Short Interest and Lottery Stocks

We find short interest‐related mispricing is strongest in lottery stocks. As stocks become more lottery‐like, arbitrage risk increases, resulting in higher overpricing (underpricing) in high (low) relative short interest (RSI) stocks. Monthly portfolio alphas are –1.61% for high RSI lottery stocks, whereas high RSI stocks with the least lottery‐like attributes show statistically insignificant alphas. Among lightly shorted stocks, lottery securities exhibit monthly alphas of 1.80%. Thus, although lottery stocks as a group typically underperform, investors can earn positive abnormal returns in lightly shorted lottery stocks. Our results suggest that lottery stocks’ greater noise trader risk and higher transactions costs impedes arbitrage in short interest‐related mispricing.     

Displaying expected values in risk elicitation tasks: the effect of information in experimental risk research

We investigate the influence of providing expected lottery results to experiment participants in two common risk attitude elicitation tasks. In a between-subject design, either the Holt and Laury task or the Eckel and Grossman task is carried out by a sample of 208 students. We find no significant effect of shown expected values on the risk attitude measured by the tasks. This result even holds true if we divide the experiment participants into specific sub-groups, i.e. female and male, or lower numeracy and higher numeracy participants. Furthermore, comprehension and processing time are not significantly influenced by presented expected values. Therefore, we conclude that providing information on expected values does not influence decision-making in tasks involving risk. This result indicates the robustness of elicited risk attitudes to variation in common experimental methods, and demonstrates that more information could be provided without creating bias in the results.     

New methods in the classical economics of uncertainty: comparing risks

Second-order stochastic dominance answers the question “Under what conditions will all risk-averse agents prefer \(\tilde{x}_2\) to \(\tilde{x}_1\)?” Consider the following related question: “Under what conditions will all risk-averse agents who prefer lottery \(\tilde{x}_1\) to a reference lottery \(\tilde{\omega }\) also prefer lottery \(\tilde{x}_2\) to that reference lottery?” Each of these two questions is an example of a broad category of questions of great relevance for the economics of risk. The second question is an example of a contingent risk comparison, while the question behind second-order stochastic dominance is an example of a non-contingent risk comparison. The stochastic order arising from a contingent risk comparison is obviously weaker than that arising from the corresponding non-contingent risk comparison, but we show that the two stochastic orders are closely related, so that the answer to a non-contingent risk comparison problem always provides the answer to the corresponding contingent risk comparison problem. In addition to showing the connection between parallel contingent and non-contingent risk comparison problems, we articulate a method for solving both kinds of problems using the “basis” approach. The basis approach has often been used implicitly, but we argue that there is value in making its use explicit, particularly in indicating which new, previously unsolved problems can readily be solved by the basis approach and which cannot.     

Insights into the reception and acceptance of risk messages: nuclear emergency communication

The objective of this paper is to test whether the effect of variables such as knowledge, attitudes, trust, risk perception, and psychometric risk characteristics changes in the different stages of risk-related information processing. To address this question, a distinction is made between two information-processing steps, reception (measured as a person’s ability to retain the information communicated) and acceptance (measured as a person’s level of agreement with the communicated information). An empirical study was conducted, using a radiological accident (2008) in Belgium as a communication case study. Face-to-face interviews were conducted on a large sample of Belgian population representative with respect to province, region, level of urbanization, gender, age, and professionally active status (N?=?1031) and among the population living in vicinity of the accident (N?=?104). All factors were measured on reliable scales (Cronbach’s α?>?.75). The reception–acceptance model was used to produce new insights into risk communication. The results demonstrate that knowledge was the driving factor only for the reception of risk messages, while heuristic predictors such as psychometric risk characteristics, attitudes, and trust were most influential for the acceptance of risk messages. It is discussed how the results will facilitate a more thorough understanding of information processing and how they could be used to design more focused risk communication strategies.     

