Life-cycle decisions, dynamic programming, and correlation neglect : experimental analysis of alternative decision rules

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IZA Seminar

Place: Schaumburg-Lippe-Str. 9, 53113 Bonn

Date: 19.11.2019, 12:15 - 13:30


Presentation by 

Charles Bellemare (Université Laval)


Rational forward looking behavior requires solving complex problems involving computation of the expected maximum future valuations across choice alternatives (Emax computations). We conduct an experiment to measure the share of subjects able to perform these computations as well as the share of subjects using two alter- native (sub-optimal) rules of computation which ignore correlation between future valuations. The first alternative rule captures subjects who perform Emax computa- tions ignoring correlation between unobservables in the information set. The second alternative rule captures subjects computing the maximum of the expected future valuations (maxE computations), akin to the option-value model of Stock and Wise (1990). Our experimental design exploits different correlation structures between future valuations to separate the share of subjects using each rule. The experiment was conducted with a large and heterogenous sample of subjects, allowing to relate the propensity to use a given rule to a rich set of socio-economic characteristics. Our results suggest that 28% of subjects are able to perform Emax computations exploiting the correlation structure, 20% of subjects perform Emax computations ignoring correlation, while 52% of subjects perform maxE computations. Moreover, we find that the propensity to use a given rule significantly varies across educa- tion levels { higher educated subjects a significantly more likely to perform Emax computations. We discuss implications for models of labor market outcomes.

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