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Economic Engineering of Cooperation in Modern Markets

Periodic Reporting for period 2 - EEC (Economic Engineering of Cooperation in Modern Markets)

Reporting period: 2019-09-01 to 2021-02-28

Economic engineering is the science of designing real-world institutions and mechanisms that align individual incentives and behavior with the underlying goals. Cooperation represents one such goal and is essential for the functioning of societies, economies and organizations. Yet, people often fail to contribute to the greater good. With inadequate institutions and without mechanisms to promote cooperation, the outcome can be bleak or even catastrophic (Ostrom, Elinor. 1990. “Governing the Commons: The Evolution of Institutions for Collective Action.” Cambridge University Press.). This project will generate important knowledge to improve the functioning of modern markets and organizations, and at the same time open new horizons in the sciences of cooperation and “behavioral economic engineering”.

One work package studies the design of mechanisms in specific markets. For example, market design can help to avoid a wasteful arms race for speed in real-time financial markets. The fastest traders in modern real-time markets rely on algorithmic “sniping” strategies, even though these strategies can be collectively wasteful and threaten market liquidity and stability. We plan to explore the robustness of alternative market designs that fix such problems, under both calm, and stressful market conditions in laboratory experiments.

The other work package studies the descriptive nature of ethical and related constraints to market and organizational design. For instance, people sometimes have a distaste for certain types of modern transactions, such as organ exchanges and the purchase of pollution rights in climate markets. We build models that capture such behaviors and make use of incentivized laboratory and field experiments to examine the underlying motivational and cognitive mechanisms empirically. Furthermore, we investigate the design features in markets and organizations that alleviate such constraints.
Based on new theoretical insights and empirical testing, we developed and piloted financial market experiment software, which we plan to use for running laboratory experiments that study real-time financial market transactions under different market rules, designed to eliminate sniping and improve market efficiency and stability.

We provide new and exciting descriptive evidence on the nature of ethical and related constraints to market and organizational design. Among several other phenomena, we show that a distaste for certain types of economic transactions can be best explained by a “projective paternalism” motive; we find that higher monetary incentives attract less informed subjects to participate in risky transactions and thus leads to more ex post regret (which highlights a conflict between incentive payments and the principles of informed consent); and our experiments suggest that monetary incentives can be perceived as a threat to autonomy.
Based on the theoretical and empirical insights so far, and utilizing our newly developed experimental software, we plan to study sniping under alternative financial market designs and under various stress tests. Eventually, we hope that this will lead to important insights on how high frequency trading can be disciplined.

Building on our research successes regarding ethical and related constraints we plan to expand this research in line with our research objectives. In particular, we are planning experiments in the laboratory and in the field, and with practitioners, in order to study the robustness and external validity of our behavioral economic findings across various important contexts. We also plan to extend our theoretical modeling of human motives related to repugnancy.

Similarly, since behavioral economic engineering is a research field that is constantly evolving in response to new challenges and exciting opportunities in research and society, we are further developing and refining our hypotheses and agenda. We are applying our results on engineering cooperation to “market design that saves lives” as a response to the scarcity of medical equipment and vaccines caused by the Covid-19 pandemic; to “improving cooperation and eliminating traffic congestion through transport markets” prompted by the fact that cities and the environment increasingly suffer from a lack of cooperation when making traffic decisions; and to “economic engineering of cooperation” in organizations. We hope that our economic engineering approach to promote cooperation will contribute to solving such important cooperation challenges of modern societies.