Information,endogenous uncertainty and risk aversion

The importance of incomplete information and risk aversion for the allocation of economic resources is shown to depend critically on whether uncertainty is exogenously imposed or endogenously related to the ability of the price system to aggregate and disseminate the information possessed by the agents in a decentralized market economy. The specific example analysed in this paper is a two-period exchange model with competitive markets and a homogeneous product.Comments and suggestions by anonymous referees, Jacques Drèze, Jan Rose Sørensen, and financial support from the Danish Social Science Research Council are gratefully acknowledged.     

Ambiguity,uncertainty aversion and equilibrium welfare

Summary. In order to analyse the effect of ambiguity and uncertainty aversion on equilibrium welfare, a two period, pure exchange one good economy is considered. Agents are Choquet-expected-utility maximizers with same convex capacity and strictly concave utility index. It is proven that equilibrium is indeterminate whenever several probabilities in the core of the capacity minimize the expected value of aggregate endowment and not all agents have same expected endowments under those probabilities. It is further shown that small changes in aggregate endowment may have drastic welfare implications. A more general model is considered in the case of no aggregate uncertainty: agents have a set of priors and are uncertainty averse as modelled by Gilboa-Schmeidler [1989]. In the case of complete markets, it is shown that assets have a spread of equilibrium prices similar to the spread of no-arbitrage prices compatible with absence of arbitrage in markets with imperfections.Received: 2 June 2000, Revised: 27 March 2003, JEL Classification Numbers: D46, D59,D60, G12.I have benefited from conversations with L. Epstein, F. Magnien and J. M. Tallon.     

Stochastically independent randomization and uncertainty aversion

Summary.   This paper proposes a preference-based condition for stochastic independence of a randomizing device in a product state space. This condition is applied to investigate some classes of preferences that allow for both independent randomization and uncertainty or ambiguity aversion (a la Ellsberg). For example, when imposed on Choquet Expected Utility (CEU) preferences in a Savage framework displaying uncertainty aversion in the spirit of Schmeidler [27], it results in a collapse to Expected Utility (EU). This shows that CEU preferences that are uncertainty averse in the sense of Schmeidler should not be used in settings where independent randomization is to be allowed. In contrast, Maxmin EU with multiple priors preferences continue to allow for a very wide variety of uncertainty averse preferences when stochastic independence is imposed. Additionally, these points are used to reexamine some recent arguments against preference for randomization with uncertainty averse preferences. In particular, these arguments are shown to rely on preferences that do not treat randomization as a stochastically independent event. Received: February 10, 2000; revised version: March 30, 2000     

Monotone continuous multiple priors

Summary. In a multiple priors model á la Gilboa and Schmeidler (1989), we provide necessary and sufficient behavioral conditions ensuring the countable additivity and non-atomicity of all priors.Received: 25 November 2002, Revised: 24 June 2004, JEL Classification Numbers: D81.We thank Roko Aliprantis, Maristella Botticini, Erio Castagnoli, Larry Epstein, Paolo Ghirardato, Itzhak Gilboa, Luigi Montrucchio, David Schmeidler, Marciano Siniscalchi, an Associate Editor, and an anonymous referee for helpful discussions. Fabio Maccheroni and Massimo Marinacci gratefully acknowledge the financial support of MIUR and NOMOS Sistema (Milano).     

Population uncertainty,social insurance,and actuarial bias

The authors examine the relation between changes in the size of the working population and the value of a social insurance contract between unborn workers and future retirees. They develop a model suggesting that such a contract will benefit both of the generations concerned. The implied geographical focus is on developed countries.     

Mean-dispersion preferences and constant absolute uncertainty aversion

We axiomatize, in an Anscombe–Aumann framework, the class of preferences that admit a representation of the form V(f)=μ−ρ(d)$V(f)=\mu -\rho (d)$, where μ is the mean utility of the act f with respect to a given probability, d   is the vector of state-by-state utility deviations from the mean, and ρ(d)$\rho (d)$ is a measure of (aversion to) dispersion that corresponds to an uncertainty premium. The key feature of these mean-dispersion   preferences is that they exhibit constant absolute uncertainty aversion. This class includes many well-known models of preferences from the literature on ambiguity. We show what properties of the dispersion function ρ(⋅)$\rho (\cdot )$ correspond to known models, to probabilistic sophistication, and to some new notions of uncertainty aversion.     

Probabilistic dominance and status quo bias

Decision makers have a strong tendency to retain the current state of affairs. This well-documented phenomenon is termed status quo bias. We present the probabilistic dominance approach to status quo bias: an alternative is considered acceptable to replace the status quo only if the chances of a (subjectively) severe loss, relative to the status quo, are not too high. Probabilistic dominance is applied and behaviorally characterized in a choice model that allows for a range of status quo biases, general enough to accommodate unanimity, but also standard expected utility maximization. We present a comparative notion of “revealing more bias towards the status quo” and study its implications to the probabilistic dominance model of choice. Lastly, the model is applied to the endowment effect phenomenon and to a problem of international portfolio choice when investors are home biased.     

Agreeable bets with multiple priors

This paper considers a two-agent model of trade with multiple priors. Firstly, we characterize the existence of an agreeable bet on some event in terms of the set of priors. It is then shown that the existence of an agreeable bet on some event is a strictly stronger condition than the existence of an agreeable trade, whereas the two conditions are equivalent in the standard Bayesian framework. Secondly, we show that the two conditions are equivalent when the set of priors is the core of a convex capacity. These results are also related to the no trade theorems under asymmetric information.     

