Prudence, Demand Uncertainty, Background Risk, and the Law of Supply: A Nonexpected Utility Approach to the Firm

We identify two motives, prudence and risk aversion, which give rise to precautionary behavior for a quantity- or price-setting monopolist facing demand uncertainty who has dual theoretic preferences. We also analyze a piecewise linear profit function due to a tax on profits that varies with the profit level. We show that the comparative statics of greater risk (mean-preserving spread and mean-utility preserving spread) can be totally or partially determined by the Diamond-Stiglitz and Kihlstrom-Mirman single-crossing property. For example, for a prudent risk-averse quantity-setting dual theoretic monopolist, a mean-preserving spread will have the same impact on output under uncertainty as a fall in the state of demand under certainty. Finally, we find that, in contrast to expected utility, a stochastically larger state of demand (first-order stochastic dominance) will raise output even if background risk is present.     

Multivariate risk aversion and uninsurable risks: Theory and applications

The objective of this paper is to develop conditions for global multivariate comparative risk aversion in the presence of uninsurable, or background, risks, and thus generalize Kihlstrom and Mirman [1974] and Karni [1979,1989]. We analyze von Neumann-Morgenstern (VNM) utility functionsas well as smooth preference functionals which are nonlinear in distribution but locally linear in probabilities. In each case we provide an economic application which illustrates how our theorems can be used. We analyze a risk sharing, a portfolio choice, and a labor supply problem for VNM utility functions, and the optimal allocation of effort to risky technologies in the presence of a random supply (or quality) of a public good for nonlinear preference functionals. We consider thecase where the random variables are mean-independent as well as the case where they are independent. In the labor supply application for VNM utility functions, we show that if the two risks are independent, the comparative statics effect of greater risk aversion on labor supply in the presence of a background non-wage income risk is determined by a monotonic relationship between labor supply and the wage rate under certainty. That is, we extend the applicability of the Diamond-Stiglitz [1974]-Kihlstrom-Mirman [1974]single-crossing property to the case where an independent background risk is present.     

Discussion of “biases in multi-year management financial forecasts: Evidence from private venture-backed U.S. companies”

Armstrong, Dávila, Foster, and Hand (“ADFH”) use a proprietary venture capital database of revenue and profit projections submitted by young firms seeking financing to attempt to address a number of questions related to forecasts by managers of early stage, venture-backed, private entrepreneurial firms. The proprietary dataset together with the creative use of a “historically-grounded conditional projections” methodology are the most interesting features of ADFH’s study. However, these same aspects give rise to empirical design constraints that the study does not fully overcome. In addition, there are numerous leaps of logic required to arrive at some of ADFH’s conclusions and there are alternative explanations for ADFH’s findings that have not been entirely refuted. This leaves the reader with some doubt as to whether all of ADFH’s conclusions are fully substantiated. Nevertheless, the evidence presented makes an interesting contribution to our understanding of the forecasting behavior of young, private, rapidly growing, VCbacked firms, and provides some natural economic and methodological leads into further studies of these issues.     

Saving under uncertainty: A bivariate non-expected utility approach

We adopt the multivariate non-expected utility approach proposed by Yaari [1986] to provide a characterization of the comparative statics effects of greater risk aversion and of mean-preserving increases in risk on saving and borrowing in the presence of income and interest rate risk.We show that in Yaari's model, it is possible to extend the applicability of the Diamond and Stiglitz [1974] and Kihlstrom and Mirman [1974] (DSKM) single-crossing property to establish a relationship between greater risk aversion and saving (or borrowing) on the basis of the individual's ordinal preferences as long as the two risks are independent. We also demonstrate that the comparative statics effects of a joint mean-preserving increase in random income and interest rate on saving and borrowing can be determined by an extension of the DSKM single-crossing property.     

Human extinction scenario frameworks

It is a natural human instinct to wonder about the future. Some have long speculated about the various events that could potentially lead to the extinction of the human race. While a dark subject, the point of exploring factors that could drastically impact the ability to sustain life on our planet has utility in preparing for events of this nature. It is in the spirit of learning how to change before catastrophe strikes that such wondering occurs.     

