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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.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Psychology.

Volume (Year): 33 (2012)
Issue (Month): 1 ()
Pages: 19-29

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Handle: RePEc:eee:joepsy:v:33:y:2012:i:1:p:19-29

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Web page: http://www.elsevier.com/locate/joep

Related research

Keywords: Coarse thinking; Thinking-by-analogy; Asset pricing; Call option; Cognitive psychology;

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  1. Sendhil Mullainathan & Joshua Schwartzstein & Andrei Shleifer, 2008. "Coarse Thinking and Persuasion," The Quarterly Journal of Economics, MIT Press, vol. 123(2), pages 577-619, 05.
  2. Shefrin, Hersh & Statman, Meir, 2000. "Behavioral Portfolio Theory," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 35(02), pages 127-151, June.
  3. 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.
  4. Urs Fischbacher, 2007. "z-Tree: Zurich toolbox for ready-made economic experiments," Experimental Economics, Springer, vol. 10(2), pages 171-178, June.
  5. 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.
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Cited by:
  1. Siddiqi, Hammad, 2013. "Analogy Making, Option Prices, and Implied Volatility," MPRA Paper 48862, University Library of Munich, Germany.
  2. Siddiqi, Hammad, 2013. "Mental Accounting: A Closed-Form Alternative to the Black Scholes Model," MPRA Paper 50759, University Library of Munich, Germany.

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