efficiency, prices, volume, and pro…fit distribution. As suggested by ratings in on-line auctions or by the role of immigrant networks in international trade or by the buyer-seller networks in agricultural markets in developing countries, the links among network members spread information, e.g., the identity of cheaters. Such links boost market performance by fostering trust (based on reputation) and unifying trade.

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A Simple Testable Model of Double Auction Markets // 1991-01-01

Dan Friedman , Steven Gjerstad, James C. Cox

Abstract

We propose a model of price formation in Double Auction markets which employs the strong simplifying assumption that agents neglect strategic feedback efforts and regard themselves as playing a Game against Nature. Agents otherwise are strict expected utility maximizers employing Bayesian updating procedures. We prove the optimality of simple ('aggressive reservation price') strategies in our general model and propose a parametric form that yields very detailed and computable predictions of market behavior.

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A laboratory Investigation of Deferral Options // 2007-03-21

Dan Friedman , Ryan Oprea , Steven Anderson

Abstract

An irreversible investment opportunity has value $V$ governed by Brownian motion with upward drift and random expiration. Human subjects choose in continuous time when to invest. If she invests before expiration, the subject receives $V - C$: the final value $V$ less a given avoidable cost $C$. The optimal policy is to invest when $V$ first crosses a threshold $V^* = (1+w^*)C$, where the option premium $w^*$ is a specific function of the Brownian parameters representing drift, volatility and discount (or expiration hazard) rate. We ran 80 periods each for 69 subjects. Subjects in the Low $w^*$ treatment on average invested at values quite close to optimum. Subjects in the two Medium treatments and the High $w^*$ invested at values below optimum, but with the predicted ordering, and values approached the optimum by the last block of 20 periods. Behavior was most heterogeneous in the High treatment. Subjects underrespond to differences in both the volatility and expiriation hazard parameters. A directional learning model suggests that subjects react reliably to ex-post losses due to early investment, and react much more heterogeneously (and on average more strongly) to missed investment opportunities. Simulations show that this learning process converges on a nearly optimal steady state.

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• A laboratory Investigation of Deferral Options

A tractable model of reciprocity and fairness // 2005-04-12

Dan Friedman , Steven Gjerstad, James C. Cox

Abstract

We introduce a parametric model of other-regarding preferences in which my emotional state determines the marginal rate of substitution between my own and others’ payoffs, and thus my subsequent choices. In turn, my emotional state responds to relative status and to the kindness or unkindness of others’ choices. Structural estimations of this model with six existing data sets demonstrate that other-regarding preferences depend on status, reciprocity, and perceived property rights.

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• A tractable model of reciprocity and fairness

An Experiment on the Core // 2008-04-26

Dan Friedman , Huibin Yan

Abstract

Each of n ≥ 1 identical buyers (and m ≥ 1 identical sellers) wants to buy (sell) a single unit of an indivisible good. The core predicts a unique and extreme outcome: the entire surplus is split evenly among the buyers when m > n and among the sellers when m < n; the long side gets nothing. We test this core conjecture in the lab with n + m = 3 or 5 randomly rematched traders and minimal imbalances (m = n ± 1) in three market institutions. In the standard continuous double auction, the surplus indeed goes overwhelmingly towards the short side. The DA-Chat institution allows traders to have cheap talk prior to the double auction, while the DA-Barg institution allows the long siders to negotiate enforceable profit sharing agreements while trading. Despite frequent attempts to collude and occasional large deviations from the core prediction, we find that successful collusion is infrequent in both new institutions. A disproportionate fraction of the successful collusions are accompanied by appeals to fairness.

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• An Experiment on the Core

BUY IT NOW: A HYBRID INTERNET MARKET INSTITUTION // 2008-05-07

Dan Friedman , Steven Anderson , Nirvikar Singh , Garrett Milam

Abstract

This paper analyzes seller choices and outcomes in approximately 700 Internet auctions of a relatively homogeneous good. The 'Buy it Now‘ option allows the seller to convert the auction into a posted price market. We use a structural model to control for the conduct of the auction as well as product and seller characteristics. In explaining seller choices, we find that the 'Buy it Now‘ option was used more often by sellers with higher ratings and offering fewer units; and posted prices were more prevalent for used items. In explaining auction outcomes, we find that auctions with a 'Buy it Now‘ price had higher winning bids, ceteris paribus, whether or not the auction ended with the 'Buy it Now‘ offer being accepted, possibly reflecting signaling or bounded rationality. We also find that posting prices, by combining 'Buy it Now‘ and an equal starting price, was an effective strategy for sellers in the sample. +++This paper appeared in the Journal of Electronic Commerce Research, VOL 9, NO 2, 2008.

