Ernst Fehr Department of Economics

University of Zurich

Degustibus Est Disputandum The Emerging Science of

Preference Formation

Outline of presentation

n  The „stable preference assumption“ n  Sociologists view n  Economists view n  How sound is the economists viewpoint?

n  How society shapes our preferences n  Aggregate asset prices & risk aversion n  Business culture & honesty n  Affecting private attitudes towards female genital cutting n  Long term consequences of a nuclear catastrophe n  Promoting prosocial behavior in children

n  Summary

Are preferences stable or are they shaped by „society“?

A sociologist‘s view

The assumption that society shapes individuals‘ preferences „clearly concerns one of the core pillars of sociology but it is not easy to suggest any literature to you. It is almost too fundamental for that – like asking economists to suggest some tests on the importance of choice. Almost all sociologists take it as obvious that individuals‘ preferences are formed by society and that society, so to speak, exists within persons.“ (Peter Hedstrom, Oxford)

Are preferences stable or are they shaped by „society“?

A view from economics

n  De Gustibus non est disputandum (Stigler & Becker) n  „... tastes neither change capriciously nor differ

importantly between people. On this interpretation one does not argue about tastes for the same reason that one does not argue over the Rocky Mountains – both are there, will be there next year, too, and are the same to all men.“

n  Not just stable preferences but also no heterogeneity

Not all economists subscribe to this extreme view but ...

n  Compelling evidence that preference heterogeneity matters and interacts in important ways with the institutional environment n  Social preference research (e.g., Fehr & Schmidt QJE 1999) n  Risk preference research (e.g., Bruhin/Epper/Fehr-Duda Ectra 2010)

n  But: almost all economic research examines the changes in individual behavior and aggregate outcomes that follow from changes in constraints n  Tax, cost, price and information changes n  Changes in property rights & the contractual environment

n  Implicit assumption: n  Strong preference stability: changes in constraints („the

environment“) leave preferences unaffected n  Weak preference stability: for the problem under consideration

preferences are more stable than constraints

Remarks on the assumption of preference stability

n  Important to recognize n  It is NOT a fact that changes in the environment

leave preferences unaffected n  It is merely a useful assumption that took on the

nature of a social convention n  It is considered bad practice to invoke changes in

preferences as explanations

n  „One can explain everything if one invokes changes in preferences as an explanation“

n  „It is too easy to explain changes in behavior by changes in preferences“

Problems with the economists‘ argument

n  „One can explain everything if one invokes changes in preferences as an explanation“

n  „One can explain everything if one invokes changes in the environment (constraints) as an explanation“ n  „Give me a real world contract and I will find an

extensive form game that rationalizes this contract as an equilibrium of the game“

n  Clever contract theorists can rationalize „everything“ in terms of changes in the environment

John Sutton

n  The elaboration of multi-stage games allowed a tremendous flexibility in modelling.

Sutton continued

n  Paradoxically, it is the very success of these game theoretic models in providing a rich menu of candidate „explanations“, which leaves them open to a quite fundamental line of criticism

n  This richness of possible formulations leads to an often embarrassingly wide range of outcomes supportable as equilibria within some „reasonable“ specification

n  In explaining everything, have we explained nothing? What do these models exclude?

My View

n  The methodological arguments against invoking „preference changes“ are not very convincing

n  They rest on conventions, social norms and (unproven) beliefs about the empirical validity of the assumption that one can neglect changes in preferences for the problem at hand

n  Deep down, most of us believe that preferences are shaped by teaching, role models, the behaviors we observe around us and our social interactions with other people

n  Educating one‘s children is not just about skill formation – it‘s also about teaching the „right“ preferences

The time is ripe for a «Science of Preference Formation»

n  Measuring preferences n  Can now be solved with good behavioral experiments n  Sometimes also with good surveys

n  Identifying specific social circumstances that impact on preferences

n  Inferring causality n  Causal econometric tools (substitutes for random

assignment to treatment & control) n  Field experiments

Social and Biological Influences on Preferences

n  Ernst Fehr & Karla Hoff (2011): Tastes, Castes and Culture – The Influence of Society on Preferences. Economic Journal 121, F396–F412.

n  Neuroeconomic research shows that by noninvasively affecting neuronal firing in the DLPFC we can change n  Time preferences n  Risk preferences n  Social preferences n  Norm compliance

Examples n  Aggregate asset prices affect traders’ risk preferences

n  Cohn-Engelmann-Fehr-Marechal (AER 2011): Evidence on counter-cyclical risk aversion – an experiment with financial professionals

n  Banks’ business culture affects the honesty of their employees n  Cohn-Marechal-Fehr (Nature 2014): Business culture and dishonesty in

the banking industry

n  Movies affect attitude towards female genital cutting n  Efferson-Vogt-Zaid-Fehr (2015): Changing attitudes about female genital

cutting through movies

n  Nuclear catastrophe in Chernobyl affects time and risk preferences

n  Promoting prosocial preferences in children

Do aggregate asset price movements affect risk preferences?

