1. The Behavioral “Revolution” Rachel Croson, UTD

2. Behavioral Revolution in Psychology

3. Skinner, Pavlov, others (1930’s) Reaction to Jung, Freud, others Use behavior (elicited and observed under controlled conditions) to guide creation and and testing of models – Rather than simply self-reports or introspection Quite an innovation, and very controversial

4. More Recent Behavioral Revolutions Some examples from – Behavioral Economics – Behavioral Finance – Behavioral Operations Management – Behavioral Strategy What’s generalizable? Relationship between data and models Opportunities for Behavioral Marketing Science (modeling and data)

5. Behavioral Economics Individuals are not unboundedly rational, purely self-interested Predictable consequences for economic decisions – Bidding in auctions – Buying/selling in markets – Game Theory – Bargaining – Voluntary provision of public goods, …

6. For Example… People don’t play equilibrium (field, lab) Model of bounded rationality (level-n) – Relaxing perfect rationality – Homogeneous – Heterogeneous Games where this relaxation matters and does not matter Explain previous data / predict out-of-sample Stahl and Haruvy (2006). Level-n Bounded Rationality and Dominated Strategies in Normal Form Games

7. Behavioral Finance Individuals are not unboundedly rational, purely self-interested Predictable consequences for financial decisions – Stock market activity (individual, aggregate) – Corporate finance (e.g. M&A activities) – Retirement savings – Housing choices, …

8. For Example… Bubbles in Financial Markets – Plus other evidence against rational market hypothesis Model of feedback traders + “smart money” – Expected price is weighted average of previous prices (momentum traders) Representative heuristic + attribution bias – Know fundamentals + feedback traders (level n+1) Model generates bubbles, low autocorrelation Shiller (1990). Speculative Prices and Popular Models.

9. Behavioral Operations Management Individuals are not unboundedly rational, purely self-interested Predictable consequences for operational decisions – Inventory/ordering – Supply chain coordination – Optimal search – Service operations… 2008 Special Issue on Behavioral and Experimental Operations Management, MSOM 4th Annual Conference on Behavioral Operations Management

10. For Example… Excess inventory in low-profit markets, insufficient inventory in high-profit markets (experimental, observational) Model of overconfident newsvendor – Biased beliefs of the distribution of demand (underestimate variance) Resulting orders consistent with observations Construct de-biasing technique – Buyback contracts (salvage value), … Experimentally tested Croson, Croson and Ren (2008): How to Manage an Overconfident Newsvendor

11. Behavioral Strategy Individuals are not unboundedly rational, purely self-interested Predictable consequences for strategic decisions – Market entry and exit – New product introduction – Technology adoption – Horizontal and vertical differentiation, … Overlap with behavioral and experimental Industrial Organization

12. For Example… Entrepreneurs not only enter too often (Camerer and Lovallo 1999), but fail to exit – Many possible reasons (principal-agent problems, barriers to exit, …) – Psychological bias: escalation of commitment Observational and experimental data shows high sunk costs impedes exit – Effect is moderated (disappears) with specific and explicit goals Khavul, Markoczy, Croson and Yitshaki (2008). The Moderating Effect of Goal Specificity on Escalation of Commitment in Entrepreneurial Firm Exit

13. What’s Generalizable? Good behavioral research… – Is well motivated (recognized anomaly from data) – Is well grounded >50 papers in top journals demonstrating regularity Regularity is robust (multiple populations, settings,…) – Doesn’t assume the conclusion – Is parsimonious Smallest possible deviation Minimum parameters (seven camel)

14. Rachel’s PPF of Science

15. Relationship Between Models and Data Data motivates models – Anomalies Data suggests modeling directions – Behavioral regularities Data tests models – Comparative statics or estimating parameters (observational) – Point predictions, strategies (structural models), comparing competing models (experimental)

16. Dialectic Creates Scientific Progress…

17. Opportunities for Behavioral Marketing Science Careful models incorporating psychological regularities (bounded rationality, other-regarding preferences, …) can improve explanatory and predictive ability Opportunities for testing new models with existing and new data Many papers in Marketing Science already do this – Almadoss and Jain’s paper today good example Integrates behavioral regularity of status-seeking, derives and tests new predictions

18. Question Assumptions