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• BUY IT NOW: A HYBRID INTERNET MARKET INSTITUTION

Bargaining versus Posted Price Competition in Customer Markets // 2000-09-01

Dan Friedman , Timothy Cason , Garrett Milam

Abstract

We compare posted price and bilateral bargaining (or `haggle`) market institutions in 12 pairs of laboratory markets. Each market runs 50-75 periods in a customer market environment, where buyers incur a cost to switch sellers. Costs evolve following a random walk process. Coasian and New Institutionalist traditions provide competing conjectures on relative market performance. We find that efficiency is lower, sellers price higher, and prices are stickier under haggle than under posted offer.

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• Bargaining versus Posted Price Competition in Customer Markets

Bubble and Crashes: a Cyborg Approach // 2008-06-17

Dan Friedman , Ralph Abraham , Todd Feldman

Abstract

In joint work since 2004 we have created a family of agent-based models for financial markets in which bubbles and crashes occur in imitation of real markets. The evolution of behavioral rules in these models has shed light on some possible mechanisms used by human account managers or traders. Our programming environment, NetLogo, has proved ideal for this work, and also offers a feature, HubNet, capable of extending simulation to include human as well as robot traders. Recently we have used this feature to test a bubbles and crash model in a controlled laboratory environment. The experiment uses agent-based modeling to create a virtual financial market where human subjects act as stock market traders alongside automated robots. We use the experimental data to first test whether humans adjust their exposure to risk in response to a payoff gradient and to test second whether humans perceive risk by responding to an exponential average of their losses. We find that humans do not exactly follow a gradient but are very close. We also find that humans strongly respond to losses putting more weight on the most current losses. However, how they respond to losses depends on the frequency and predictability of crashes.

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• Bubble and Crashes: a Cyborg Approach

Bubbles and Crashes // 2008-07-01

Dan Friedman , Ralph Abraham

Abstract

We develop a financial market model focused on fund managers who continuously adjust their exposure to risk in response to the payoff gradient. The base model has a stable equilibrium with classic properties. However, bubbles and crashes occur in extended models incorporating an endogenous market risk premium based on investors' historical losses and constant gain learning. When losses have been small for a long time, asset prices inflate as fund managers adopt riskier portfolios. Then slight losses can trigger a crash, as a widening risk premium accelerates the decline in asset price.

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• Bubbles and Crashes

Buyer Search and Price Dispersion: A Laboratory Study // 2000-01-01

Dan Friedman , Timothy Cason

Abstract

Posted offer markets with costly buyer search are investigated in 18 laboratory sessions. Each period sellers simultaneously post prices. Then each buyer costlessly observes one or (with probability 1-q) two of the posted prices, and either accepts an observed price, drops out, or pays a cost to search again that period. The sessions vary q, the search cost, the number of sellers, and the number and kind of buyers. Observed transaction prices conform fairly closely to theory (specific unified prices for q=0 and 1 and specific distributions of dispersed prices for q=1/3 and 2/3) when there are more sellers and when there are more buyers (especially robot buyers). With smaller numbers of traders we often see `conscious parallelism` in pricing behavior.

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• Buyer Search and Price Dispersion: A Laboratory Study

Cheating in Markets // 2007-07-01

Dan Friedman , Alessandra Cassar , Patricia Higino Schneider

Abstract

We develop a two-market model under three conditions: autarky, frictionless free trade, and free trade with cheating. Under cheating, in cross market trades the buyer can underpay by π% and the seller can deliver π% less than full value. We fully characterize competitive equilibrium with cheating and obtain novel testable predictions on price, volume and surplus. For example, agents with highest value and lowest cost are predicted to trade exclusively in the domestic market, while agents closer to the margin trade only in the cross market and always cheat; the overall volume is higher (!) than in frictionless free trade; and as π% decreases from 100 to 0, domestic prices move non-linearly from autarky levels to the frictionless free trade level. We test many of these predictions in a laboratory experiment with human traders using parameters intended to challenge the theory. The results are generally consistent with the competitive predictions, in the cheating treatments as well as in the autarky and frictionless free trade treatments. We find evidence of price unification, market segmentation, and an overall volume of trade higher (but a cross market volume lower) under cheating than in frictionless free trade.

