Luís Santos-Pinto Home




Curriculum Vitae





   My main area of research is applied microeconomic theory. I investigate the links between information, cognition, judgment, and economic behavior. I study the implications of behavioral biases like overconfidence and optimism in terms of individual decision making, the design of incentives in organizations, market outcomes, and welfare. I use laboratory and field experiments to study the existence and consequences of these biases for economic decisions.
  My most significant contributions to this literature are as follows. Santos-Pinto and Sobel (2005) describes a mechanism which explains how people become overconfident. Santos-Pinto (2008) analyzes the impact of worker overconfidence on employment relationships using the principal-agent model of moral hazard. I show how a principal can take advantage of an agent's mistaken beliefs about own ability and that workers' mistaken beliefs about their coworkers abilities make interdependent incentive schemes more attractive to firms than individualistic ones. Santos-Pinto (2010) shows how firms can design bonuses and promotion incentive schemes to benefit from worker overconfidence and that moderate levels of worker overconfidence can improve welfare. Santos-Pinto (2012) shows that worker overconfidence can explain wage compression and that gender differences in confidence can contribute to the gender pay gap. Santos-Pinto and Dell'Era (2017) analyze the impact of entrepreneurial optimism on the market for new issues. We find that optimism generates a new reason for entrepreneurs to own equity in their firms and is a natural explanation for why some new issues are underpriced while others are overpriced.
     My work can be grouped into two main axes of research. The first axis focuses on the impact of overconfidence and optimism on individual decisions, incentives in organizations, market outcomes, and welfare. I generalize theoretical models by assuming that some agents are rational, some are overconfident or optimist. I derive equilibrium predictions of these models and generate testable implications.
    The second axis of my research uses experimental methods to study risk attitudes, their interaction with self-confidence and strategic decisions. I am particularly interested in understanding how individuals react to skewed payoff distributions, that is, situations where there is a small probability of a large gain (e.g. gambling in public lotteries, entry into entrepreneurship, market entry) or a small probability of a large loss (e.g., insurance). I am also interested in understanding how beliefs about skill affect risky decisions like career choices, market entry, and
financial investments.




How Do Beliefs about Skill Affect Risky Decisions?                                                 (with Adrian Bruhin and David Staubli)
Journal of Economic Behavior and Organization, forthcoming.  Download

Beliefs about skill matter for risky decisions such as market entry, career choices, and financial investments. Yet in most laboratory experiments risk is exogenously given and beliefs about skill play no role. We use a laboratory experiment without strategy confounds to isolate the impact of beliefs about skill on risky choices. We find that low (high) skill individuals are more (less) willing to take risks on gambles where the probabilities depend on skill than on gambles with exogenously given probabilities.This happens because low (high) skill individuals overestimate (underestimate) their relative skill. Consequently, the wrong people may engage in risky activities while the right people may be crowded out. JEL Codes: C91; D81. Keywords: Individual Risk Taking Behavior; Self-Confidence; Laboratory Experiment.

Home Bias in Multimarket Cournot Games
(with Catherine Roux and Christian Thoni) 
European Economic Review
, forthcoming. Download

We explore the role of trade costs for the home bias in trade. In a series of Cournot duopoly experiments with a home and an export market, we compare output choices when fims face different levels of trade costs. We find that there is two-way trade in identical products and that firms hold the majority market share in their home market. The resulting home bias turns out to be, however, stronger than that predicted by theory, and it even occurs without trade costs. Tacit collusion contributes to the home bias observed in our experiment but does not offer a full explanation for the phenomenon. JEL Codes: F12, L13, C91. Keywords: Intra-Industry Trade; Spatial Oligopoly; Home Bias; Collusion; Experiment.

Entrepreneurial Optimism and the Market for New Issues
(with Michele Dell'Era)
International Economic Review, 2017, Vol. 58, No. 2, 383-419. Download 

This paper analyzes the impact of entrepreneurial optimism on the market for new issues. We find that the existence of optimists generates a new reason for entrepreneurs to own equity in their firms. We show that optimism is a natural explanation for why some new issues are underpriced and others overpriced. We also show that the impact of optimism on entrepreneurs’ equity holdings depends on the number of optimists, absolute risk aversion, and cash flow variance. Optimism makes entrepreneurs worse off. In contrast, optimism can make outside investors better off when entrepreneurs signal firm value by retaining shares and underpricing. JEL Codes: D82; G11; G14; G32; Keywords: Optimism; Signaling; Equity Market; Underpricing; Overpricing.


