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on Utility Models and Prospect Theory |
| By: | Olaf Posch (Aarhus University, School of Economics and Management and CREATES) |
| Abstract: | This paper shows that non-linearities can generate time-varying and asymmetric risk premia over the business cycle. These (empirical) key features become relevant and asset market implications improve substantially when we allow for non-normalities in the form of rare disasters. We employ explicit solutions of dynamic stochastic general equilibrium models, including a novel solution with endogenous labor supply, to obtain closed-form expressions for the risk premium in production economies. We find that the curvature of the policy functions affects the risk premium through controlling the individual's effective risk aversion. |
| Keywords: | Risk premium, Continuous-time DSGE, Optimal stochastic control |
| JEL: | E21 G11 O41 |
| Date: | 2009–11–01 |
| URL: | http://d.repec.org/n?u=RePEc:aah:create:2009-58&r=upt |
| By: | Arvind Krishnamurthy |
| Abstract: | This article explains how debt markets have malfunctioned in the crisis, with deleterious consequences for the real economy. I begin with a quick overview of debt markets. I then discuss three areas that are crucial in all debt markets decisions: risk capital and risk aversion, repo financing and haircuts, and counterparty risk. In each of these areas, feedback effects can arise, so that less liquidity and a higher cost for finance can reinforce each other in a contagious spiral. I document the remarkable rise in the premium that investors placed on liquidity during the crisis. Next, I show how these issues caused debt markets to break down: fundamental values and market values seemed to diverge across several markets and products that were far removed from the “toxic” subprime mortgage assets at the root of the crisis. Finally, I discuss briefly four steps that the Federal Reserve took to ease the crisis, and how each was geared to a specific systemic fault that arose during the crisis. |
| JEL: | E43 E44 E52 |
| Date: | 2009–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:15542&r=upt |
| By: | Da Silva, Sergio; Baldo, Dinorá; Matsushita, Raul |
| Abstract: | We conducted a questionnaire study with student subjects to look for explicit correlations between selected biological characteristics of the subjects and manifestation of the Allais paradox in the pattern of their choices between sets of two pairs of risky prospects. We find that particular bio-characteristics, such as gender, menstrual cycle, mother’s age, parenthood, digit ratio, perceived negative life events, and emotional state, can be related to the paradox. Women, in particular if not menstruating, are less susceptible to the paradox. Those born to not-too-young mothers are also less prone to the paradox. The same holds true for those who father children, those with high prenatal testosterone exposure, who have reported many negative life events, and those who were anxious, excited, aroused, happy, active, and fresh at the time of the experiment. Further, left-handers and atheists may be less inclined to exhibit the paradox. |
| Keywords: | Allais paradox; choice under risk; biological characteristics |
| JEL: | D81 C91 |
| Date: | 2009–11–30 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:18938&r=upt |
| By: | Edmans, Alex; Gabaix, Xavier |
| Abstract: | This paper identifies a class of multiperiod agency problems in which the optimal contract is tractable (attainable in closed form). By modeling the noise before the action in each period, we force the contract to provide sufficient incentives state-by-state, rather than merely on average. This tightly constrains the set of admissible contracts and allows for a simple solution to the contracting problem. Our results continue to hold in continuous time, where noise and actions are simultaneous. We thus extend the tractable contracts of Holmstrom and Milgrom (1987) to settings that do not require exponential utility, a pecuniary cost of effort, Gaussian noise or continuous time. The contract's functional form is independent of the noise distribution. Moreover, if the cost of effort is pecuniary (multiplicative), the contract is linear (log-linear) in output and its slope is independent of the noise distribution, utility function and reservation utility. In a two-stage contracting game, the optimal target action depends on the costs and benefits of the environment, but is independent of the noise realization. |
| Keywords: | closed forms; contract theory; dispersive order; executive compensation; incentives; principal-agent problem; subderivative |
| JEL: | D2 D3 G34 J3 |
| Date: | 2009–11 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7578&r=upt |