Shiller AER 1981

Solid line: real stock price index; dotted line: ex-post rational price

Real Standard & Poor’s Stock Price Index Real Dow Jones Industrial Average

Solving the causality problem Priming boom & bust

§  Activation of mental representations or associations in the memory system by attentional or environmental cues

§  Rendering booms and bust mentally salient while keeping expectations, wealth and other factors constant

§  Does the mere mental priming of booms and busts affect risk aversion?

§  If the mere priming of booms/busts affects risk preferences actual booms/busts, which constitute much more powerful primes (i.e. are extremely salient), are also likely to have these effects

Treatments Boom

Imagine you find yourself in a continuing stock market boom, would you … 1)  buy or sell particular stocks? 2)  invest in gold or other precious

metals? 3)  deposit part of your assets on your

savings account? 4)  invest in Exchange Traded Funds? 5)  consider purchasing real estate (e.g. a

house)?

Treatments Boom

Imagine you find yourself in a continuing stock market boom, would you … 1)  buy or sell particular stocks? 2)  invest in gold or other precious metals? 3)  deposit part of your assets on your

savings account? 4)  invest in exchange traded funds (ETFs)? 5)  consider purchasing real estate (e.g.

house)?

Bust Imagine you find yourself in a continuing stock market bust, would you … 1)  buy or sell particular stocks? 2)  invest in gold or other precious metals? 3)  deposit part of your assets on your

savings account? 4)  invest in exchange traded funds (ETFs)? 5)  consider purchasing real estate (e.g.

house)?

Risk task (subjects are professional traders)

Risky asset Safe account

CHF (200 – X) CHF X

2.5·CHF X CHF 0

Red ball Yellow ball

CHF (200 – X)

Ambiguity Task (subjects are professional traders)

Risky asset Safe account

CHF (200 – X) CHF X

2.5·CHF X CHF 0

Red ball Yellow ball

CHF (200 – X)

How does priming affect risk aversion? (Cohn-Engelmann-Fehr-Marechal AER 2014)

n  During bust 22% lower investment in risky asset

Further Results

n  Traders with more experience are slightly more prone to the priming effect

n  Traders with higher financial literacy are slightly more prone to the priming effect

n  Priming a bust induces fear and fear seems to be an independent causal force in shaping risk aversion

n  Highlights the causal role of an important emotion - FEAR

Does business culture affect bank employees’ honesty?

(Cohn-Fehr-Marechal Nature 2014)

Jerome Kerviel caused a €4.9bn loss for Société Générale with unauthorized trading

“The culture of the trading room was to make as much money as possible as quickly as possible”

[Jerome Kerviel, interview in the Financial Times 2010]

Research Design

n  We are all in different social roles. These roles are associated with partially different value systems

n  If business culture in banks is problematic it should induce higher levels of dishonesty compared to other social contexts (i.e., leisure context)

n  Priming employees’ professional identity versus priming their private «leisure identity»

Priming professional identity among bank employees

Banker identity treatment

1)  At which bank are you presently

employed? 2)  What is your function at this bank? 3)  For how many years have you

been working in the banking industry?

4)  Why did you decide to become a banker?

5)  – 6) …

Control treatment

1)  What is your favorite leisure

activity? 2)  Which 3 opportunities for leisure

activities would you most like in your area?

3) – 6) …

Coin flipping task $20 per successful coin flip

Competitive environment: earnings from coin flipping task were only paid out if the reported outcome exceeded the outcome of a randomly drawn subject from the pilot study

Does bankers’ professional identity facilitate dishonesty?

