Determinants of Experienced Utility: Laws and Implications. M. Baucells, R.K. Sarin. July 2012.
Satisfaction in experiencing the future depends on decisions made today. We consider six well-known psychological laws governing satisfaction. The laws capture habit formation, social comparison, and satiation. We show it is possible to formalize these laws by means of a utility model, and to derive implications from the laws: wanting vs. liking, crescendo, recharge periods, variety seeking, and craving. The discussion combines mathematical propositions, experimental findings in psychology, and time-honored wisdom. We discuss how the sixth law, presentism, may lead to incorrect predictions of experienced utility and suboptimal life-balance choices.
Gender Differences in Risk Aversion: When and Why? A. Wieland, R.K. Sarin. May 2012.
It has become well-accepted that women are more risk averse than men. This research investigates when gender differences in risk aversion are likely to occur and when they are less likely to manifest. We find that gender differences in risk aversion are likely to occur in decisions under risk, where the probability of outcomes is known and objectively quantified, such as games of chance, and less likely to occur in decisions under uncertainty, where one must rely on their own internal subjective expectancies of the probabilities of outcomes – the kind of decisions that dominate our day-to-day decision-making. We propose and test the mechanism that is responsible for producing gender differences in risk aversion: one’s subjective expectancy of the outcome. In decisions under risk, when subjective expectancies are accounted for, the gender difference in risk aversion disappears; while in decisions under uncertainty, we do not observe any gender differences in risk aversion, but instead find one’s subjective expectancies of the outcome to be the only reliable predicator of valuation.
Reference Dependence and Conjoint Analysis. B. Davis, I.S. Currim, R.K. Sarin. Review of Marketing Science. Forthcoming.
Although there is enormous evidence that reference levels influence preferences, conjoint models, one of the most successful marketing research tools, assume that preferences depend on the absolute levels of attributes. In this paper we investigate the relevance of reference effects in two settings, compositional or self-explicated models in experimental studies 1 and 2, and decompositional or choice-based models in experimental study 3. In particular, we introduce a simple modification of the traditional self-explicated conjoint model which permits dependence of preference on reference levels. By eliciting gains and losses from expectations the model is adaptable to changes in respondents’ reference points, which the traditional model is incapable of. Reference options are found to clearly affect subject choices in studies 1 and 2. In addition, the reference dependent self-explicated model is found to offer useful predictions when reference points are manipulated in study 1, and improve on predictions of its traditional counterpart when reference points are measured in study 2. In contrast, in study 3, the choice-based model’s diagnostics and predictions are found to be robust to reference point manipulations. Taken together, these results suggest that the self-explicated model is more suited than the choice-based model to understanding and predicting how respondents make judgments relative to reference points because reference points and gains and losses from reference levels are more salient in the self-explicated model. We discuss implications for managers constructing conjoint models in product-market settings wherein reference points are changing due to new product introductions or marketing efforts.
Domain Specificity of Sex Differences in Competition. A. Wieland, R.K. Sarin. Journal of Economic Behavior and Organization. 83(1): 151-157. June 2012.
There has been much recent literature about sex differences in competition, mostly noting that women are innately less competitive than men (Croson and Gneezy, 2009). This article examines the hypothesis that sex differences in propensity to compete are domain specific. We conducted a 2 (sex) × 4 (domain) experiment with 434 participants examining competition decisions, familiarity with the domain, and performance. We find no overall sex differences in rates of competition when collapsing across all four domains, but do find sex differences in rates of competition for individual domains. Additionally we examined the importance of winning at competition on self-esteem using the Contingencies of Self-Worth, Competition subscale (Crocker et al., 2003) and find that the subscale fully mediates the effect of sex on the strength of competitive pay preferences.
An Examination of Ambiguity Aversion: Are Two Heads Better Than One? L.R. Keller, R.K. Sarin, J. Sounderpandian. Judgment and Decision Making. 2(6): 390-397. December 2007.
Ambiguity aversion has been widely observed in individuals’ judgments. Using scenarios that are typical in decision analysis, we investigate ambiguity aversion for pairs of individuals. We examine risky and cautious shifts from individuals’ original judgments to their judgments when they are paired up in dyads. In our experiment the participants were first asked to specify individually their willingness-to-pay for six monetary gambles. They were then paired at random into dyads, and were asked to specify their willingness-to-pay amount for the same gambles. The dyad’s willingness-to-pay amount was to be shared equally by the two individuals. Of the six gambles in our experiment, one involved no ambiguity and the remaining five involved different degrees of ambiguity. We found that dyads exhibited risk aversion as well as ambiguity aversion. The majority of the dyads exhibited a cautious shift in the face of ambiguity, stating a smaller willingness-to-pay than the two individuals’ average. Our study thus confirms the persistence of ambiguity aversion in a group setting and demonstrates the predominance of cautious shifts for dyads.