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• Cheating in Markets

Cheating in Markets: A Methodological Exploration // 2004-12-01

Dan Friedman

Abstract

In the 1970s, experimental economics split from social psychology by embracing rational choice and equilibrium methods. Behavioral economics has recently narrowed the divide, to the dismay of some. The present paper argues that evolutionary dynamics provides a framework which unifies the best features of social psychology with equilibrium and rational choice. Ongoing research in cheating in markets illustrates the main points. A new equilibrium model provides distinctive testable predictions under three regimes: autarky, frictionless free trade, and anonymous foreign trade with opportunities to cheat. The predictions organize quite well the data collected so far. Later phases of the project will allow trader networks to evolve, altering the market institution and perhaps affecting preferences. Thus the major forces recognized by social psychologists can be combined with a rationality and equilibrium to study how markets respond to the risk of cheating. ***This paper appeared as a chapter in S. Oda, editor, Developments on Experimental Economics, Springer Lecture Notes in Economics and Mathematical Sciences #590, July 2007.

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• Cheating in Markets: A Methodological Exploration

Competitivity in Auction Markets: An Experimental and Theoretical Investigation // 1995-01-01

Dan Friedman , Joseph Ostroy

Abstract

We report successive rounds of theory and laboratory experiment investigationg price-taking behaviour and market efficiency. We focus on the impact of structural parameters as well as trading institution. the structural parameters involve non-competitive supply and demand, and a new odd-lot trading procedure for divisible goods. We present and justify an as-if complete information theory which explains the competitive outcomes and which correctly predicts highly non-competitive outcomes in CHQ markets.

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• Competitivity in Auction Markets: An Experimental and Theoretical Investigation

Conspicuous Consumption Dynamics // 2007-12-19

Dan Friedman

Abstract

We formalize Veblen's idea of conspicuous consumption as two alternative forms of rank-dependent preferences, dubbed envy and pride. Agents adjust consumption patterns gradually, in the direction of increasing utility. From an arbitrary initial state, the distribution of consumption among agents with identical preferences converges to a unique equilibrium distribution. When pride is stronger, the equilibrium distribution has a right-skewed density. When envy is stronger, the equilibrium is concentrated at a single point, and the adjustment dynamics involve a shock wave that can be interpreted as a growing, moving, homogeneous `middle class.` This paper is forthcoming in Games and Economic Behavior.

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• Conspicuous Consumption Dynamics

Contagion of Financial Crises under Local and Global Networks // 2001-01-01

Alessandra Cassar , Nigel Duffy

Abstract

As the world economy becomes increasingly global, will the financial sector become more stable or fragile? In this paper we study how the pattern of relations linking financial institutions - the network - affect the diffusion of a financial crisis. We analyze two such networks with a computational model: the local network, in which each bank is allowed to interact only with the most immediate neighbors, and the global network, in which each bank is allowed to interact with banks located anywhere in the system. We find that the network matters both for the amount of illiquidity in the system and for the spread of bankruptcy. When interactions are local, bankruptcy spreads slower but illiquidity hits harder. When interactions are global, bankruptcy spreads faster, but illiquidity presents fewer problems. We explain our results applying tools from graph theory. We conclude that a global system, in which financial institutions are not restricted to interact only with close neighbors, is more efficient in collecting and allocating funds, but is more vulnerable to contagion of bankruptcy crises.

Customer Search and Market Power: Some Laboratory Evidence // 1999-01-01

Dan Friedman , Timothy Cason

Abstract

Posted offer markets with costly buyer search are investigated in 18 laboratory sessions. Each period sellers simultaneously post prices. Then each buyer costlessly observes one or two of the posted prices and either accepts an observed price, drops out, or pays a cost to search again that period. The sessions vary the number of observed prices (one or two), the search cost, and the number and kind of buyers. When there are more buyers (especially robot buyers), observed transaction prices conform remarkably closely to theory (competitive Bertrand prices when buyers observe two prices and monopoly Diamond prices when buyers observe only one price). With human subject buyers we observe less extreme prices, but outcomes are closer to theory than outcomes in previous laboratory experiments with similar environments.

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• Customer Search and Market Power: Some Laboratory Evidence

Dynamics of Price Dispersion // 2003-03-01

Dan Friedman , Timothy Cason , Florian Wagener

Abstract

Hypotheses on the dynamics of dispersed prices are extracted from computer simulations, as well as traditional and recent theory. The hypotheses are tested on existing laboratory data. As predicted in some variations of the Edgeworth hypothesis, the laboratory data exhibit a significant cycle. Relative to the unique stationary distribution, the empirical distribution of posted prices has excess mass in an interval that moves downward over time until it approaches the lower boundary of the stationary distribution. Then the excess mass jumps upward and the downward cycle resumes. The amplitude of the cycle seems fairly constant over the longer experimental sessions. Of the simulations we consider, the one closest to Edgeworth's 1925 account, a hybrid of gradient dynamics and logit dynamics, seems to best reproduce the observed dynamics.

