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Investment Under Uncertainty: Testing the Options Model with Professional Traders

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  • John A. List

    (University of Chicago and NBER)

  • Michael S. Haigh

    (Commodities Future Trading and Commission)

Abstract

An important class of investment decisions is characterized by unrecoverable sunk costs, resolution of uncertainty through time, and the ability to invest in the future as an alternative to investing today. The options model provides guidance in such settings, including an investment decision rule called the bad news principle: the downside investment state influences the investment decision, whereas the upside investment state is ignored. This study takes a new approach to examining predictions of the options model by using the tools of experimental economics. Our evidence, drawn from student and professional trader subject pools, is broadly consonant with the options model. (c) 2010 The President and Fellows of Harvard College and the Massachusetts Institute of Technology.

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Bibliographic Info

Article provided by MIT Press in its journal The Review of Economics and Statistics.

Volume (Year): 92 (2010)
Issue (Month): 4 (November)
Pages: 974-984

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Handle: RePEc:tpr:restat:v:92:y:2010:i:4:p:974-984

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  1. Robert E. Lucas & Jr., 1967. "Adjustment Costs and the Theory of Supply," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 75, pages 321.
  2. Gneezy, U. & Potters, J.J.M., 1997. "An experiment on risk taking and evaluation periods," Open Access publications from Tilburg University, Tilburg University urn:nbn:nl:ui:12-73908, Tilburg University.
  3. John A. List, 2003. "Neoclassical Theory Versus Prospect Theory: Evidence from the Marketplace," NBER Working Papers 9736, National Bureau of Economic Research, Inc.
  4. Haigh, Michael S. & List, John A., 2002. "Do Professional Traders Exhibit Myopic Loss Aversion? An Experimental Analysis," Working Papers, University of Maryland, Department of Agricultural and Resource Economics 28554, University of Maryland, Department of Agricultural and Resource Economics.
  5. John A. List, 2006. "Using Hicksian Surplus Measures to Examine Consistency of Individual Preferences: Evidence from a Field Experiment," Scandinavian Journal of Economics, Wiley Blackwell, Wiley Blackwell, vol. 108(1), pages 115-134, 03.
  6. Locke, Peter R. & Mann, Steven C., 2005. "Professional trader discipline and trade disposition," Journal of Financial Economics, Elsevier, Elsevier, vol. 76(2), pages 401-444, May.
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Cited by:
  1. Ryan Kellogg, 2010. "The Effect of Uncertainty on Investment: Evidence from Texas Oil Drilling," NBER Working Papers 16541, National Bureau of Economic Research, Inc.
  2. Gong, Binglin & Lei, Vivian & Pan, Deng, 2013. "Before and after: The impact of a real bubble crash on investors’ trading behavior in the lab," Journal of Economic Behavior & Organization, Elsevier, Elsevier, vol. 95(C), pages 186-196.
  3. Al-Ubaydli, Omar & Boettke, Peter, 2010. "Markets as economizers of information: Field experimental examination of the “Hayek Hypothesis”," MPRA Paper 27660, University Library of Munich, Germany.
  4. Pütz, Alexander & Ruenzi, Stefan, 2010. "Overconfidence among professional investors: Evidence from mutual fund managers," CFR Working Papers, University of Cologne, Centre for Financial Research (CFR) 08-08 [rev.], University of Cologne, Centre for Financial Research (CFR).
  5. Fahr, René & Janssen, Elmar & Sureth, Caren, 2014. "Can tax rate increases foster investment under entry and exit flexibility? Insights from an economic experiment," arqus Discussion Papers in Quantitative Tax Research, arqus - Arbeitskreis Quantitative Steuerlehre 166, arqus - Arbeitskreis Quantitative Steuerlehre.

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