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Feasibility Study: Biases and Cognitive Failures in Markets

NOMIS Project 2020

— 2022

Markets aggregate individual economic behavior and determine economic outcomes. Analytical results in microeconomics show how frictionless markets lead to efficiency, but those results rest on a number of assumptions. Chief among them is that economic agents are fully rational and capable of taking into account all relevant information. This assumption runs counter to overwhelming evidence from behavioral economics, social and cognitive psychology, and neuroeconomics, showing that humans are clearly not fully rational, all-knowing optimizers.

However, does this matter for economic outcomes in markets? Surprisingly, this basic question has not been answered convincingly. It has been argued that irrational behavior should be wiped out in markets, as more rational agents will take advantage of less rational ones and ultimately seize their assets. This conclusion is markedly different from those of modern branches of economics that fully embrace the cognitive limitations of economic agents in trying to explain irregularities in markets. From an empirical point of view, the question has proven to be staggeringly difficult to analyze, because identifying individual biases in markets is usually impossible due to the complexity of information available to agents, while market experiments within a controlled laboratory environment are usually statistically underpowered for cost reasons, as in those experiments an observation is a market with possibly many participants. More importantly, even in a controlled, large-market experiment, it has until now not been possible to causally manipulate the reliance on heuristics and biases.

The Biases and Cognitive Failures in Markets project served a feasibility study for a latter, more extensive phase and sought to overcome these problems by causally manipulating the reliance on biases and heuristics within medium-sized markets in the behavioral laboratory employing transcranial direct current stimulation (tDCS), a technique that allows us to enhance or impair neuronal excitability and hence influence brain cognitive functions in selected market participants. The aim was to provide a definitive answer to the question of whether individual decision biases affect collective market outcomes, thereby closing the gap between the study of individual behavioral biases in economic behavior and the study of aggregate market outcomes and their effects on society.

The project was led by Carlos Alós-Ferrer and Christian Ruff at the University of Zurich (Switzerland).


NOMIS Researcher(s)

Full professor of neuroeconomics and decision neuroscience
University of Zurich