The valuation of nonsystematic risks and the pricing of Swedish lottery bonds

Swedish government lottery bonds have coupon payments determinedby lottery. They offer a unique opportunity to study a securitywith uncertain payoffs having a known, observable distribution.The risk associated with the lotteries is idiosyncratic by constructionand should not command a risk premium in equilibrium. The bondsare traded in two forms, allowing us to evaluate the rewardsto bearing extra lottery risk. Despite its idiosyncratic nature,we find prices appear to reflect aversion to this risk. We evaluatethe empirical determinants of this differential pricing andpossible explanations for it.     

US government TARP bailout and bank lottery behavior

Considerable debate surrounds how the US government's TARP bailout intervention has affected the risk-taking and moral hazard behavior of U.S. banks around the global financial crisis. We examine this issue with a focus on lottery behavior introducing MAX/MIN as a new measure of lotteryness in banking to capture the loss protection from bank bailout guarantees. We find that the TARP bailout increased the likelihood of bank lotteryness and risk shifting. Lottery-like bank equities are riskier after TARP and exhibit fatter right to left tails. A consistent pattern of risk taking and lottery behavior extends both before and after the 2008–2009 crisis, engulfing the largest systemic banks (SIFIs). While confirming that lottery-like bank equities have lower short-term return, we find they exhibit better cumulative long-term return performance. Our findings have important policy implications regarding government intervention in banking crises.     

Implicit attitudes toward risk: the construction and validation of the measurement method

Methods that are typically used to examine individual differences in risk attitudes (e.g. lotteries, dilemmas, questionnaires) require participants to explicitly declare their willingness to take risk. Therefore, they may be biased by the need for self-presentation or situational characteristics such as time pressure and cognitive constraints that lead to more spontaneous and automatic processing of risk-related information. The aim of this study was to construct an indirect measure of risk attitudes that is free of these methodological limitations. The method based on the Implicit Association Test shows high internal reliability and satisfactory stability over time. It correlates moderately with different explicit measures of risk attitudes that are related to sensation seeking. Finally, it is characterized by a high predictive power. Adding the implicit measure to the set of independent variables representing declarative evaluations of risk attitudes significantly improved the model predicting risky real-life behavior. We argue that the indirect assessment of risk attitudes presented in this paper may be used as an universal measure of people’s risk propensity that is free of biases related to self-presentation and situational factors.     

Parameter risk in time-series mortality forecasts

The projection of mortality rates is an essential part of valuing liabilities in life insurance portfolios and pension schemes. An important tool for risk management and solvency purposes is a stochastic projection model. We show that ARIMA models can be better representations of mortality time-series than simple random-walk models. We also consider the issue of parameter risk in time-series models from the point of view of an insurer using them for regulatory risk reporting – formulae are given for decomposing overall risk into undiversifiable trend risk (parameter uncertainty) and diversifiable volatility. Particular attention is given to the contrasts in how academic researchers might view these models and how insurance regulators and practitioners in life offices might use them. Using a bootstrap method we find that, while certain kinds of parameter risk are negligible, others are too material to ignore. We also find that an objective model selection criterion, such as goodness of fit to past data, can result in the selection of a model with unstable parameter values. While this aspect of the model is superficially undesirable, it also leads to slightly higher capital requirements and thus makes the model of keen interest to regulators. Our conclusions have relevance to insurers using value-at-risk capital assessments in the European Union under Solvency II, but also territories using conditional tail expectations such as Australia, Canada and Switzerland.     

Tracking investor gambling intensity

We provide a simple method to track firm-specific investor gambling intensity based on the publicly available transaction data. This identification approach effectively incorporates information on what and how much to buy in the trading decision of an investor with a gambling preference. With empirical analysis based on data of the Chinese stock market from January 2003 to May 2021, we document that investor gambling intensity is strongly persistent and significantly predicts future stock returns, which is not a rediscovery of the well-known lottery effect. Stocks with high aggregate gambling intensity underperform stocks with low aggregate gambling intensity by approximately 117 basis points over the following month. Several potential explanations for such empirical findings are examined, and we document support for the explanation based on information diffusion.     

