Behavioral Economic Theory and Experimental Investigation Dissertation Presented in Partial Fulfillment of the Requirements for the Degree Doctor of Philosophy in the Graduate School of The Ohio State University By Jeevant Rampal, M.A. Graduate Program in Economics The Ohio State University 2017 Dissertation Committee: James Peck, Advisor John Kagel Paul J Healy Dan Levin Copyrighted by Jeevant Rampal 2017 Abstract This dissertation investigates how and why individuals’ limitations in understanding decision problems, or behavioral biases, affect their optimal choices. The first chapter defines the Limited Foresight Equilibrium, henceforth referred to as LFE. LFE provides an equilibrium assessment for a model where players can possess limited foresight and they are uncertain about the opponents' foresight while playing a finite dynamic game of perfect information. We show the existence of LFE. The LFE entails limited foresight players updating their beliefs about the opponents' foresights within the play of a game. LFE implies that the higher the foresight of a player, the more accurate his beliefs about the opponents' foresights; further, if a low foresight player finds himself at an “unexpected” position in the game, he believes that one of his opponents has higher foresight than him. Thus, high foresight types, in LFE, take reputation effects into account. In applications, LFE is shown to rationalize experimental findings on the Bargaining game and the Centipede game. The second chapter provides experimental evidence for the LFE's novel predictions in the context of a modified Race game. This experimental study investigates how and why the behavior of experienced players, who understand the “sure-win” strategy in a “winner-take-all” sequential move game, varies systematically based on two types of information about the opponent’s expertise. Treatment one: experienced subjects are told their opponent's experience-level in the game. Treatment two: a different set of experienced subjects are only shown their opponent's play against a computer. We find that both exogenous information and endogenous inference about the opponent's inexperience increase the probability with which experienced players abandon the ii “sure-win” strategy and try for a higher payoff attainable only by winning from a losing position, that is, a position from which one wins only if the opponent makes a mistake. A maximum likelihood analysis shows that the LFE explains the data better than the Dynamic Level-k and Agent Quantal Response Equilibrium models. The third chapter reports and models the discrepancy between the full-bidding and endow-and-upgrade findings from a willingness-to-pay (WTP) elicitation Becker-Degroot- Marschak (BDM) experiment for an improved food, conducted in rural India. We found that the distribution of the WTP for exchanging 1kg local pearl millet (LPM) for 1 kg of bio-fortified high-iron pearl millet (HIPM) dominated the distribution of the difference between the WTPs for 1kg HIPM and 1kg LPM. Thus the data rejects preferences that are standard or have status quo reference points, in favor of an expectations-based reference dependence model of loss aversion for the new product. The data is used to identify and estimate the loss aversion parameter and latent consumer valuations for HIPM in the consumer model, which point to a significant downward bias in conventional WTP estimates of HIPM using the BDM procedure, suggesting caution when one is using standard incentive compatible mechanisms for value elicitation. iii Dedicated to my parents, Alka and Rakesh, to my wife, Sikta, my brother, Daksh, his wife, Anumeha, and my niece, Aria iv Acknowledgments I thank James Peck and Abhijit Banerji for being inspirations for me in academia and beyond. They have been instrumental in helping conceptualize, write and rewrite the chapters in this dissertation. I would also like to thank John Kagel, Paul J Healy, Yaron Azreili, and Dan Levin for their comments and help. v Vita 2007................................................................B.A. Economics, Delhi University 2011................................................................M.A. Economics, Delhi University 2013................................................................M.A. Economics, The Ohio State University 2013 to present ..............................................Graduate Teaching Associate, Department of Economics, The Ohio State University Fields of Study Major Field: Economics vi Table of Contents Abstract ............................................................................................................................................ ii Dedication ...................................................................................................................................... iiii Acknowledgments........................................................................................................................... iii Vita.................................................................................................................................................. vi List of Tables ................................................................................................................................ viii List of Figures .................................................................................................................................. x Chapter 1: Limited Foresight Equilibrium ....................................................................................... 1 Chapter 2: Opponent’s Foresight and Optimal Choice .................................................................. 37 Chapter 3: Loss Aversion and Willingness to Pay for New Products ............................................ 83 References .................................................................................................................................... 111 Appendix A: Proofs and Applications for Chapter One .............................................................. 121 Appendix B: Data Analysis for Chapter Two .............................................................................. 131 Appendix C: Willingness to Pay Elicitation ................................................................................ 155 vii List of Tables Table 1. Factors Influencing Probability of Choosing “First Mover” ........................................... 49 Table 2. Rate of Imperfect Play by Position .................................................................................. 53 Table 3. Proportions of Choices from Losing Positions ................................................................ 54 Table 4. Ex-post Earnings of Experienced Subjects against Inexperienced Opponents ................ 55 Table 5. Factors Influencing Probability of Choosing “First Mover” ........................................... 63 Table 6. Relative MLE Performance of Theoretical Models ......................................................... 78 Table 7. MLE Results for Treatment 2 .......................................................................................... 79 Table 8. Summary: HIPM-LPM Premia across Treatments .......................................................... 93 Table 9. Demographic and Socioeconomic Characteristics ........................................................... 94 Table 10. HIPM-LPM Bid Differences: Difference-in-Differences Regression ........................... 95 Table 11. OLS Regression: HIPM Exchange Bids ........................................................................ 96 Table 12. Treatment Effect using Overbid Benchmarks ................................................................ 98 Table 13. Estimated values versus bids for HIPM ....................................................................... 109 Table 14. Estimated Exchange Values, Bids, and Premium Comparisons .................................. 109 Table 15. LFE Strategies for the Sequential Bargaining Game ................................................... 128 Table 16. Percentage of “First Mover” choices of Exp Subjects by Round, Opponent’s Experience ................................................................................................................................... 132 Table 17. Percentage of “First Mover” choices of Exp against Exp, Inexp against Inexp .......... 132 Table 18. Treatment 1 Learning Speed Difference ...................................................................... 132 viii Table 19. Proportion of “First Mover” Choice of Exp Subjects in H13 by Round and Opponent’s Performance ................................................................................................................................. 133 Table 20. Exp and Inexp Subjects’ Percentage of Wins in the C13 Part of Respective First Six Rounds ......................................................................................................................................... 134 Table 21. Rate of Imperfect Play by Position .............................................................................. 135 Table 22. Proportions of Choices from Losing Positions ............................................................ 135 Table 23. Ex-post Mean Earnings of Exp Subjects in H13 vs. Opponent who Lost C13 ............ 136 Table 24. Updated Distributions Due to C13 Win or Loss .......................................................... 141 ix List of Figures Figure 1. An Underlying Game of Perfect Information: Three-Staged Centipede