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• Dynamics of Price Dispersion

Effective Scoring Rules for Probabilistic Forecasts // 1983-01-01

Dan Friedman

Abstract

This paper studies the use of a scoring rule for the elicitation of forecasts in the form of probability distributions and for the subsequent evaluation of such forecasts. Given a metric (distance function) on a space of probability distributions, a scoring rule is said to be effective if the forecaster's expected score is a strictly decreasing function of the distance between the elicited and `true` distributions. Two simple, well-known rules (the spherical and the quadratic) are shown to be effective with respect to suitable metrics. Examples and a practical application (in Foreign Exchange rate forecasting) are also provided.

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• Effective Scoring Rules for Probabilistic Forecasts

Equilibrium Vengeance // 2008-07-23

Dan Friedman , Nirvikar Singh

Abstract

This paper introduces two ideas, emotional state dependent utility components (ESDUCs), and evolutionary perfect Bayesian equilibrium (EPBE). Using a simple extensive form game, we illustrate the efficiency-enhancing role of a powerful ESDUC, the vengeance motive. Incorporating behavioral noise and observational noise leads to seven continuous families of (short run) Perfect Bayesian equilibria (PBE) that involve both vengeful and non-vengeful types. We then show that the evolutionary equilibrium concept shrinks the long-run equilibrium set to two points. In one EPBE, only the non-vengeful type survives and there are no mutual gains. In the other EPBE, both types survive and reap mutual gains.

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• Equilibrium Vengeance

Evolutionary Economics Goes Mainstream: A Review of the Theory of Learning in Games // 1999-03-01

Dan Friedman

Abstract

Evolutionary economics in recent decades has defined itself as a radical al- ternative to mainstream economics. The mainstream studies simple interac- tions of unboundedly clever agents, and assumes that the agents instanta- neously achieve mutual consistency, as in competitive equilibrium or Nash equilibrium. The intent is to illuminate the fundamental role of tastes and technology in determining economic outcomes, and to reveal unsuspected consequences of policies that alter private opportunities and incentives (e.g., Mas-Colell, Whinston and Green, 1995).

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• Evolutionary Economics Goes Mainstream: A Review of the Theory of Learning in Games

Evolutionary Games in Economics // 1991-04-13

Dan Friedman

Abstract

Evolutionary games are introduced as models for repeated anonymous strategic interaction. The basic idea is that actions (or behaviors) which are more `fit,` given the current distribution of behaviors, tend over time to displace less fit behaviors. Simple numerical examples motivate the key concepts of fitness function and compatible dynam- ics, and illustrate the relation to previous biological models. Cone fields are introduced to characterize the continuous-time dynamical processes compatible with a given fitness function. The analysis focuses on dynamic steady state equilibria and their relation to the static equilibria known as NE (Nash equilibrium) and ESS (evolutionary stable state). For large classes of dynamics it is shown that all stable dynamic steady states are NE and that all NE are dynamic steady states. The biologists' ESS condition is less closely related to the dynamic equilibria. The paper concludes with a brief survey of economic applications.

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• Evolutionary Games in Economics

Evolving Landscapes for Population Games // 1997-02-01

Dan Friedman , Joel Yellin

Abstract

We consider population games where the possible actions of each player are labeled by a real number that ranges over a finite interval. The adjustment dynamics of such games can be visualized in terms of the ``landscape'' - the graph of the payoff (or fitness) function. A leading example is gradient dynamics, in which the speed with which a player changes action is proportional to the gradient (or slope) of the landscape at his current action. The time behavior of the action distribution in gradient dynamics is described by a class of nonlinear partial differential equations. Cases are exhibited in which the distribution of actions develops compressive and rarefaction shock waves. We discuss connections to the learning in games literature and to replicator and other monotone (or order compatible) dynamics. Applications are suggested in economics and population biology.

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• Evolving Landscapes for Population Games

Financial Engineering and Rationality: Experimental Evidence Based on the Monty Hall Problem // 2005-07-01

Dan Friedman , Brian Kluger

Abstract

Financial engineering often involves redefining existing financial assets to create new financial products. This paper investigates whether financial engineering can alter the environment so that irrational agents can quickly learn to be rational. The specific environment we investigate is based on the Monty Hall problem, a well-studied choice anomaly. Our results show that, by the end of the experiment, the majority of subjects understand the Monty Hall anomaly. Average valuation of the experimental asset is very close to the expected value based on the true probabilities.