Predicting Utility under Satiation and Habit Formation. M. Baucells, R.K. Sarin. Management Science. 56(2): 286-301. February 2010.
We introduce a modification of the discounted utility model that accounts for both satiation and habit formation in intertemporal choice. Preferences depend on the satiation level and the habitual consumption level. These two state variables, together with the shape of the value function, drive the properties of the model. One unique feature of our model is that it addresses the trade-off between seeking variety and maintaining acquired habits. We examine several properties of our model, such as the nontrivial patterns of desirability (willingness to pay) for an additional unit of consumption, or the effect of abstaining from consumption (craving). We explore the shape of optimal consumption patterns in discrete and continuous choice settings. If subjects underestimate the changes in satiation and habituation levels, as occurs under projection bias, our model explains why people buy more when hungry, or prefer variety in advance of consumption but stay with the same consumption good in actual use.
Happiness and Time Allocation. M. Baucells, R.K. Sarin. June 2007.
We consider a resource allocation problem in which time is the principal resource. Utility is derived from time-consuming leisure activities, as well as from consumption. To acquire consumption, time needs to be allocated to income generating activities (i.e., work). Leisure (e.g., social relationships, family and rest) is considered a basic good, and its utility is evaluated using the Discounted Utility Model. Consumption is adaptive and its utility is evaluated using a reference-dependent model. Key empirical findings in the happiness literature can be explained by our time allocation model. Further, we examine the impact of projection bias on time allocation between work and leisure. Projection bias causes individuals to overrate the utility derived from income; consequently, individuals may allocate more than the optimal time to work. This misallocation may produce a scenario in which a higher wage rate results in a lower total utility.
Satiation in Discounted Utility.Operations Research. 55(1): 170-181. January-February 2007.
In this paper, we propose a model of intertemporal choice that explicitly incorporates satiation due to previous consumption in the evaluation of the utility of current consumption. In the discounted utility (DU) model, the utility of consumption is evaluated afresh in each time period. In our model, the utility of current consumption represents an incremental utility from the past level. When the time interval between consumption periods is large, and there are, therefore, no carryover effects, our model coincides with the DU model. For short time intervals between consumption periods, the satiation due to previous consumption lowers the utility of current consumption. Several implications of our model are examined, and comparisons with the DU model and the habituation model are made.
Evaluating Time Streams of Income: Discounting What? M. Baucells, R.K. Sarin. Theory and Decision. 63(2): 95-120. September 2007.
For decisions whose consequences accrue over time, there are several possible techniques to compute total utility. One is to discount utilities of future consequences at some appropriate rate. The second is to discount per-period certainty equivalents. And the third is to compute net present values (NPVs) of various possible streams and to then apply the utility function to these net present values. We find that the best approach is to first compute NPVs of various possible income streams and then take the utility of such NPVs. We show the drawbacks of other alternative models of evaluating income streams. The article discusses the advantages of the power and logarithmic forms in the modeling of time preference. These are the only forms for which utility of income and utility of consumption are strategically equivalent. Further, these forms permit the flexibility in the choice of a time period (e.g., monthly or quarterly) without modifying the utility function, thus simplifying analysis.
The Retrospective Evaluation of Payment Sequences: Duration Neglect and Peak-and-End Effects. T. Langer, R.K. Sarin, M. Weber. Journal of Economic Behavior and Organization. 58(1): 157-175. September 2005.
In this paper, we present the results of two experimental studies that examine the quality of retrospective evaluations of payment sequences. In line with a large body of evidence on biases in the retrospective evaluation of hedonic episodes, we observe systematic biases, the tendency to weigh the peak and the end of a sequence too heavily and to neglect its length. However, such effects only show up if we link the payments to performance in strenuous tasks that distract the participants. If payments are simply presented and no distraction is provided, most subjects make normatively appropriate choices.
An Experimental Investigation of the Impact of Information on Competitive Decision Making. C. Abramson, I.S. Currim, R.K. Sarin. Management Science. 51(2): 195-207. 2005.