Detecting Heterogeneous Risk Attitudes with Mixed Gambles 
Adrian Bruhin, José Mata, and Thomas Astebro)
Theory and Decision2015, Vol. 79, Issue 4, 573-600.  Download  

We propose a task for eliciting attitudes towards risk that is close to real world risky decisions which typically involve gains and losses. The task consists of accepting or rejecting gambles that provide a gain with probability p and a loss with probability 1-p. We employ finite mixture models to uncover heterogeneity in risk preferences and find that (i) behavior is heterogeneous, with one half of the individuals behaving as expected utility maximizers, (ii) for the others, reference-dependent models perform better than those where subjects derive utility from final outcomes, (iii) models with sign dependent decision weights perform better than those without, and (iv) there is no evidence for loss aversion. The procedure is sufficiently simple so that it can be easily used in field or lab experiments where risk elicitation is not the main experiment.  JEL Codes: D81, C91; Keywords: Individual Risk Taking Behavior; Latent Heterogeneity; Finite Mixture Models; Reference-dependence; Loss Aversion.

Skewness Seeking: Risk Loving, Optimism or Overweighting of Small Probabilities?
(with Thomas Astebro and José Mata)  
Theory and Decision, 2015, Vol. 78, Issue 2, 189-208. Download   Appendix

In a controlled laboratory experiment we use one sample of college students and one of mature executives to investigate how positive skew influences risky choices. In reduced-form regressions we find that both students and executives make riskier choices when lotteries display positive skew. We estimate decision models to explore three explanations for skew seeking choices: risk-loving (convex utility), optimism (concave probability weighting), and likelihood insensitivity (inverse s-shape probability weighting). We find no role for love for risk as neither students nor executives have convex utility. Both optimism and likelihood insensitivity play a part in skew seeking choices. Likelihood insensitivity is larger for students than for executives. Executives have more concave utility and are more optimistic than students,but this is found to be largely due to them being older.  JEL Codes: D81, C91; Keywords: Decision Making under Risk, Skew, Laboratory Experiment.


A Cognitive Hierarchy Model of Behavior in the Action Commitment Game 
(with Daniel Carvalho) 
International Journal of Game Theory,
 2014, Vol. 43, Issue 3, 551-577. Download

We apply the cognitive hierarchy model of Camerer, Ho and Chong (2004)—where players have different levels of reasoning—to Huck, Müller and Normann’s (2002) discrete version of Hamilton and Slutsky’s (1990) action commitment game—a duopoly with endogenous timing of entry. We show that, for empirically reasonable average number of thinking steps, the model rules out Stackelberg equilibria, generates Cournot outcomes including delay, and outcomes where the first mover commits to a quantity higher than Cournot but lower than Stackelberg leader. We show that a cognitive hierarchy model with quantal responses can explain the most important features of the experimental data on the action commitment game in Huck, Müller and Normann (2002). In order to gauge the success of cognitive hierarchy model in fitting the data, we compare it to a noisy Nash model. We find that the cognitive hierarchy model with quantal responses fits the data better than the noisy Nash model. JEL Codes: C72, D43, L13; Keywords: Endogenous Timing Games; Thinking Steps; Cognitive Hierarchy.

Experimental Cournot Oligopoly and Inequity Aversion 
(with Doruk Iris) 
Theory and Decision2014, Vol. 76, Issue 1, 31-45. Download  

This paper explores the role of inequity aversion as an explanation for observed behavior in experimental Cournot oligopolies. We show that inequity aversion can change the nature of the strategic interaction: quantities are strategic substitutes for sufficiently asymmetric output levels but strategic complements otherwise. We find that inequity aversion can explain why: (i) some experiments result in higher than Cournot-Nash production levels while others result in lower, (ii) collusion often occurs with only two players whereas with three or more players market outcomes are very close to Cournot-Nash, and (iii) players often achieve equal profits in asymmetric Cournot oligopoly. JEL Codes: D43, D63, L13, L21. Keywords: Inequity Aversion; Cournot Oligopoly; Experiments.