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• Financial Engineering and Rationality: Experimental Evidence Based on the Monty Hall Problem

From Local Interactions to Global Cooperation and Coordination? // 2001-01-01

Alessandra Cassar

Abstract

Latest works in economics have focused on local communities of interactions as a way to model sustainable cooperation - in Prisoner's Dilemma games - and relatively fast coordination on the risk-dominant equilibrium - in Coordination games. A crucial assumption of these computational and theoretical models with local interactions is that the agents have bounded rationality and they are often required to behave imitating the most successful strategy in their neighborhood. Under this assumption, a spatial context - such a local structure to both the interactions and the information available - allows for cooperation and rapid coordination, while non-spatial contexts do not. We tested this hypothesis in the laboratory with subjects playing local versions of Prisoner's Dilemma and Coordination game, in which players are matched with a left and a right neighbor, as if they were sitting around a table. The experiments were conducted under three alternative information treatments: one with no information about neighbors' payoffs (to prevent eventual imitation), one with local information only (right and left neighbors' payoffs), one with full information (payoff in the neighborhood plus the previous period average action chosen by the entire group). Consistent with theory, for the Prisoner's Dilemma we found that a local structure to both the interactions and the information available allows the players to achieve a level of cooperation consistently higher than a more global information structure. Unexpectedly though, we found that cooperation can be even higher if the players have no information on their neighbors' payoff. Different from theory, for the Coordination game, we found that the local information environment, versus the more global one, does not speed up the process toward the risk-dominant equilibrium: it consistently presents more payoff-dominant decisions than the full information case, even if under both treatments agents seem to coordinate towards the risk-dominant equilibrium. On the contrary, and unexpectedly, when agents have no information on others' payoff, they successfully tend to coordinate on the payoff-dominant equilibrium. On individual behavior, for both games, we found no evidence that players imitate the most successful strategy they can observe. When they have the possibility of imitate - knowledge of their neighbors' payoffs - they tend to cooperate less, and coordinate less on payoff-dominant equilibrium.

ITEM Proposal // 2006-09-01

Dan Friedman

Abstract

The project description for the ITEM GRANT

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• ITEM Proposal

Individual Learning in Normal Form Games: Some Laboratory Results // 1997-01-01

Dan Friedman , Yin-Wong Cheung

Abstract

We propose and test a simple belief learning model. We find considerable heterogeneity across individual players; some players are well described by ficti- tious play (long memory)learning, other players by Cournot (short memory)learning, and some players are in between. Representative agent versions of the model fit significantly less well and sometimes point to incorrect inferences. The model tracks players' behavior well across a variety of payoff matrices and information conditions.

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• Individual Learning in Normal Form Games: Some Laboratory Results

Internet Congestion: A Lab Experiment // 2004-04-30

Dan Friedman , Bernardo Huberman

Abstract

Human players and automated players (bots) interact in real time in a congested network. A player's revenue is proportional to the number of successful ''downloads'' and his cost is proportional to his total waiting time. Congestion arises because waiting time is an increasing random function of the number of uncompleted download attempts by all players. Surprisingly, some human players earn considerably higher profits than bots. Bots are better able to exploit periods of excess capacity, but they create endogenous trends in congestion that human players are better able to exploit. Nash equilibrium does a good job of predicting the impact of network capacity and noise amplitude. Overall efficiency is quite low, however, and players overdissipate potential rents, i.e., earn lower profits than in Nash equilibrium.

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• Internet Congestion: A Lab Experiment

Laboratory Study of Customer Markets // 2000-04-01

Dan Friedman , Timothy Cason

Abstract

In our laboratory customer markets, sellers post price and buyers incur cost (controlled at zero, low and high values) when they switch to a new seller. Sellers' production costs follow various random walks in 28 sessions, each with 50-100 trading periods. We find that prices are sticky, and sellers absorb almost half of their cost shocks. Sellers price about 10 percent higher when buyers face either high or low switch costs, and trading efficiency is slightly impaired. Experienced buyers switch about 10 percent of the time with either high or low switch costs. Buyers switch more often when they face a higher posted price, have a lower valuation for the good, face lower switch costs, have more time remaining, and have more favorable information on alternative prices. Sellers price higher when they have more attached buyers, when buyers have less information on rivals' prices, when rivals post higher prices, and when less time remains.

