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The relevance of thinking-by-analogy for investors’ willingness-to-pay: An experimental study

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  • Siddiqi, Hammad

Abstract

People tend to think by analogies. We investigate whether thinking-by-analogy matters for investors’ willingness-to-pay for a risky asset in a laboratory experiment. We find that thinking-by-analogy has a strong influence when the assets in question have similar (but not identical) payoffs. The hypothesis of thinking-by-analogy or coarse thinking clearly outperforms other hypotheses including the hypothesis of arbitrage-free or rational pricing. When the similarity between the payoffs is reduced, the risk neutral and risk averse hypotheses outperform the hypothesis of thinking-by-analogy. Regardless of the similarity between the payoffs, the arbitrage-free or rational pricing remains the hypothesis with the worst performance.

Suggested Citation

  • Siddiqi, Hammad, 2012. "The relevance of thinking-by-analogy for investors’ willingness-to-pay: An experimental study," Journal of Economic Psychology, Elsevier, vol. 33(1), pages 19-29.
    • Handle: RePEc:eee:joepsy:v:33:y:2012:i:1:p:19-29
    DOI: 10.1016/j.joep.2011.08.008
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    1. Sendhil Mullainathan & Joshua Schwartzstein & Andrei Shleifer, 2008. "Coarse Thinking and Persuasion," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 123(2), pages 577-619.
    2. Urs Fischbacher, 2007. "z-Tree: Zurich toolbox for ready-made economic experiments," Experimental Economics, Springer;Economic Science Association, vol. 10(2), pages 171-178, June.
    3. Rubinstein, Ariel, 1988. "Similarity and decision-making under risk (is there a utility theory resolution to the Allais paradox?)," Journal of Economic Theory, Elsevier, vol. 46(1), pages 145-153, October.
    4. Shefrin, Hersh & Statman, Meir, 2000. "Behavioral Portfolio Theory," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 35(2), pages 127-151, June.
    5. Rockenbach, Bettina, 2004. "The behavioral relevance of mental accounting for the pricing of financial options," Journal of Economic Behavior & Organization, Elsevier, vol. 53(4), pages 513-527, April.
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    Citations

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    Cited by:

    1. Siddiqi, Hammad, 2014. "Analogy Making and the Structure of Implied Volatility Skew," MPRA Paper 60921, University Library of Munich, Germany.
    2. Siddiqi, Hammad, 2013. "Analogy Making in Complete and incomplete Markets: A New Model for Pricing Contingent Claims," Risk and Sustainable Management Group Working Papers 160608, University of Queensland, School of Economics.
    3. Siddiqi, Hammad, 2015. "Anchoring Heuristic in Option Pricing," Risk and Sustainable Management Group Working Papers 207677, University of Queensland, School of Economics.
    4. Siddiqi, Hammad, 2015. "Analogy Based Valuation of Currency Options," MPRA Paper 62333, University Library of Munich, Germany.
    5. Siddiqi, Hammad, 2013. "Mental Accounting: A Closed-Form Alternative to the Black Scholes Model," MPRA Paper 50759, University Library of Munich, Germany.
    6. Hammad, Siddiqi, 2015. "Index Option Returns from an Anchoring Perspective," MPRA Paper 65331, University Library of Munich, Germany.
    7. Siddiqi, Hammad, 2014. "Analogy Making and the Structure of Implied Volatility Skew," Risk and Sustainable Management Group Working Papers 187407, University of Queensland, School of Economics.
    8. Siddiqi, Hammad, 2015. "Analogy Based Valuation of Commodity Options," Risk and Sustainable Management Group Working Papers 197334, University of Queensland, School of Economics.
    9. Siddiqi, Hammad, 2013. "Managing Option Trading Risk with Greeks when Analogy Making Matters," Risk and Sustainable Management Group Working Papers 160607, University of Queensland, School of Economics.
    10. Siddiqi, Hammad, 2013. "Analogy Making, Option Prices, and Implied Volatility," MPRA Paper 48862, University Library of Munich, Germany.
    11. Siddiqi, Hammad, 2015. "Anchoring Heuristic in Option Pricing," MPRA Paper 63218, University Library of Munich, Germany.
    12. Siddiqi, Hammad, 2014. "The Financial Market Consequences of Growing Awareness: The Case of Implied Volatiltiy Skew," Risk and Sustainable Management Group Working Papers 162568, University of Queensland, School of Economics.
    13. Siddiqi, Hammad, 2013. "Analogy Making In Complete and Incomplete Markets: A New Model for Pricing Contingent Claims," Risk and Sustainable Management Group Working Papers 156934, University of Queensland, School of Economics.
    14. Siddiqi, Hammad, 2014. "Mental Accounting: A New Behavioral Explanation of Covered Call Performance," Risk and Sustainable Management Group Working Papers 162567, University of Queensland, School of Economics.
    15. Siddiqi, Hammad, 2014. "Anchoring Heuristic in Option Prices," MPRA Paper 66018, University Library of Munich, Germany, revised 15 Jul 2015.
    16. Siddiqi, Hammad, 2015. "Relative Risk Perception and the Puzzle of Covered Call writing," MPRA Paper 62763, University Library of Munich, Germany.
    17. Siddiqi, Hammad, 2015. "Explaining the Smile in Currency Options: Is it Anchoring?," MPRA Paper 63528, University Library of Munich, Germany.
    18. Siddiqi, Hammad, 2015. "Anchoring and Adjustment Heuristic in Option Pricing," MPRA Paper 68595, University Library of Munich, Germany.
    19. Siddiqi, Hammad, 2014. "Analogy Making and the Puzzles of Index Option Returns and Implied Volatility Skew: Theory and Empirical Evidence," Risk and Sustainable Management Group Working Papers 177302, University of Queensland, School of Economics.
    20. Siddiqi, Hammad, 2015. "Analogy based Valuation of Commodity Options," MPRA Paper 61083, University Library of Munich, Germany.

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    More about this item

    Keywords

    Coarse thinking; Thinking-by-analogy; Asset pricing; Call option; Cognitive psychology;
    All these keywords.

    JEL classification:

    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
    • G00 - Financial Economics - - General - - - General
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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