Tacit Collusion under Fairness and Reciprocity 
(with Doruk Iris)
, 2013, 4, 50-65. Download

This paper departs from the standard profit-maximizing model of firm behavior by assuming that firms are motivated in part by personal animosity—or respect—towards their competitiors. A reciprocal firm responds to unkind behavior of rivals with unkind actions (negative reciprocity), while at the same time, it responds to kind behavior of rivals with kind actions (positive reciprocity). We find that collusion is easier to sustain when firms have a concern for reciprocity towards competing firms provided that they consider collusive prices to be kind and punishment prices to be unkind. Thus, reciprocity concerns among firms can have adverse welfare consequences for consumers. JEL Codes: D43, D63, L13, L21; Keywords: Fairness; Reciprocity; Collusion; Repeated Games.


Labor Market Signaling and Self-Confidence: Wage Compression and the Gender Pay Gap
Journal of Labor Economics, 2012, Vol. 30, No. 4, 873-914.

I extend Spence’s (1973) signaling model by assuming some workers are overconfident—they underestimate their marginal cost of acquiring education—and some are underconfident. Firms cannot observe workers’ productive abilities and beliefs but know the fractions of high-ability, overconfident, and underconfident workers. I find that biased beliefs lower the wage spread and compress the wages of unbiased workers. I show that gender differences in self-confidence can contribute to the gender pay gap. If education raises productivity, men are overconfident, and women underconfident, then women will, on average, earn less than men. Finally, I show that biased beliefs can improve welfare. JEL Codes: D03; D82; J24; J31. Keywords: Signaling; Education; Self-Confidence; Wage Compression; Gender Pay Gap.


Positive Self-Image in Tournaments
International Economic Review, 2010, Vol. 51, No. 2, 475-496. Download

This paper analyzes the implications of worker overestimation of productivity for firms in which incentives take the form of tournaments. Each worker overestimates his productivity but is aware of the bias in his opponent’s self-assessment. The manager of the firm, on the other hand, correctly assesses workers’ productivities and self-beliefs when setting tournament prizes. The paper shows that, under a variety of circumstances, firms can benefit from worker positive self-image. The paper also shows that worker positive self-image can improve welfare in tournaments.In contrast, workers’ utility declines due to their own misguided choices. JEL Codes: A12, J41; Keywords: Positive Self-image, Tournaments, Behavioral economics.


Overconfidence in Tournaments: Evidence from the Field
(with Young-Joon Park)
Theory and Decision, 2010, Vol. 69, 143-166. Download

This paper uses a field survey to investigate the quality of individuals’ beliefs of relative performance in tournaments. We consider two field settings, poker and chess, which differ in the degree to which luck is a factor and also in the information that players have about the ability of the competition. We find that poker players’ forecasts of relative performance are random guesses with an overestimation bias. Chess players also overestimate their relative performance but make informed guesses. We find support for the “unskilled and unaware hypothesis” in chess: high skilled chess players make better forecasts than low skilled chess players. Finally, we find that chess players’ forecasts of relativeperformance are not efficient.  JEL Codes: A12, C93, J41; Keywords: Tournaments; Rationality; Learning; Field Experiment.


The Impact of Firm Cost and Market Size Asymmetries on National Mergers in a Three-Country Model
International Journal of Industrial Organization, 2010, Vol. 28, 682-694. 

This paper studies the impact of firm cost and market size asymmetries on merger decisions. I consider a model where a small and a large country compete in a third (world) market. Each of the two countries has two firms (with potentially different costs) that supply the domestic market and export to the third market. Merger decisions in the two countries are modeled as a simultaneously move game. The paper finds that firms in the large country have more incentives to merge than firms in the small country. In contrast, the government of the large country has more incentives to block a merger than the government of the small country. Thus, the model predicts that conflicts of interest between governments and firms concerning national mergers are more likely in large countries than in small ones. JEL Codes: F13, H77,L11, L41. Keywords: Mergers; International Trade; Merger Policy; Size Asymmetry.


Asymmetries in Information Processing in a Decision Theory Framework
Theory and Decision, 2009, Vol. 66, 317-343. Download

Research in psychology suggests that some individuals are more sensitive to positive than to negative information while others are more sensitive to negative rather than positive information. I take these cognitive positive-negative asymmetries in information processing to a Bayesian decision-theory model and explore its consequences in terms of decisions and payoffs. I show that in monotone decision problems economic agents with more positive-responsive information structures are always better off, ex-ante, when they face problems where payoffs are relatively more sensitive to the action chosen when the state of nature is favorable. JEL Codes: A12, D81. Keywords: Information Processing; Decision Theory.