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• Laboratory Study of Customer Markets

Learning in a Laboratory Market with Random Supply and Demand // 1999-01-01

Dan Friedman , Timothy Cason

Abstract

We propose a quantitative version of directional learning in a call market. Buyers (resp. sellers) adjust markdown (or markup) relative to true value (or cost) towards the ex-post optimum after each period. The model explains a considerable portion of behavior in a relevant laboratory experiment.

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• Learning in a Laboratory Market with Random Supply and Demand

Learning to Forecast Price // 1999-01-01

Dan Friedman , Hugh Kelley

Abstract

We study human learning in a individual choice laboratory task called Or- ange Juice Futures price forecasting (OJF), in which subjects must implic- itly learn the coefficients of two independent variables in a stationary linear stochastic process. The 99 subjects each forecast in 480 trials with feedback after each trial. Learning is tracked for each subject by fitting the forecasts to the independent variables in a rolling regression. Results include: (1) learning is fairly consistent in that coecient estimates for most subjects converge closely to the objective values, but there is a mild general tendency toward over-response. (2) Typically learning is noticeable slower than the Marcet-Sargent ideal. Among the more striking treatment effects are a gen- eral tendency towards (3) over-response with high background noise and (4) under-response with asymmetric coefficients.

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• Learning to Forecast Price

Litigation with symmetric bargaining and two-sided incomplete information // 2003-06-01

Dan Friedman , Donald Wittman

Abstract

We construct game theoretic foundations for bargaining in the shadow of a trial. Plaintiff and defendant both have noisy signals of a common-value trial judgment and make simultaneous offers to settle. If the offers cross, they settle on the average offer; otherwise, both litigants incur an additional cost and the judgment is imposed at trial. We obtain an essentially unique NE and characterize its conditional trial probabilities and judgments. Some of the results are intuitive, e.g., an increase in trial cost (or a decrease in the range of possible outcomes) reduces the probability of a trial. Other results reverse findings from previous literature. For example, trials are possible even when the defendant's signal indicates a higher potential judgment than the plaintiff's signal, and when trial costs are low, the middling cases (rather than the extreme cases) are more likely to settle.

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• Litigation with symmetric bargaining and two-sided incomplete information

Market theories evolve, and so do markets // 2007-06-30

Dan Friedman

Abstract

Responding to Mirowski’s target article, this paper discusses some intellectual currents of 1970s–1990s and offers suggestions on measuring market performance, on including automated agents as market participants, on evolving new market formats, and on dealing with highly differentiated goods. +++The paper was published in a special issue of the Journal of Economic Behavior & Organization, Vol. 63 (2007) pp. 247–255.

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• Market theories evolve, and so do markets

Markups in Double Auction Markets // 2005-10-01

Dan Friedman , Wenjie Zhan

Abstract

We study the continuous double auction market with simulated traders using various markup rules. A higher markup trades off increased profitability against reduced probability of a transaction. The tradeoff in Nash equilibrium turns out to be remarkably close to the most efficient tradeoff. This may partially explain the `mysterious` efficiency of double auction markets. **This paper appeared in Journal of Economic Dynamics and Control 31:9, 2984-3005 (September 2007)

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• Markups in Double Auction Markets

Money-Mediated Disequilibrium Processes // 1979-02-02

Dan Friedman

Abstract

Dan's Dissertation. Studies cone fields of price adjustment and allocation adjustment in continuous time in a pure exchange economy. Demonstrates convergence to competitive equilibrium under rather mild conditions.

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• Money-Mediated Disequilibrium Processes

Monty Hall's Three Doors: Construction and Deconstruction of a Choice Anomaly // 1998-01-01

Dan Friedman

Abstract

Sometimes people make decisions that seem inconsistent with rational choice theory. We have a `choice anomaly` when such decisions are systematic and well documented. From a few isolated examples such as the Maurice Allais (1953) paradox and the probability matching puzzle of William K. Estes (1954), the set of anomalies expanded dramatically following the work of Daniel Kahneman and Amos Tversky (e.g., 1979).