Betting against correlation: Testing theories of the low-risk effect

We test whether the low-risk effect is driven by leverage constraints and, thus, risk should be measured using beta versus behavioral effects and, thus, risk should be measured by idiosyncratic risk. Beta depends on volatility and correlation, with only volatility related to idiosyncratic risk. We introduce a new betting against correlation (BAC) factor that is particularly suited to differentiate between leverage constraints and behavioral explanations. BAC produces strong performance in the US and internationally, supporting leverage constraint theories. Similarly, we construct the new factor SMAX to isolate lottery demand, which also produces positive returns. Consistent with both leverage and lottery theories contributing to the low-risk effect, we find that BAC is related to margin debt while idiosyncratic risk factors are related to sentiment.     

Reorganization in bankruptcy and the issue of strategic risk

The decision by creditors to force the firm into bankruptcy, where bankruptcy includes reorganization, is shown to involve the valuation of a lottery over (cooperative) games rather than a lottery over specific monetary outcomes. In the absence of assumptions about strategic (negotiating) risk, the value of creditor claims is seen to be ambiguous. This paper extends Van Horne's model of the optimal initiation of bankruptcy proceedings to include the reorganization option and strategic risk. A modified decision rule is obtained to determine the optimal solution.     

Corporate leverage and growth the game-theoretic issues

The equilibrium value of a levered firm facing growth opportunities is shown to involve the valuation of a lottery over (cooperative) games rather than a lottery over specific monetary outcomes. In the absence of assumptions about negotiating risk, the value of the firm's claims is seen to be ambiguous even with zero transactions costs. This ambiguity is compounded if the core of the game is empty. This paper rationalizes specific financial instruments and institutions as means for attenuating negotiation costs and core existence problems. Furthermore, the valuation of these instruments requires determining the certainty-equivalent of a lottery over games.     

Risk and wealth in a model of self-fulfilling currency attacks

Market participants’ risk attitudes, wealth and portfolio composition influence their positions in a pegged foreign currency and, therefore, may have important effects on the sustainability of currency pegs. This paper analyzes such effects in a global game model of currency crises with continuous action choices, generating a rich set of theoretical comparative static predictions related to often discussed but rarely modelled accounts of currency attacks. The model can be solved in closed form and the methods could be used to study other economic issues in which coordination and risk aversion play important roles.     

Does reporting quality affect systematic risk? Evidence from a regulatory lottery

On June 1, 1976, the Swedish parliament voted on a legislative bill that, if approved, would have substantially increased the quality of the corporate information disclosed to the public. Since parliament was hung, the outcome of the vote was decided by a lottery. The winning lottery ticket was a “No”, which meant that the bill was rejected. I exploit this lottery as an exogenous event to study if reporting quality affects systematic risk. I find that the rejection of the bill resulted in a negative abnormal return that persisted in the following day. This result suggests that there is a causal relationship between reporting quality and equity prices through its impact on systematic risk.     

The relationship between default prediction and lending profits: Integrating ROC analysis and loan pricing

In evaluating credit risk models, it is common to use metrics such as power curves and their associated statistics. However, power curves are not necessarily easily linked intuitively to common lending practices. Bankers often request a specific rule for defining a cut-off above which credit will be granted and below which it will be denied. In this paper we provide some quantitative insight into how such cut-offs can be developed. This framework accommodates real-world complications (e.g., “relationship” clients). We show that the simple cut-off approach can be extended to a more complete pricing approach that is more flexible and more profitable. We demonstrate that in general more powerful models are more profitable than weaker ones and we provide a simulation example. We also report results of another study that conservatively concludes a mid-sized bank might generate additional profits on the order of about $4.8 million per year after adopting a moderately more powerful model.     

