Social Economics and Risk Analysis

Risk analysis studies the likelihood and potential severity of harm created by a hazard. Research suggests that public “paranoia” about environmental risks is a product of mistrust, and that perceptions should carry weight in public policy. Application of social economic's “dual self” framework suggests that the willingness-to-pay approach to deciding whether risk reduction efforts are economical is flawed in its presumption against public values, its bias against the poor and the unborn, and its neglect of risk prevention. If comparative risk analysis can minimize rent-seeking and view environmental protection as an investment good, it may improve environmental policy.     

Rotating Savings and Credit Associations When Participants are Risk Averse*

We model rotating savings and credit associations (Roscas) among risk‐averse participants who experience privately observed income shocks. A random Rosca is not advantageous, whereas a bidding Rosca is if temporal risk aversion is less pronounced than static risk aversion. The payoff scheme of a bidding Rosca facilitates risk sharing in the presence of information asymmetries. The risk‐sharing performance of a simple arrangement where a group of homogenous individuals runs several bidding Roscas simultaneously is as good as that of a linear risk‐sharing contract, and is more enforceable because it carries a fixed rather than a variable contribution.     

Preference intensities and risk aversion in school choice: a laboratory experiment

We experimentally investigate in the laboratory prominent mechanisms that are employed in school choice programs to assign students to public schools and study how individual behavior is influenced by preference intensities and risk aversion. Our main results show that (a) the Gale–Shapley mechanism is more robust to changes in cardinal preferences than the Boston mechanism independently of whether individuals can submit a complete or only a restricted ranking of the schools and (b) subjects with a higher degree of risk aversion are more likely to play “safer” strategies under the Gale–Shapley but not under the Boston mechanism. Both results have important implications for enrollment planning and the possible protection risk averse agents seek.     

Risk Aversion and Trade‐Union Membership*

If trade unions provide only their members with insurance against income variations, as a private good, this insurance will provide a stronger incentive for more risk‐averse employees to become union members. Using data from the German Socio‐Economic Panel (SOEP) and various direct measures of individual risk attitudes, we find robust evidence of a positive relationship between risk aversion and the likelihood of union membership for full‐time employees. This association is particularly strong for males and in West Germany.     

The Private Provision of Public Goods under Uncertainty: A Symmetric-Equilibrium Approach

Various studies have examined whether increased uncertainty about the non‐Nash response of others to an individual's voluntary contribution to a public good affects that individual's contribution so as to mitigate the free‐rider problem. We extend this single‐agent approach to the analysis of a symmetric equilibrium. We provide conditions on group size and endogenous relative risk aversion that imply increased equilibrium contributions in response to greater uncertainty about the productivity of each individual's contribution to the actual level of the public good. These results enable us to broaden the circumstances in which the theory predicts that increased uncertainty reduces free riding.     

Providing global public goods under uncertainty

We study how uncertainty and risk aversion affect international agreements to supply global public goods. We consider a benchmark model with homogeneous countries and linear payoffs. When countries directly contribute to a public good, uncertainty tends to lower signatories' efforts but may increase participation. Despite risk aversion, uncertainty may improve welfare. In contrast, when countries try to reduce a global public bad, uncertainty tends to increase signatories' efforts and decrease participation. In that case, an ex-ante reduction of uncertainty may have a large positive multiplier effect on welfare.     

Employment Protection and Unemployment Benefits: On Technology Adoption and Job Creation in a Matching Model

We analyse the effects of different labour‐market policies (employment protection, unemployment benefits, and payroll taxes) on job creation and technology choices in a model where firms are matched with workers of different productivity and wages are determined by ex post bargaining. The model is characterized by two intertwined sources of inefficiency, namely a matching externality and a hold‐up externality associated with the bargaining strength of workers. The results depend on the relative importance of the two externalities and on worker risk aversion. “Flexicurity”, meaning low employment protection and generous unemployment insurance, can be optimal if workers are sufficiently risk‐averse and the hold‐up problem is relatively important.     

Career Risk

The author defines asset manager career risk as the risk that asset owners terminate an existing manager due to an extended period of underperformance relative to a benchmark or peer group even though the manager has skill (defined here as positive information ratio). The author shows that myopic loss aversion gives rise to career risk even for skilled asset managers and that the current industry practice of quarterly or annual performance evaluations puts even the most skilled asset managers at risk of undue termination. The author also investigates how a reduction of tracking error leads to a reduction of career risk even though this comes at the expense of lower long-term performance. Finally, the author computes the minimum evaluation period needed to reduce career risk for asset managers of different skill levels.     