Cheating rate increases from 3% to 16% (p = 0.03, Mann-Whitney)

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Further Results

n  Priming professional identity in other industries does NOT increase dishonesty

n  Priming students with the concept of «MONEY» does NOT increase dishonesty

n  Treatment effect occurs across all sections of the bank but level of cheating is highest in investment banking & wealth management

n  Priming banker identity increases endorsement of materialistic norms

Affecting Attitudes towards Female Genital Cutting

n  Ancient practice that removes or otherwise injures any part of a female’s external genitalia for non-medical reasons

n  Often leads to serious health problems such as n  bleeding, urine retention, genital swelling, urinary tract infections,

bacterial vaginosis, psychological trauma, infertility, and a number of adverse obstetric outcomes

n  Every year, an estimated 3 million girls are at risk of being cut in Africa and Asia

n  Two classes of reasons for cutting n  Extrinsic benefits: marriageability and avoidance of social stigma n  Intrinsic benefits: perceived religious obligation, cut women

perceived as more feminine, etc.

Can we change deeply entrenched attitudes towards cutting with a movie?

n  Jensen and Oster (2009) show that cable television has improved women’s status in various ways in India

n  La Ferrara et al. (2012) show that Brazilian telenovelas have lowered fertility rates

n  DellaVigna et al. (2014) show that nationalistic Serbian radio increases ethnic hatred of Serbs among Croats in regions of Croatia near the border

n  Kearney and Levine (2014) show that MTV’s “16 and Pregnant” has led to sharp declines in teen pregnancy

n  However, observational data make it sometimes difficult to infer causality

Movies as treatments n  Movies are about an extended family in Sudan

n  Four movies in total: control movie, values movie, stigma movie, values & stigma movie

n  They share an entertaining plot which is not about cutting

n  Three treatment movies include a sub-plot n  depicts the members of the extended family as they grapple with

the question whether to continue cutting or abandon thge practice

n  Random assignment of members of 5 communities to treatments and control

The values movie

n  Characters present arguments based on their own private evaluation of the relevant costs and benefits.

n  For some characters, health is paramount; other characters worry that not cutting would be unlawful under Islam.

n  Other characters fear that, if they do not cut their daughters, their daughters will not grow up to behave the way women are supposed to behave.

n  Altogether, the values subplot begins by depicting a set of competing fears and concerns.

n  The characters then examine and eventually alleviate the fears and concerns that would favor cutting.

n  Finally, the family decides not to cut their daughters

The stigma movie

n  Focuses on the need to match the prevailing norm in the community. Everyone in the family agrees that they must follow the local norm or face social ostracism.

n  Members of the family, however, disagree about what the norm is. n  Some argue that times are changing rapidly, and cutting will soon

disappear. n  Others argue, however, that change, if it comes at all, will take

generations. Thus, the best way to guarantee a good future for their daughters is to cut them.

n  The sub-plot discusses these competing opinions and new information is collected that alleviates fears that change will take very long

n  Finally, the family jointly decides not to cut their daughters

How can we measure attitude change?

Implicit Association Test

§  Implemented an implicit association test (IAT) on cutting with the participants.

§  IAT measures attitudes about sensitive topics that are difficult to measure explicitly because of social desirability bias §  Racism, Xenophobic sentiments, etc. §  Test limits the scope for the participant to misrepresent her

attitudes with socially desirable responses

How does the IAT work?

Subjects with a positive attitude towards uncut girls are slower because they have to match something positive with something negative («social stroop task»)

Uncut girl Cut girl

Subject should as quickly as possible match the uncut girl in the middle with the corresponding girl on the left

Does the implicit association test capture aggregate cutting rates?

§  Validated the implicit association test (IAT) with 2260 randomly selected adults in the 45 communities.

§  Communities with higher cutting rates have much more negative attitudes towards uncut girls

§  Spearmans rank correlation: ρ = 0.493, p < 0.001

Can we change attitudes? (measure varies between -2 and +2)

OLS regression with standardized dependent variable

Other Examples

n  Severe poverty is associated with high levels of chronic stress which causes risk aversion and high preference for present consumption n  Haushofer & Fehr, On the Psychology of Poverty, Science 2014

n  Providing friends to children in adverse socio-economic circumstances significantly increases their altruism, trust & trustworthiness n  Falk and colleagues, Formation of Human Prosociality – The role of

the social environment

Summary n  Preferences are an important object of scientific inquiry n  Time, risk and social preferences are shaped in important

ways by the social and economic factors. They are affected by n  Asset prices, business culture, education, ethnic and other

conflicts, etc.

n  If preferences are endogenous, they can – and sometimes – should be targeted by economic and social policies

n  Attitudes – a precursor of preferences – towards health relevant behaviors can also be shaped by policy measures

n  Degustibus est disputandum – we must «quarrel» about preferences