Managers often employ market response models as decision aids and historical information of competitors' market outcomes to aid their competitive decisions in oligopolistic settings. However, little is known about how access to a decision aid or the availability of competitors' market outcomes impacts a firm’s competitive decisions (e.g., prices) or market outcomes resulting from those decisions (e.g., profits) or how managers make these decisions across such informational conditions. Hence, the objective of this paper is twofold. First, we investigate whether access to a decision aid and historical information of competitors’ outcomes yields more or less-competitive decisions and outcomes. Second, we determine which learning constructs, such as choice reinforcement and beliefs about projected profits, best explain competitive actions across various information conditions. We find that relative to the availability of competitive information, access to a decision aid has a larger effect on lowering prices and profits. We also find that in two-firm markets price competition is even more intense than in five-firm markets. Similarly, the availability of market share information leads to more aggressive pricing even when profits are held constant. Finally, we outline the implications of our findings in making managerial resource allocations to market research endeavors.
Group Decisions With Multiple Criteria. M. Baucells, R.K. Sarin. Management Science. 49(8): 1105-1118. 2003.
We consider a decision problem where a group of individuals evaluates multi-attribute alternatives. We explore the minimal required agreements that are sufficient to specify the group utility function. A surprising result is that, under some conditions, a bilateral agreement among pairs of individuals on a single attribute is sufficient to derive the multi-attribute group utility. The bilateral agreement between a pair of individuals could be on the weight of an attribute, on an attribute evaluation function, or on willingness to pay. We investigate cases in which each individual's utility function is either additive or multiplicative. In the additive case, the group utility can be represented as the weighted sum of group attribute weights and group attribute evaluation functions. In the multiplicative case, the group utility takes a more complex form.
Known, Unknown, and Unknowable Uncertainties. C.C. Chow, R.K. Sarin. Theory and Decision. 52(2): 127-138. March 2002.
In normative decision theory, the weight of an uncertain event in a decision is governed solely by the probability of the event. A large body of empirical research suggests that a single notion of probability does not accurately capture peoples' reactions to uncertainty. As early as the 1920's, Knight made the distinction between cases where probabilities are known and where probabilities are unknown. We distinguish another case – the unknowable uncertainty – where the missing information is unavailable to all. We propose that missing information influences the attractiveness of a bet contingent upon an uncertain event, especially when the information is available to someone else. We demonstrate that the unknowable uncertainty – the case where the missing information is inaccessible to everyone including the experimenters – falls in preference somewhere in between the known and the unknown uncertainty.
Comparative Ignorance and the Ellsberg Paradox. C.C. Chow, R.K. Sarin. Journal of Risk and Uncertainty. 22(2) 129-139. 2001.
We investigate the evaluation of known (where probability is known) and unknown (where probability is unknown) bets in comparative and non-comparative contexts. A series of experiments support the finding that ambiguity avoidance persists in both comparative and non-comparative conditions. The price difference between known and unknown bets is, however, larger in a comparative evaluation than in separate evaluation. Our results are consistent with Fox and Tversky's (1995) Comparative Ignorance Hypothesis, but we find that the strong result obtained by Fox and Tversky is more fragile and the complete disappearance of ambiguity aversion in non-comparative condition may not be as robust as Fox and Tversky had supposed.
Cumulative Dominance and Probabilistic Sophistication. R.K. Sarin, P.P Wakker. Mathematical Social Sciences. 40(2): 191-196. September 2000.
Machina and Schmeidler [Econometrica, 60 (1992) 745-780] gave preference conditions for probabilistic sophistication, i.e. decision making where uncertainty can be expressed in terms of (subjective) probabilities without commitment to expected utility maximization. This note shows that simpler and more general results can be obtained by combining results from qualitative probability theory with a `cumulative dominance' axiom.
Dynamic Choice and NonExpected Utility. R.K. Sarin, P.P. Wakker. Journal of Risk and Uncertainty. 17(2): 87-119. November 1998.
This paper explores how some widely studied classes of non-expected utility models could be used in dynamic choice situations. A new "sequential consistency" condition is introduced for single-stage and multi-stage decision problems. Sequential consistency requires that if a decision maker has committed to a family of models (e.g., the multiple priors family, the rank-dependent family, or the betweenness family) then he use the same family throughout. Conditions are presented under which dynamic consistency, consequentialism, and sequential consistency can be simultaneously preserved for a nonexpected utility maximizer. An important class of applications concerns cases where the exact sequence of decisions and events, and thus the dynamic structure of the decision problem, is relevant to the decision maker. It is shown that for the multiple-priors model, dynamic consistency, consequentialism, and sequential consistency can all be preserved. The result removes the argument that nonexpected utility models cannot be consistently used in dynamic choice situations. Rank-dependent and betweenness models can only be used in a restrictive manner, where deviation from expected utility is allowed in at most one stage.
Revealed Likelihood and Knightian Uncertainty. R.K. Sarin, P.P. Wakker. Journal of Risk and Uncertainty. 16(3): 223-250. May 1998.