Free riders and the optimal prize in public‐good funding lotteries

We prove the existence and uniqueness of an equilibrium in a game where players, whose preferences exhibit constant absolute risk aversion or constant relative risk aversion, contribute to a public good via lottery‐ticket purchases. Contrasting models with risk neutrality, we show that an equilibrium with a strictly positive amount of the public good may not exist without a sufficient number of participants who are not too risk‐averse. We show that players who are more risk‐averse purchase fewer lottery tickets and are more likely to free ride in equilibrium. In fact, it is possible for free riders to place a larger value on the public good than do those who contribute. In a symmetric equilibrium, we show that an upper bound exists for the amount of the public good, even though there are infinitely many participants. Furthermore, we derive a lottery prize that maximizes the amount of the public good in a symmetric equilibrium and find that such a prize always results in an overprovision of the public good.     

Economic Policy in the Face of Severe Tail Events

From time to time, something occurs which is outside the range of normal expectations. We will call these “tail events” in the sense that they are way out of the tail of a probability distribution. I consider the question of the implications of tail events for economic policy and climate‐change economics. This issue has been analyzed by Martin Weitzman who proposed a Dismal Theorem. The general idea is that, under limited conditions concerning the structure of uncertainty and risk aversion, society has an indefinitely large expected loss from high‐consequence, low‐probability events. Under such conditions, standard economic tools such as cost‐benefit analysis cannot be applied. The present study is intended to put the Dismal Theorem in context and examine the range of its relevance, with an application to catastrophic climate change. I conclude that tail events are sometimes of extreme importance, and we must be extremely careful to include them in situations of deep uncertainty. However, we conclude that no loaded gun of strong tail dominance has been uncovered to date.     

Risk aversion,impatience, and optimal timing decisions

In this paper, a theory measuring a decision maker's aversion to temporal risks is developed in the context of a simple choice framework that admits the interpretation “time varying utility of wealth.” A relation “more temporally risk averse” is defined and characterized in terms of instantaneous risk aversion (the usual single variable case) and impatience. A further characterization of this relation is obtained in the context of a class of action timing problems known as optimal stopping problems and is applied to preference based investigations of information production, incentives to innovate, and job search.     

Risk Preferences and Environmental Uncertainty: Implications for Crop Diversification Decisions in Ethiopia

To the extent that diversifying income portfolio is used as a strategy for shielding against production risk, both individual risk aversion and weather uncertainty could affect crop diversification decisions. This paper is concerned with empirically assessing the effects of risk aversion and rainfall variability on farm level diversity. Unique panel data from Ethiopia consisting of experimentally generated risk aversion measures combined with rainfall data are employed in the analysis. The major contribution of this study is its explicit treatment of individual risk preferences in the decision to diversify, simultaneously controlling for environmental risk in the form of rainfall variability. Covariate shocks from rainfall variability are found to positively contribute to an increased level of diversity with individual risk aversion having a positive but less significant role. We find that rainfall variability in spring has a greater effect than rainfall variability summer??the major rainy season. This finding is in line with similar agronomic-meteorological studies. These results imply that in situ biodiversity conservation could be effective in areas with high rainfall variability. However, reduction in risk aversion, which is associated with poverty reduction, is likely to reduce in situ conservation.     

α‐SERIAL MECHANISMS FOR THE PROVISION OF AN EXCLUDABLE PUBLIC GOOD

We present a new class of “α‐serial mechanisms” for the provision of an excludable public good. Those mechanisms have a similar structure to the serial mechanism, but may let the non‐consumers pay a positive cost. They inherit desirable properties such as anonymity, envy‐freeness, Maskin monotonicity, and population monotonicity from the serial mechanism. We calculate the “maximal efficiency loss” and “maximal manipulation” of α‐serial mechanisms and point out a trade‐off between these two properties.     

