Abstract: Many observers have asserted that there is a correlation between emotions and asset market behavior, with Joviality associated with high prices and Fear with low prices. In this paper, we conduct a laboratory experiment to examine the direction of causality in this relationship. The results show that incidental emotions, induced by videos shown in virtual reality, do not influence market prices. However, there is a strong relationship between market activity and subsequent emotional states, suggesting that the correlation between emotions and market activity is driven by the influence of market activity on emotions, not the other way around.
Abstract: How do past emotional reactions shape current decisions? This paper investigates the dynamic impact of negative emotions on investment decisions. We first provide a framework to extend traditional reference-dependent preferences (Koszegi and Rabin, 2006; Kahneman and Tversky, 1979) to incorporate the effect of emotions on utility. Specifically, we focus on the negative emotions triggered by outcomes that fall below the decision-maker’s subjective expectation and generically call these emotions frustration. Using these principles, we derive theoretical implications of frustration’s dynamic in different investment environments and test them in the lab. Through a within-subject design, we elicit subjects’ willingness to invest before and after they experience frustration. Subjects exhibit strong and heterogeneous reactions to frustration. These results can be explained by how sensitivity to frustration changes when frustration increases. Risk preference, loss aversion, and other individual traits cannot explain such dynamic behaviour patterns.
Abstract: In this paper, I design a new coordination device in minimum-effort games called "stochastic monitoring" and test its effectiveness in the lab. This device is characterized by: (1) stochastic (negative) material consequences, and (2) non-deterrence, in the sense that the coordination device does not remove any pure-strategy Nash equilibria in the basic minimum-effort game. The results show that stochastic monitoring significantly improved coordination among groups that were stuck at inefficient outcomes. This effect was even stronger under a relatively high punishment, low monitoring probability scheme compared to two other low punishment, high probability alternatives due to a reduction in the number of groups that ended up with extremely low outcomes. Further analysis reveals that stochastic monitoring functioned as a coordination device, despite having the feature of material incentives.