Positive Self-Image and Incentives in Organizations
Economic Journal, 2008, Vol. 118, 1315-1332. Download

This paper investigates the implications of individuals' mistaken beliefs of their abilities on incentives in organizations using the principal-agent model of moral hazard. The paper shows that if effort is observable, then an agent's mistaken beliefs about own ability are always favorable to the principal. However, if effort is unobservable, then an agent's mistaken beliefs about own ability can be either favorable or unfavorable to the principal. The paper provides conditions under which an agent's over estimation about own ability is favorable to the principal when effort is unobservable. Finally, the paper shows that workers' mistaken beliefs about their coworkers' abilities make interdependent incentive schemes more attractive to firms than individualistic incentive schemes. JEL Codes: A12; J41. Keywords: Self-Image; Optimism; Incentives, Behavioral Economics.

Making Sense of the Experimental Evidence on Endogenous Timing in Duopoly Markets
Journal of Economic Behavior and Organization, 2008, Vol. 68, 657-666. Download

The prediction of asymmetric equilibria with Stackelberg outcomes is clearly the most frequent result in the endogenous timing literature. Several experiments have tried to validate this prediction empirically, but failed to find support for it. By contrast, the experiments find that simultaneous-move outcomes are modal and that behavior in endogenous timing games is quite heterogeneous. This paper generalizes Hamilton and Slutsky's (1990) endogenous timing games by assuming that players are averse to inequality in payoffs. I explore the theoretical implications of inequity aversion and compare them to the empirical evidence. I find that this explanation is able to organize most of the experimental evidence on endogenous timing games. However, inequity aversion is not able to explain delay in Hamilton and Slutsky's endogenous timing games. JEL Codes: C72, D43, D63, L13. Keywords: Endogenous Timing; Cournot; Stackelberg; Inequity Aversion.

A Model of Positive Self-Image in Subjective Assessments
(with Joel Sobel)
American Economic Review, 2005, Vol. 95, No. 5, 1386-1402.  

This paper suggests a mechanism that describes individuals' positive self image in subjective assessments of their relative abilities. The mechanism assumes individuals have heterogeneous production functions that determine ability as a function of multiple skills, individuals make skill-enhancing investments with the goal of maximizing their ability, and make ability comparisons using their own production function. Within this framework, the paper provides conditions under which there is positive self image. Positive self image is increasing in the ease of the task, the number of different skills needed for the task, and the variability of production technologies in the population. JEL Codes: A12, D01; Keywords: Self-image; Behavioral economics; Psychology.



Subjective Performance Evaluation of Employees with Biased Beliefs
(with Matteo Foschi)
This version: May 2018. Download

We analyze how optimism and overconfidence affect subjective performance evaluation (SPE) contracts. An optimistic worker overestimates the probability of observing an acceptable SPE given the realization of the principal's SPE. An overconfident worker believes his SPE signal is more informative about the outcome of the project than it actually is. The manager of the firm is better informed about performance than the worker and knows the worker's bias. We show that both optimism and overconfidence: i) change the optimal incentive scheme under SPE, ii) may lower the deadweight loss associated with SPE contracts, and iii) can lead to a Pareto improvement. JEL Codes: D82, D84, D86, J41, J7; Keywords: Optimism, Overconfidence, Contract, Effort, Moral Hazard, Biased Beliefs, Mechanism Design.


A General Equilibrium Theory of Occupational Choice under Optimistic Expectations  (with Michele Dell'Era and Luca Opromolla)
This version: June 2018.  Download

This paper studies the impact of optimism on occupational choice using a general equilibrium framework. The model shows that optimism has four main qualitative effects: it leads to a misallocation of talent, drives up input prices, raises the number of entrepreneurs, and makes entrepreneurs worse off. We calibrate the model to match U.S. manufacturing data. This allows us to make quantitative predictions regarding the impact of optimism on occupational choice, input prices, the returns to entrepreneurship, and output. The calibration shows that optimism can explain the empirical puzzle of the low mean returns to entrepreneurship compared to average wages. JEL Codes: D50; H21; J24; L26. Keywords: General Equilibrium; Occupational Choice; Entrepreneurship; Optimism.




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