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Financial Engineering and Rationality: Experimental Evidence Based on the Monty Hall Problem

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  • Brain Kluger

    ()

  • Daniel Friedman

    ()

Abstract

Financial engineering often involves redefining existing financial assets to create new financial products. This paper investigates whether financial engineering can alter the environment so that irrational agents can quickly learn to be rational. The specific environment we investigate is based on the Monty Hall problem, a well-studied choice anomaly. Our results show that, by the end of the experiment, the majority of subjects understand the Monty Hall anomaly. Average valuation of the experimental asset is very close to the expected value based on the true probabilities.

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File URL: http://www.econ-pol.unisi.it/labsi/labsi_paper/labsi7.pdf
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Bibliographic Info

Paper provided by University of Siena in its series Labsi Experimental Economics Laboratory University of Siena with number 007.

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Date of creation: Jul 2006
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Handle: RePEc:usi:labsit:007

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Keywords: experiment; behavioral finance;

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  1. Ignacio Palacios-Huerta, 2002. "Learning to Open Monty Hall's Doors," Working Papers 2002-23, Brown University, Department of Economics.
  2. Tilman Slembeck & Jean-Robert Tyran, 2002. "Do Institutions Promote Rationality? An Experimental Study of the Three-Door Anomaly," University of St. Gallen Department of Economics working paper series 2002 2002-21, Department of Economics, University of St. Gallen.
  3. Page, Scott E., 1998. "Let's make a deal," Economics Letters, Elsevier, vol. 61(2), pages 175-180, November.
  4. Brian D. Kluger & Steve B. Wyatt, 2004. "Are Judgment Errors Reflected in Market Prices and Allocations? Experimental Evidence Based on the Monty Hall Problem," Journal of Finance, American Finance Association, vol. 59(3), pages 969-998, 06.
  5. Friedman, Daniel, 1998. "Monty Hall's Three Doors: Construction and Deconstruction of a Choice Anomaly," American Economic Review, American Economic Association, vol. 88(4), pages 933-46, September.
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