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

Author

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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.

Suggested Citation

  • Brain Kluger & Daniel Friedman, 2006. "Financial Engineering and Rationality: Experimental Evidence Based on the Monty Hall Problem," Labsi Experimental Economics Laboratory University of Siena 007, University of Siena.
    • Handle: RePEc:usi:labsit:007
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    File URL: http://repec.deps.unisi.it/labsi/labsi_paper/labsi7.pdf
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    References listed on IDEAS

    as
    1. Slembeck, Tilman & Tyran, Jean-Robert, 2004. "Do institutions promote rationality?: An experimental study of the three-door anomaly," Journal of Economic Behavior & Organization, Elsevier, vol. 54(3), pages 337-350, July.
    2. 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, June.
    3. 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 933-946, September.
    4. Weber, Martin & Keppe, Hans-Jurgen & Meyer-Delius, Gabriela, 2000. "The impact of endowment framing on market prices -- an experimental analysis," Journal of Economic Behavior & Organization, Elsevier, vol. 41(2), pages 159-176, February.
    5. Ignacio Palacios-Huerta, 2003. "Learning to Open Monty Hall's Doors," Experimental Economics, Springer;Economic Science Association, vol. 6(3), pages 235-251, November.
    6. Page, Scott E., 1998. "Let's make a deal," Economics Letters, Elsevier, vol. 61(2), pages 175-180, November.
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    Cited by:

    1. Marcel Boumans, 2011. "The two-model problem in rational decision making," Rationality and Society, , vol. 23(3), pages 371-400, August.
    2. S.N. O'Higgins & Arturo Palomba & Patrizia Sbriglia, 2010. "Second Mover Advantage and Bertrand Dynamic Competition: An Experiment," Labsi Experimental Economics Laboratory University of Siena 028, University of Siena.

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    More about this item

    Keywords

    experiment; behavioral finance;

    JEL classification:

    • C90 - Mathematical and Quantitative Methods - - Design of Experiments - - - General

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