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• Monty Hall's Three Doors: Construction and Deconstruction of a Choice Anomaly

Motivation and Coordination Games; Experiencing Organizational Dynamics // 1997-09-01

Nicole Bouchez

Abstract

The motivation and coordination games covered here are used in the Managerial Economics class that is taught at UC Santa Cruz. Both games provide students with a hands on way to experience the differences between problems of motivation and coordination, a distinction which many under-graduates do not immediately understand. Both games are conducted in class and they have a short follow-up assignment that is announced after the game is finished. This assignment is meant to help the students understand what they have been doing and why the two games are different. In the coordination game, the students have a common interest (the equilibria are Pareto ranked, and one is efficient). The problem is aligning expectations (and actions). Generally, the students initially settle on an inefficient equilibrium. Direct communication between students allows students to achieve efficiency and move to the Pareto efficient equilibrium without the need for binding commitments. In contrast, in the motivation game, the players have a personal interest diametrically opposed to the common interest (a sort of multilateral prisoner’s dilemma). By playing the game, students come to realize how difficult it can be to achieve cooperation when the benefits to defection are great. Even in the classroom, it seems impossible to get the Pareto optimal equilibrium without some kind of binding agreement.

On economic applications of evolutionary games // 1998-03-01

Dan Friedman

Abstract

Evolutionary games have considerable unrealized potential for modeling substantive economic issues. They promise richer predictions than orthodox game theoretic models but often require more extensive specification. This article exposits the specification of evolutionary game models and classifies their asymptotic behavior in one and two dimensions.

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• On economic applications of evolutionary games

On the Viability of Vengeance // 1999-05-01

Dan Friedman , Nirvikar Singh

Abstract

Using a simple symmetric game to illustrate, we point out shortcomings in previous theoretical accounts of how the human vengeance motive survives despite a free rider problem. We offer a new theoretical explanation involving the coevolution of genes that determine the capacity for vengeance and memes that regulate its expression. The main result, illustrated in a simple parametric example, is that coevolution in a fixed environment circumvents the free rider problem and that the prevailing vengeance level will efficiently serve groups of individuals.

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• On the Viability of Vengeance

Preemption Games: Theory and Experiment // 2008-03-06

Dan Friedman , Ryan Oprea , Steven Anderson

Abstract

Several investors face an irreversible investment opportunity whose value V is governed by Brownian motion with upward drift and random expiration. The first investor i to seize the opportunity before expiration receives the current V less a privately known cost Ci; the other investors receive nothing. We characterize Bayesian Nash Equilibrium (BNE) for this game, extending previously known results. We also report a laboratory experiment with 72 subjects randomly matched into 600 tri- opolies. As predicted in BNE, subjects in triopolies invested at lower values than in monopolies, changes in Brownian parameters significantly altered investment values in monopoly but not in triopoly; and the lowest cost investor in a triopoly usually preempted the others. Evidence was mixed on other BNE predictions, e.g., whether higher cost brings smaller markups. Overall, subjects' earnings came rather close to the BNE prediction.

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• Preemption Games: Theory and Experiment

Producers' Markets // 1989-01-01

Dan Friedman

Abstract

A model of oligopoly with sales costs. Producers set prices and incur most transactions costs. The paper shows that non-collusive behavior leads to price leadership by the lowest cost producer. The prevailing price will be somewhat sticky. Essentially, the model provides microfoundations for the kinked demand curve model of imperfect competition.

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• Producers' Markets

Revealed Altruism // 2007-12-16

Dan Friedman , James C. Cox , Vjollca Sadiraj

Abstract

This paper develops a theory of revealed preferences over one's own and others' monetary payoffs. We introduce `more altruistic than`(MAT), a partial ordering over preferences, and interpret it with known parametric models. We also introduce and illustrate `more generous than` (MGT), a partial ordering over opportunity sets. Several recent discussions of altruism focus on two player extensive form games of complete information in which the first mover (FM) chooses a more or less generous opportunity set for the second mover (SM). Here reciprocity can be formalized as the assertion that an MGT choice by the FM will elicit MAT preferences in the SM and, furthermore, that the effect on preferences is stronger for acts of commission than acts of omission by FM. We state and prove propositions on the observable consequences of these assertions. Then we test those propositions using existing data from investment games with dictator controls and Stackelberg games and new data from Stackelberg mini-games. The test results provide support for the theory of revealed altruism. ++++++++ The copyright to this Article is held by the Econometric Society. It may be downloaded, printed and reproduced only for educational or research purposes, including use in course packs. No downloading or copying may be done for any commercial purpose without the explicit permission of the Econometric Society. For such commercial purposes contact the Office of the Econometric Society (contact information may be found at the website http://www.econometricsociety.org or in the back cover of Econometrica). This statement must the included on all copies of this Article that are made available electronically or in any other format.

