John D. Hey LUISS & University of York Julia A. Knoll University of Düsseldorf Strategies in Dynamic Decision Making An Experimental Investigation on the Rationality of Decision Behaviour John D. Hey LUISS & University of York Julia A. Knoll University of Düsseldorf

Strategies in Dynamic Decision Making An Experiment on the Rationality of Decision Behaviour Content 1.Introduction 2.Experimental Design 3.The Decision Strategies 4.Summary

Strategies in Dynamic Decision Making An Experiment on the Rationality of Decision Behaviour Introduction Dynamic decision problems under risk start end  sequence of interdependent decisions  external forces - “Nature”  Nature moves with a known probability  very complex decision node chance node payoff nodes

Strategies in Dynamic Decision Making An Experiment on the Rationality of Decision Behaviour Introduction How do people solve dynamic decision problems? Economic Theory vs. Experimental Evidence  Theory: rational dynamic decision making implies to plan ahead  optimal decision on every decision level  Experiments: subjects fail to anticipate or plan their future decisions (Carbone & Hey, 2001; Bone et al. 2003)  ignore the fact that they will take decisions in the future  simplify the decision problem.

Strategies in Dynamic Decision Making An Experiment on the Rationality of Decision Behaviour Experimental Design The decision tree  3 decision levels  Nature moves  with equal probability  independent of previous moves  special features:  notepads  replay function  dominance property of the payoffs

Strategies in Dynamic Decision Making An Experiment on the Rationality of Decision Behaviour Experimental Design Implementation of the Experiment  4 attempts with the same set of payoffs  payment:  payoff on each attempt  4 payoffs  final payoff randomly chosen out of those 4 payoffs  EXEC, University of York  92 subjects  individually & at their own speed  instructions:  written  power point  questions

Strategies in Dynamic Decision Making An Experiment on the Rationality of Decision Behaviour The Decision Strategies Overview 1.Effort Minimizer / Ignorants 2.Backward Inducters  Rationalists  Quasi- Rationalists  Simplifier  Desperates  Effort & Time Savers 3.Forward Worker 4.Strategy Mixers 34% 12% 3% 16% 24% 11% SimplifierQuasi- Rationalists Rationalists Forward Workers Effort Minimizer Strategy mixer

Strategies in Dynamic Decision Making An Experiment on the Rationality of Decision Behaviour The Decision Strategies Effort Minimizer / Ignorants  do not check payoffs at all or  checked payoffs arbitrarily but ignored this information  few subjects: wrong decision on DL3 although they have checked the remaining two payoffs before  very fast  almost no cognitive effort

Strategies in Dynamic Decision Making An Experiment on the Rationality of Decision Behaviour The Decision Strategies Overview 1.Effort Minimizer / Ignorants 2.Backward Inducters  Rationalists  Quasi- Rationalists  Simplifier  Desperates  Effort & Time Savers 3.Forward Worker 4.Strategy Mixers 34% 12% 3% 16% 24% 11% SimplifierQuasi- Rationalists Rationalists Forward Workers Effort Minimizer Strategy mixer

Strategies in Dynamic Decision Making An Experiment on the Rationality of Decision Behaviour The Decision Strategies Backward Inducters: Overview  in common: tackle the decision problem backwards  three subgroups with different degrees of rational decision behaviour  Rationalists: completely rational  Quasi-Rationalists: almost rational  Simplifier: partially rational  different degrees of Backward Induction

Strategies in Dynamic Decision Making An Experiment on the Rationality of Decision Behaviour The Decision Strategies Overview 1.Effort Minimizer / Ignorants 2.Backward Inducters  Rationalists  Quasi- Rationalists  Simplifier  Desperates  Effort & Time Savers 3.Forward Worker 4.Strategy Mixers 34% 12% 3% 16% 24% 11% SimplifierQuasi- Rationalists Rationalists Forward Workers Effort Minimizer Strategy mixer

Strategies in Dynamic Decision Making An Experiment on the Rationality of Decision Behaviour The Decision Strategies Backward Inducters: The Rationalists  subjects who behave according to the assumptions of economic theory  top-down  starting point DL3  infer decisions for DL 3  from decisions on DL3 decisions for DL2 are backward inducted  last step: inference of decision for DL1 from decision on higher decision levels