Walking to transit: An unexpected source of physical activity

Using data from a regional survey carried out in Montreal, this paper shows empirical evidence that modal shift from car to transit contributes to the volume of daily physical activity. First, the paper presents a method to calculate the walking distance related to transit trips, and a totally disaggregate trip assignment model. The walking distance involved in every transit trip is then associated to the individuals' characteristics to estimate the number of steps made by the population in the whole transit system.Results show that, in average, a transit trip involves 1250 steps, required to access and egress the network as well as to transfer between routes or modes. Thus, a round trip represents 2500 steps, which account for 25% of the recommended volume of physical activity per day. Hence, analysis shows that the volume of walking varies according to attributes of the traveler (general decrease with age, higher for men) and of the trip (study and work trip involve more steps, the use of train generates more steps). A regression model confirms that these variables significantly affect the number of steps involved in transit trips. Such positive outcome, for the traveler himself, is an innovative argument to promote the use of transit that is also aligned with current sustainable transportation goals.     

A Rude Awakening: Internet Shakeout in 2000

This study explores various value-drivers of business-to-consumer (B2C) Internet companies' share prices both before and after the market correction in the spring of 2000. Although many market observers had predicted that the shakeout would eventually occur (e.g., Perkins and Perkins 1999), the ultimate and previously unanswered challenge lay identifying which stocks would fall and which ones would survive the shakeout. We develop an empirical valuation model and provide evidence that the Internet stocks that this model suggests were relatively over-valued prior to the Internet stock market correction experienced relatively larger drops in their price-to-sales ratios when the shakeout occurred. This result is robust to the inclusion of competing explanatory variables suggested by the economics literature related to industry rationalizations.We examine the ability of a valuation model comprised of both financial (accounting) variables and nonfinancial web traffic metrics to explain Internet companies' market values during each of 1999 and 2000. Our findings suggest that the reach and stickiness web traffic performance measures are value-relevant to the share prices of Internet companies in each of 1999 and 2000. Our findings of significance for the year 2000 contradict the recent claims of some analysts that web traffic measures are no longer important. We also explore the valuation role of our proxy for B2C companies' current rate of cash burn and find that this proxy is a significant value-driver in each of 1999 and 2000, but with differential valuation implications for each period. Our results suggest that the market was favorably disposed towards Internet companies' aggressive cash expenditures in 1999, but appeared to adopt a more critical view of Internet companies' cash burn rates in 2000. Our results further suggest that investors adopted a more skeptical attitude towards expenditures on intangible investments as the Internet sector began to mature. We find that investors appear to implicitly capitalize product development (R&D) and advertising expenses (customer acquisition costs) during the earlier period when the market was more optimistic about the prospects of B2C companies. However, only product development costs are implicitly capitalized into value, on average, subsequent to the shakeout in the spring of 2000. Finally, we provide statistical evidence to support the conjecture that different parameter vectors characterize the estimated market valuation models for each of 1999 and 2000. Overall, our study provides a preliminary view of the shakeout and maturation of one of the most important New Economy industries to emerge to date–the Internet.     

Contemporaneous verification of language: evidence from management earnings forecasts

Research documents that linguistic tone is incrementally informative about stock returns. What remains a puzzle is the mechanism by which investors can assess its credibility. We examine whether contemporaneous information in management earnings forecasts serves as a timely alternative to ex post verification. We document that ex post verifiable quantitative news in unbundled forecasts, and characteristics of the linguistic tone itself, affect investors’ pricing of tone. Consistent with higher quality signals enhancing the credibility of contemporaneous lower quality signals, we find that quantitative news verifies the associated linguistic tone; when the two signals have the same sign, the price effect of tone is stronger. Furthermore, the pricing attenuation of tone is increasing in the imprecision of the quantitative forecast, suggesting that lower forecast quality compromises the quantitative signal’s credibility enhancement. Managerial incentives to inflate tone lead to the verification effect being greater for optimistic language, while management’s use of hyperbole results in attenuation of the tone’s pricing.