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• Revealed Altruism

Searching for the Sunk Cost Fallacy // 2005-10-01

Dan Friedman , Garrett Milam , Bernardo Huberman , Kai Pommerenke

Abstract

We isolate in the laboratory factors that encourage and discourage the famous but elusive sunk cost fallacy. Subjects play a computer game in which they decide whether to keep digging for treasure on an island or to sink a cost (which will turn out to be either high or low) to leave for another island. The research hypothesis is that subjects will stay longer on islands that were more costly to find. Eleven treatment variables are considered, including alternative displays, whether the treasure value of an island is shown on arrival or discovered by trial and error, and cost and other parameters. We detect only a small sunk cost effect that seems insensitive to the hypothesized psychological drivers of self-justification and loss aversion. ***This paper appeared in Experimental Economics 10:1, 79-104 (March 2007)

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• Searching for the Sunk Cost Fallacy

Short-run Fluctuations in Foreign Exchange Rates: Evidence from the Data 973-1979. // 1982-01-01

Dan Friedman

Abstract

(published in J. Int. Econ). The paper examines statistical properties of daily changes in exchange rates in major currencies. It finds evidence that leptokurtosis (fat tails) is due mainly to changes in the parameters (e.g., variance) in the underlying data generating process.

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• Short-run Fluctuations in Foreign Exchange Rates: Evidence from the Data 973-1979.

Speculative Attacks: A Laboratory Study in Continuous Time // 2006-08-01

Dan Friedman , Yin-Wong Cheung

Abstract

We test speculative attack models in a controlled laboratory environment featuring continuous time, size asymmetries, and varying amounts of public information. Attacks succeeded in 233 of 344 possible trading periods. When speculators have symmetric size and access to information: (a) weaker (or more rapidly deteriorating) fundamentals increase the likelihood of successful speculative attacks and hasten their onset, and (b) contrary to some theory, public access to information about either the net speculative position or the fundamentals also enhances success. The presence of a larger speculator further enhances success, and experience with large speculators increases small speculators' response to the public information. However, giving the large speculator increased size or better information does not significantly strengthen his impact.

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• Speculative Attacks: A Laboratory Study in Continuous Time

The Factory System // 1996-05-01

Dan Friedman

Abstract

Rough notes for modelling production in extensive form

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• The Factory System

The S-Shaped Value Function as a Constrained Optimum // 1989-12-01

Dan Friedman

Abstract

This paper derives an S-shaped value function as the optimal allocation of scarce sensitivity. The value function is similar to that used in Prospect Theory, except with no kink at the reference point. As the constraint relaxes, the value function converges to a classic Bernoulli function.

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• The S-Shaped Value Function as a Constrained Optimum

Towards Evolutionary Game Models of Financial Markets // 2000-08-01

Dan Friedman

Abstract

Evolutionary game models analyze strategic interaction over time; equilibrium emerges (or fails to emerge) as players/traders adjust their actions in response to the payoffs they earn. This paper sketches some early and some recent evolutionary game models that contain ideas useful in modeling financial markets. It spotlights recent work on adaptive landscapes. In an extended example, the distribution of player/trader behavior obeys a variant of Burgers' partial differential equation, and solutions involve travelling shock waves. It is conjectured that financial market crashes might insightfully be modeled in a similar fashion. A slightly modified version appears in Quantitative Finance 1:1 (Jan 2001)pp. 177-185.

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• Towards Evolutionary Game Models of Financial Markets

Understanding Variability in Binary and Continuous Choice // 1998-01-01

Dan Friedman , Dominic Massaro

Abstract

Excessive variability in binary choice (categorical judgment) can take the form of probability matching rather than the normatively correct behavior of deterministically choosing the more likely alternative. Excessive variability in continuous choice (judgment rating) can take the form of underconfidence, understating the probability of highly likely events and overstating the probability of very unlikely events. We investigate the origins of choice variability in terms of noise prior to decision (at the evidence stage) and at the decision stage.

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• Understanding Variability in Binary and Continuous Choice

eBay Sellers // 2007-12-16

Dan Friedman , Steven Anderson , Nirvikar Singh , Garrett Milam

Abstract

We examine seller tactics in 1177 eBay auctions. The largest volume sellers make rather homogeneous choices; smaller sellers are more heterogeneous. Some tactics, such as starting the auction with a ‘Buy it Now’ offer, appear to increase revenue. Perhaps due to intense competition, however, the overall impact of most tactics appears to be quite small. The main exception is the use of a secret reserve price, which raises the winning bid conditional on a sale, but reduces the probability of a sale. This can be advantageous, depending on the seller’s risk aversion and impatience. ***This paper is forthcoming in International Journal of Electronic Business

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• eBay Sellers