Friedman Receives National Science Foundation Grant

May 01, 2014

Daniel Friedman receives a grant from the National Science Foundation for his project, entitled "Collaborative Research: Preferences and Equilibrium in Laboratory Financial Markets."

Below is the abstract of the project:

General Equilibrium (GE) theory is the mathematical framework that economists use to understand how markets generate prices and distribute resources within a society. However, GE is impossible to directly test in the field because a primary input, the preferences of individuals, is private information not known to outside analysts. Working in the laboratory over several decades, some economists have instead tested aspects of GE theory by inducing artificial preferences. In parallel, another group of economists has studied how to measure the actual preferences of individuals, using a different body of theory called “Revealed Preferences” that infers individual preferences from choices made in the face of varying prices and income levels.

Remarkably, these two poles of economic research have never been brought together empirically and studied jointly: economists have not systematically investigated whether revealed preferences lead to the market outcomes predicted under GE. Our research will begin to fill this gap through a series of new experiments. This research will give us new insight into the predictive power of GE theory and a new, deeper insight into the functioning of interconnected markets, especially financial markets.

Our first project begins with a slight variation on a prominent revealed preference approach to portfolio choice. Subsequent projects incrementally transform simple preference elicitation into state-of-the-art market trading institutions. Individual decision-making tasks are gradually transformed into full-blown interactive markets, but the mechanics of making choices remains nearly identical throughout, allowing us to reliably compare behavior across settings. A suite of new software tools, called Edgeworks, will implement the entire sequence in a unified visual framework. This research will give insight into the efficiency and stability of interdependent (multi-good) markets, especially important aspects of financial markets. It will also help reveal the robustness of elicited preferences in the face of market experience, including recently controversial aspects such as small stakes risk aversion and reference dependence.
This is Dan's 14th National Science Foundation grant, but none that he has ever been more excited about, nor worked harder to get! Congratulations, Dan!