Mutual absolute continuity of multiple priors

This note provides a behavioral characterization of mutually absolutely continuous multiple priors.     

Complex ballot propositions,individual voting behavior,and status quo bias

One concern about direct democracy is that citizens may not be sufficiently competent to decide about complex policies. This may lead to exaggerated conservatism in the voting decision (status quo bias). To investigate how complexity affects individual voting behavior, we develop a novel measure of proposition complexity (using official pre-referendum booklets) and combine it with post-referendum survey data from Switzerland. Using Heckman selection estimations to account for endogenous variation in participation rates, we find that an increase in proposition complexity from the 10th to the 90th percentile would decrease voters' approval by 5.6 ppts, which is often decisive: an additional 12% of the propositions in our sample would be rejected.     

Past experience of uncertainty affects risk aversion

In an experiment with more than 500 participants we study how past experience of uncertainty (imperfect knowledge of the state space) affects risk preferences. Participants in our experiment choose between a sure outcome and a lottery in 32 periods. All treatments are exactly identical in periods 17–32 but differ in periods 1–16. In the early periods of the risk treatment there is perfect information about the lottery; in the ambiguity Treatment participants perfectly know the outcome space but not the associated probabilities; in the unawareness treatment participants have imperfect knowledge about both outcomes and probabilities. We observe strong treatment effects on behavior in periods 17–32. In particular, participants who have been exposed to an environment with very imperfect knowledge of the state space subsequently choose lotteries with high (low) variance less (more) often compared to other participants. Estimating individual risk attitudes from choices in periods 17–32 we find that the distribution of risk attitude parameters across our treatments can be ranked in terms of first order stochastic dominance. Our results show how exposure to environments with different degrees of uncertainty can affect individuals’ subsequent risk-taking behavior.     

Monetary control uncertainty and inflation bias

This paper offers an alternative explanation for the occurrence of an inflation bias with and without an output goal exceeding natural output. A monetary game model is developed from which an inflation bias emerges because the policymaker increases money growth in order to avoid a recession due to a possible negative control error. Whereas higher additive instrument uncertainty increases the inflation bias, higher multiplicative uncertainty decreases it. Delegating monetary policy to an independent and conservative central banker decreases the inflation bias for all types of control errors.     

Rational choice with status quo bias

Motivated by the empirical findings concerning the importance of one's current situation on her choice behavior, the main objective of this paper is to propose a rational choice theory that allows for the presence of a status quo bias, and that incorporates the standard choice theory as a special case. We follow a revealed preference approach, and obtain two nested models of rational choice that allow phenomena like the status quo bias and the endowment effect, and that are applicable in any choice situation to which the standard (static) choice model applies.     

Rounding bias in forecast uncertainty

The European Survey of Professional Forecasters (SPF) is a dataset that is widely used to derive measures of forecast uncertainty. Participants in the SPF provide not only point estimates but also density forecasts for key macroeconomic variables. The mean individual variance, defined as the average of the variances of individual forecasts, shifted up during the Great Recession and has remained elevated since the crisis. The paper seeks to explain this puzzling lack of countercyclicality by applying a smooth transition analysis on data from the European SPF. The analysis indicates that the mean individual variance is a function of the modelling preferences of forecasters and consequently shifts in individual variance are likely to be misleading for the actual changes in the perceived uncertainty. The results remain robust after potential endogeneity has been accounted for.     

Endogenous factor market distortion, risk aversion, and international trade under input uncertainty

In the context of non-diversifiable and sector-specific risks in labour markets, we show that the resulting factor market distortion – attributable to an endogenous intersectoral wage differential – can provide a possible rationale that explains why larger wage dispersion prevails in developing nations. We also demonstrate how endogenous wage distortions spill over to capital markets, with capital-poor economies offering lower rates of returns. In addition, we show that inequality in the distribution of wealth further deviates factor allocation away from first-best and impairs intersectoral mobility of the poor.
Ce mémoire montre que la distorsion dans le marché des facteurs qui résulte de risques non diversifiables et spécifiques à certains secteurs (et qui se traduit par un différentiel de salaire endogène entre secteurs) peut expliquer pourquoi on observe une dispersion plus grande des salaires dans les pays en voie de développement.On montre aussi comment des distorsions endogènes de salaires débordent vers les marchés de capitaux,ce qui fait que les pays pauvres en capital ont des rendements plus faibles.De plus, on montre que l'inégalité dans la distribution de la richesse contribue à faire dévier l'allocation des ressources de son optimum de premier ordre et nuit à la mobilité inter-sectorielle des pauvres.     

Anticipated regret as an explanation of uncertainty aversion

The paper provides a psychological explanation of uncertainty aversion based on the fear of regret. We capture an agent’s regret using a reference-dependent utility function in which the agent’s utility depends on the performance of his chosen option relative to the performance of the option that would have been best ex post. An uncertain option is represented as a compound lottery. The basic idea is that selecting a compound lottery reveals information, which alters the ex post assessment of what the best choice would have been, inducing regret. We provide sufficient conditions under which regret implies uncertainty aversion in the sense of quasi-concave preferences over compound lotteries.