Working Paper: NBER ID: w16038
Authors: John A. List; Michael S. Haigh
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, which is drawn from student and professional trader subject pools, is broadly consonant with the options model.
Keywords: investment; uncertainty; options model; bad news principle; experimental economics
JEL Codes: C9; C93; D01
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| high payoff state (h) (I26) | investment decisions (G11) |
| students (Y40) | sensitivity to high payoff changes (D91) |
| professional traders (G13) | sensitivity to payoff states (D81) |
| investment decisions (G11) | downside risk (D81) |
| low payoff state (l) (H79) | investment decisions (G11) |
| bad news principle (BNP) (D80) | investment behavior (G11) |