Does charitable gambling crowd out charitable donations? Using matching to analyze a policy reform

The impact of charitable lotteries on charitable donations depends on the motives of charitable donations, and is thus more an empirical question. Utilizing the propensity score matching method to overcome sample selection bias, this study estimates the effect of lotto outlays on direct charitable donations based on Taiwan’s experience of introducing a lottery in 2002. We find that people’s lottery spending neither crowds out nor crowds in charitable donations after the control group for lottery players is matched by propensity scores. The evidence thus suggests that people are more concerned about how they make their donations.     

Utilitarianism and risk

Abstract

In day-to-day life, we are continuously exposed to different kinds of risk. Unfortunately, avoiding risk can often come at societal or individual costs. Hence, an important task within risk management is deciding how much it can be justified to expose members of society to risk x in order to avoid societal and individual costs y – and vice versa. We can refer to this as the task of setting an acceptable risk threshold. Judging whether a risk threshold is justified requires normative reasoning about what levels of risk exposure that are permissible. One such prominent normative theory is utilitarianism. According to utilitarians, the preferred risk threshold is the one that yields more utility for the most people compared to alternative risk thresholds. In this paper, I investigate whether and the extent to which utilitarian theory can be used to normatively ground a particular risk threshold in this way. In particular, I argue that there are (at least) seven different utilitarian approaches to setting an acceptable risk threshold. I discuss each of these approaches in turn and argue that neither can satisfactorily ground an acceptable risk threshold.     

Lotteries, public good provision and the degree of rivalry

Under the standard summation technology, pure public goods can be provided via the direct contributions mechanism, even in an arbitrarily large group. However, if the public good exhibits any degree of rivalry, individual consumption of the public good will fall to zero as group size grows large. Thus, the direct contributions mechanism is not robust to the introduction of rivalry. By contrast, Morgan’s (Review of Economic Studies 67:761–784, 2000) lottery mechanism is robust to the introduction of rivalry when the lottery prize is proportional to group size. The lottery mechanism can provide public goods in a large group when the public good exhibits a degree of rivalry, provided that the degree of rivalry is not too high. This suggests that the lottery mechanism can provide a broader range of public goods in a large group than the direct contributions mechanism.     

Bestimmung von Deckungsgrenzen bei nicht-proportionalen Rückversicherungsverträgen: Selbstbehalte in Abhängigkeit von Risikoeinstellungen

Risk measures and accordingly risk measurement increasingly gains in importance in economics. Over the past years risk measures were already used at credit and shareholders' equity depositations due to Basel II regulations. The article now introduces a hybrid decision modell and applies it to the reinsurance business. The modell uses a convex combination of risk measures and therewith enables the modelling of risk attitudes. First of all, by doing that, it can be shown, which risk attitude leads to the acceptance of a reinsurance contract, and secondly which deductible an insurer is prepared to undertake. Consequently it is possible to determine the risk attitudes of insurers. In turn, on knowledge of risk attitudes, it becomes possible to generate recommendations of the extent of the deductible at similar reinsurance contracts.     

Increase in Risk and its Effects on Welfare and Optimal Policies in a Dynamic Setting: The Case of Global Pollution

This paper studies the effects of an increase in risk on welfare and optimal policies in a stochastic dynamic model of global pollution. In a first step, we focus on the case of a single decision maker, and make use of an approach pioneered by Kimball (2014) for studying the impact of a marginal change in risk in optimal stochastic control models. Using a simple model with only one state variable and one control variable, we show how the optimal carbon tax responds to an increase in risk. It is found that the third derivative of the decay function of the stock of pollution may play a decisive role. In a second step, we investigate the extent to which Kimball’s approach may be extended to the case of stochastic dynamic games. We show how strategic interactions complicate the task of evaluating the effects of an increase in risk. Interestingly, in a dynamic model of the tragedy of the commons, we find that an increase in risk can increase welfare even though all agents are risk averse. The reason is that higher risk can cause agents to be more conservative, and this mitigates the tragedy of the commons.