Nonadditive expected utility models were developed for explaining preferences in settings where probabilities cannot be assigned to events. In the absence of probabilities, difficulties arise in the interpretation of likelihood of events. In this paper we introduce a notion of revealed likelihood that is defined entirely in terms of preferences and that does not require the existence of (subjective) probabilities. Our proposal is that decision weights rather than capacities are more suitable measures of revealed likelihood in rank-dependent expected utility models and prospect theory. Applications of our proposal to the updating of beliefs and to the description of attitudes towards ambiguity are presented.
Back to Bentham? Explorations of Experienced Utility. D. Kahneman, P.P. Wakker, R.K. Sarin. The Quarterly Journal of Economics. 112(2): 375-405. May 1997.
Two core meanings of utility are distinguished. Decision utility is the weight of the outcome in a decision. Experienced utility is hedonic quality, as in Bentham's usage. Experienced utility can be reported in real time (instant utility), or in retrospective evaluations of past episodes (remembered utility). Psychological research has documented systematic errors in retrospective evaluations, which can induce a preference for dominated options. A formal normative theory of the total experienced utility of temporally extended outcomes is proposed. Measuring the experienced utility of outcomes permits tests of utility maximization and opens other lines of empirical research.
Fairness and Social Risk II: Aggregated Analyses. P.C. Fishburn, R.K. Sarin. Management Science. 43(1): 15-27. 1997.
Fairness is examined for individuals and homogeneous groups within a population. Fairness for both population benefit-risk profiles and probability distributions over profiles is considered. Fairness is based on notions of envy among individuals and groups. Individual preferences are used to assess fairness when benefits and risks are aggregated within groups or over the population. Intergroup envy measures and fairness indices are concentrated on that account for ways that aggregated benefits and risks might be allocated to members of groups or to groups within the population.
A Single-Stage Approach to Anscombe and Aumann's Expected Utility. R.K. Sarin, P.P. Wakker. Review of Economic Studies. 64: 399-409. 1997.
Anscombe and Aumann showed that if one accepts the existence of a physical randomizing device such as a roulette wheel then Savage's derivation of subjective expected utility can be considerably simplified. They, however, invoked compound gambles to define their axioms. We demonstrate that the subjective expected utility derivation can be further simplified and need not invoke compound gambles. Our simplification is obtained by closely following the steps by which probabilities and utilities are elicited.
Combining Patient Utility with Health Status Assessment to Improve Medical Decision Making. L.G. Boiney, R.L. Winkler, R.K. Sarin, D.B. Matchar. Journal of Multi-Criteria Decision Analysis. 5(4): 248-258. 1996.
Physicians often use health status assessment tools to evaluate a patient's condition, then apply established guidelines to determine the most medically effective treatment. Yet additional criteria, such as the appropriateness of the treatment given the particular patient's preferences and attitude toward risk, are also highly relevant to quality care. While such preferences could be addressed via patient utility functions, their use in actual practice is somewhat limited because elicitation is often considered too burdensome for patients, unreliable, or redundant given other measures.
For a small group of real patients who have suffered a stroke, we measure both traditional health status and patient utility for the current state to determine whether limited, focused utility assessment is a practical means of obtaining additional and relevant patient information. We find that utility assessment is perceived as reasonable and useful by patients, even when quite ill, and that utilities and health status are not redundant. In fact, investigating apparent inconsistencies between patient utility and observed health status can alert the physician to patient concerns and criteria not captured by more traditional measures. We propose an approach to medical decision-making that uses both measures to improve patient-physician communication.
Fair Processes for Societal Decisions Involving Distributional Inequalities. L.R. Keller, R.K. Sarin. Risk Analysis. 15(1): 49-59. 1995.
We investigate here fair processes for societal decisions that involve different risks and benefits to different groups. A fair decision making process is particularly important for decisions such as siting hazardous facilities. We experimentally evaluate the impact of alternative decision processes on the final choice of hypothetical facility sites and the resulting benefit and risk distribution to groups. The experimental task required choice among many alternative sites for a hazardous facility. Sites differ by the distribution of risks and benefits to each of two communities, and in the attractiveness of the sites to each community. Subjects were divided into groups: individuals who judged the best site in the role of arbitrators, pairs of negotiators with one person representing each of the two communities, and trios who identified the best site in the role of a siting jury. We found the choices of negotiating and siting jury groups tended to exhibit more emphasis on the communities' preferences than the individual arbitrators who tended to focus on balancing the distribution of risks and benefits. Also, undergraduate psychology students, regardless of the dispute resolution mechanism, tended to display more emphasis on the risks and benefits and graduate business students tended to focus more on the communities' preferences.