A Theory of Congregational Giving

This paper proposes a model to explain a broad range of established empirical facts about giving and attendance rates in religious congregations. We treat the religious service collectively consumed by the congregation as a “participatory” public good, in the sense that while its quality increases in contributions, individual consumption varies by the amount of time devoted toward attendance. The model predicts that lower income individuals will be overrepresented in religious congregations, with giving concentrated among higher income members. Inclusive doctrine is shown to increase membership but reduce average giving and attendance, while “tithing” requirements reduce membership and increase total giving.     

Inequality aversion and voting on redistribution

Some people have a concern for a fair distribution of incomes while others do not. Does such a concern matter for majority voting on redistribution? Fairness preferences are relevant for redistribution outcomes only if fair-minded voters are pivotal. Pivotality, in turn, depends on the structure of income classes. We experimentally study voting on redistribution between two income classes and show that the effect of inequality aversion is asymmetric. Inequality aversion is more likely to matter if the “rich” are in majority. With a “poor” majority, we find that redistribution outcomes look as if all voters were exclusively motivated by self-interest.     

Epstein–Zin Utility in DICE: Is Risk Aversion Irrelevant to Climate Policy?

Climate change involves uncertain probabilities of catastrophic risks, and very longterm consequences of current actions. Climate economics, therefore, is centrally concerned with the treatment of risk and time. Yet conventional assumptions about utility and optimal economic growth create a perverse connection between risk aversion and time preference, such that more aversion to current risks implies less concern for future outcomes, and vice versa. The same conflation of risk aversion and time preference leads to the equity premium puzzle in finance. A promising response to the equity premium puzzle, the recursive utility of Epstein and Zin, allows separation of risk aversion and time preference—at the cost of considerable analytic complexity. We introduce an accessible implementation of Epstein–Zin utility into the DICE model of climate economics, creating a hybrid “EZ-DICE” model. Using Epstein–Zin parameters from the finance literature and climate uncertainty parameters from the science literature, we find that the optimal climate policy in EZ-DICE calls for rapid abatement of carbon emissions; it is similar to standard DICE results with the discount rate set to equal the risk-free rate of return. EZ-DICE solutions are sensitive to the intertemporal elasticity of substitution, but remarkably insensitive to risk aversion. Insensitivity to risk aversion may reflect the difficulty of modeling catastrophic risks within DICE. Implicit in DICE are strong assumptions about the cost of climate stabilization and the certainty and speed of success; under these assumptions, risk aversion would in fact be unimportant. A more realistic analysis will require a subtler treatment of catastrophic climate risk.     

Variable Specific Factors and the “X-Efficiency Cost” of Protection *

This paper analyzes the effects of protection on X-efficiency using a general equilibrium Ricardo-Viner model with variable sector-specific effort. As in earlier models, it is found that protection only reduces effort if the income effect is sufficiently strong. It is also shown that, provided the correct compensated import demand curve is used, all welfare effects attributable to changes in effort are captured in the standard “triangle” measure of deadweight loss. Moreover, any protection-induced fall in effort will reduce the overall cost of protection, suggesting that policy-induced “X-inefficiency” may be beneficial.     

Risk Aversion and Sorting into Public Sector Employment

Abstract. This research note uses two German datasets – the large‐scale German Socioeconomic Panel and unique data from own student questionnaires – to analyse the relationship between risk aversion and the choice for public sector employment. Main results are (1) more risk‐averse individuals sort into public sector employment, (2) the impact of career‐specific and unemployment risk attitudes is larger than the impact of general risk attitudes and (3) risk taking is rewarded with higher wages in the private but not in the public sector.     

Democracy,Rule of Law,Corruption Incentives,and Growth

We bridge the gap between the standard theory of growth and the mostly static theory of corruption. Some public investment can be diverted from its purpose by corrupt individuals. Voters determine the level of public investment subject to an incentive constraint equalizing the returns from productive and corrupt activities. We concentrate on two exogenous institutional parameters: the “technology of corruption” is the ease with which rent‐seekers can capture a proportion of public spending. The “concentration of political power” is the extent to which rent‐seekers have more political influence than other people. One theoretical prediction is that the effects of the two institutional parameters on income growth and equilibrium corruption are different according to the constraints that are binding at equilibrium. In particular, the effect of judicial quality on growth should be stronger when political power is concentrated. We estimate a system of equations where both corruption and income growth are determined simultaneously and show that income growth is more affected by our proxies for legal and political institutions in countries where political rights and judicial institutions, respectively, are limited.