Microfoundations of Expectations: The Role of Emotions in the Anticipation of Aggregate Outcomes of Human Interaction Timo Ehrig, University of S. Denmark and Max Planck Institute, Leipzig Shyam Sunder, Yale University Max Planck Institue fpr <athe,atoics of Sciences, Leipzig, January 17, 2017

Microfoundations of Expectations: The Role of Emotions in the Anticipation of Aggregate Outcomes of Human Interaction What is an expectation? Why are expectations important? How can we model expectations? (In psychology, in game theory, in Macroeconomics, in strategy) What are building blocks of expectations? Can human expectations be expressed by subjective probability distributions or their first moments? What are we missing if we conceptualize expectations in this way? Our conception of expectations determines how we think about and model interaction. Changing our thinking about expectations also changes our approach to modeling interactions.

This workshop: Expectations about expectations of others The conception of expectation as a subjective probability distribution becomes especially troublesome at higher orders of expectations Example: Two generals problem Psychology and neuroscience point to the role of emotions in reasoning and expectation formation by individuals. Game theory/ statistics: expectations are first moments or distributions How well are expectations in presence of emotions, (e.g. fear, anger, hate) captured by this concept? In contrast to traditional treatment of emotions as a disrupters of rationality, we may want to focus on the functionality of human emotional endowment as a facilitator or an enabler of rationality

Two Examples House markets In theory, I may buy a house at a price above my own valuation if I believe I can resell it to somebody at a higher price later In practice, do I think about others’ thinking when I buy a house? Or do I make shortcuts, like relying only my own thinking or on my feeling? What does it mean to rely on a feeling? When is relying on feeling functional? Negative: “boom overexcitement” that mutes reasoning. Positive: “gut feeling” that valuation cannot be right at this level/ intuitive knowledge that market is overheated. Joint investments If a joint investment of two competitors in a new technology is necessary to ‘switch’ the market, they need to coordinate, but also compete (e.g. in bidding for the licenses for the technology) If the reward of a switch is ambiguous, will a joint ‘mood’ between the competitors decide if they switch? How are the terms ‘gut feeling’, ‘intuitive knowledge’, ‘mood’ related to expectations?

Two challenges Find ways to measure the role of emotions in formation and use of higher order expectations (day 1: Gabriele, Sebastian, Rainer Reisenzein) By aggregation we understand the process by which behaviour of many individuals yields outcomes at the level of groups, organisations, markets, institutions, or macro-economies. Work out consequences of this for modeling aggregates (day 2 & 3: Pierpaolo, Burkhard, Teppo, Thorbjørn)

Desired outcomes of the workshop Agenda of workshop is broad and challenging. For challenge one, we hope for a concrete answer: Suitable experimental designs to answer if and how emotions cut higher order expectation formation. For challenge two, we hope for emergence of ideas and solutions. How do our conceptualizations of expectations influence solution concepts in game theory? How do conceptualizations of expectations influence organization theory? (Down the road: What difference does it make for macroeconomics?) When and how is complexity reduction through emotions successful? Could the possible relation between emotion and rationality have a meaning in our evolutionary origin?