Strategies in Dynamic Decision Making An Experiment on the Rationality of Decision Behaviour The Decision Strategies Overview 1.Effort Minimizer / Ignorants 2.Backward Inducters  Rationalists  Quasi- Rationalists  Simplifier  Desperates  Effort & Time Savers 3.Forward Worker 4.Strategy Mixers 34% 12% 3% 16% 24% 11% SimplifierQuasi- Rationalists Rationalists Forward Workers Effort Minimizer Strategy mixer

Strategies in Dynamic Decision Making An Experiment on the Rationality of Decision Behaviour The Decision Strategies Backward Inducters: The Quasi-Rationalists  top-down  almost the same decision behaviour as ‘Rationalists’  BUT: mistake on DL2  take irrelevant information into account when inferring the decision for DL1  only 3 subjects (3%)

Strategies in Dynamic Decision Making An Experiment on the Rationality of Decision Behaviour The Decision Strategies Overview 1.Effort Minimizer / Ignorants 2.Backward Inducters  Rationalists  Quasi- Rationalists  Simplifier  Desperates  Effort & Time Savers 3.Forward Worker 4.Strategy Mixers 34% 12% 3% 16% 24% 11% SimplifierQuasi- Rationalists Rationalists Forward Workers Effort Minimizer Strategy mixer

Strategies in Dynamic Decision Making An Experiment on the Rationality of Decision Behaviour The Decision Strategies Backward Inducters: Simplifier – the desperates  top-down  backward induct the optimal decision until DL2  get stuck on DL2  apparently do not know how to further reduce the information  bottom-up: take a ‘random’ decision on DL1

Strategies in Dynamic Decision Making An Experiment on the Rationality of Decision Behaviour The Decision Strategies Backward Inducters: Simplifier – Effort & Time Savers  first bottom-up  first decision on DL1  number of decisions reduced to 6  then top-down  backward induct the optimal decisions for the remaining branches

Strategies in Dynamic Decision Making An Experiment on the Rationality of Decision Behaviour The Decision Strategies Overview 1.Effort Minimizer / Ignorants 2.Backward Inducters  Rationalists  Quasi- Rationalists  Simplifier  Desperates  Effort & Time Savers 3.Forward Worker 4.Strategy Mixers 34% 12% 3% 16% 24% 11% SimplifierQuasi- Rationalists Rationalists Forward Workers Effort Minimizer Strategy mixer

Strategies in Dynamic Decision Making An Experiment on the Rationality of Decision Behaviour The Decision Strategies Forward Worker  bottom-up  check (most of the) 64 payoffs  make a move on DL1  check the remaining 16 payoffs  make a move on DL2  check the remaining 4 payoffs  make a move on DL3  no decision is taken in advance  decisions will only be made when subjects get to a decision node

Strategies in Dynamic Decision Making An Experiment on the Rationality of Decision Behaviour The Decision Strategies Overview 1.Effort Minimizer / Ignorants 2.Backward Inducters  Rationalists  Quasi- Rationalists  Simplifier  Desperates  Effort & Time Savers 3.Forward Worker 4.Strategy Mixers 34% 12% 3% 16% 24% 11% SimplifierQuasi- Rationalists Rationalists Forward Workers Effort Minimizer Strategy mixer

Strategies in Dynamic Decision Making An Experiment on the Rationality of Decision Behaviour The Decision Strategies Strategy Mixers  subjects use different strategies  could not be assigned unequivocally to one of the groups  guessing  take in new information  changes the way they tackle the decision problem

Strategies in Dynamic Decision Making An Experiment on the Rationality of Decision Behaviour Summary  there are subjects who do behave according to economic theory  Rationalists  only 12 %  few subjects seem to have an idea how to solve the decision problem but fail when implementing their strategy  Quasi-Rationalists and Desperates  majority of subjects does not decide rationally  decision strategies are fast and do not require a lot of cognitive effort  cost-benefit analysis

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