Internal rationality, imperfect market knowledge and asset prices

We present a decision theoretic framework in which agents are learning about market behavior and that provides microfoundations for models of adaptive learning. Agents are ‘internally rational’, i.e., maximize discounted expected utility under uncertainty given dynamically consistent subjective beliefs about the future, but agents may not be ‘externally rational’, i.e., may not know the true stochastic process for payoff relevant variables beyond their control. This includes future market outcomes and fundamentals. We apply this approach to a simple asset pricing model and show that the equilibrium stock price is then determined by investors? expectations of the price and dividend in the next period, rather than by expectations of the discounted sum of dividends. As a result, learning about price behavior affects market outcomes, while learning about the discounted sum of dividends is irrelevant for equilibrium prices. Stock prices equal the discounted sum of dividends only after making very strong assumptions about agents? market knowledge.     

General equilibrium models of monopolistic competition: A new approach

We analyze a class of ‘large group’ Chamberlinian monopolistic competition models by applying different concepts of functional separability to the same set of first-order conditions for utility maximization. We show that multiplicatively quasi-separable (MQS) functions yield ‘constant relative risk aversion’ (CRRA), and, therefore ‘constant elasticity of substitution’ (CES), functions, whereas additively quasi-separable (AQS) functions yield ‘constant absolute risk aversion’ (CARA) functions. We then show that the CARA specification sheds new light on: (i) pro-competitive effects, i.e., profit-maximizing prices are decreasing in the mass of competing firms; and (ii) a competitive limit, i.e., profit-maximizing prices converge to marginal costs when the mass of competing firms becomes arbitrarily large.     

Recursive multiple-priors

This paper axiomatizes an intertemporal version of multiple-priors utility. A central axiom is dynamic consistency, which leads to a recursive structure for utility, to ‘rectangular’ sets of priors and to prior-by-prior Bayesian updating as the updating rule for such sets of priors. It is argued that dynamic consistency is intuitive in a wide range of situations and that the model is consistent with a rich set of possibilities for dynamic behavior under ambiguity.     

Bargaining in committees as an extension of Nash's bargaining theory

This paper addresses the following issue: if a set of agents bargain on a set of feasible alternatives ‘in the shadow’ of a voting rule, that is, any agreement can be enforced if a ‘winning coalition’ supports it, what general agreements are likely to arise? In other words: what influence can the voting rule used to settle (possibly nonunanimous) agreements have on the outcome of consensus? We model the situation as an extension of the Nash bargaining problem in which an arbitrary voting rule replaces unanimity. In this setting a natural extension of Nash's solution is characterized.     

Certainty Independence and the Separation of Utility and Beliefs

Economists often operate under an implicit assumption that the tastes of a decision maker are quite stable, while his beliefs change with the availability of new information. We show that for a general class of preferences, a separation of a key component of tastes, the utility function, from the other components of the representation is possible only if the decision maker's preferences satisfy a mild but not completely innocuous condition, called ‘certainty independence’. We also outline the axiomatic characterization of the preferences that obtain such separation, which are a subset of the biseparable preferences.     

Reference-dependent subjective expected utility

A reference-dependent generalisation of subjective expected utility theory is presented. In this theory, preferences between acts depend both on final outcomes and on reference points (which may be uncertain acts). It is characterised by a set of axioms in a Savage-style framework. A restricted form of the theory separates attitudes to end states (encoded in a ‘satisfaction function’) from attitudes to gains and losses of satisfaction. Given weak additional assumptions, the restricted theory excludes cycles of choice, explains observed disparities between willingness-to-pay and willingness-to-accept valuations of lotteries, and predicts preference reversal.     

Endogenous private information structures

We formally incorporate the option to gather information into a game and thus endogenize the information structure. We ask whether models with exogenous information structures are robust with respect to this endogenization. Any Nash equilibrium of the game with information acquisition induces a Nash equilibrium in the corresponding game with an exogenous structure. We provide sufficient conditions on the structure of the game for which this remains true when ‘Nash’ is replaced by ‘sequential’. We characterize the (sequential) Nash equilibria of games with exogenous information structures that can arise as a (sequential) Nash equilibrium of games with endogenous information acquisition.     

Regular Effective Demand Systems (REDS)

Empirical demand analysis is usually conducted on the basis of either ‘regularity’ or ‘flexibility’. This paper takes a middle ground between ‘regularity’ and ‘flexibility’, offering a compromise in the form of a new specification termed ‘REDS’.     

An efficiency and welfare classification of rationing by waiting in the presence of bribery

Governments often allocate commodities at low prices and on a first-come-first-served basis (rationing by waiting), while bureaucrats who distribute the commodities usually take bribes. A model is developed to classify the efficiency implications of bribery, and socially optimal pricing schemes in rationing by waiting. If the rationed good and individual income spent on other goods (‘other’ income) are ‘complements’, then bribery may enhance allocative efficiency, and a ‘dual pricing’ scheme can augment social welfare. However, if the rationed commodity and ‘other’ income are ‘substitutes’, then bribery may not improve allocative efficiency, and distributing the rationed commodity free is socially optimal.     

International trade between consumer and conservationist countries

We consider trade between a ‘consumer’ country with an open access renewable resource and a ‘conservationist’ country that regulates resource harvesting to maximize domestic steady-state utility. In what we call the mild overuse case, the consumer country exports the resource good and suffers steady-state losses from trade, as suggested by the conventional wisdom that weak resource management standards confer a competitive advantage on domestic firms in the resource sector but cause welfare losses. Strikingly, however, when the resource stock is most in jeopardy, the conservationist country exports the resource good in steady state and both countries experience gains from trade.     

The Shill Bidding Effect versus the Linkage Principle

The analysis of second price auctions with externalities is utterly modified if the seller is unable to commit not to participate in the mechanism. For the General Symmetric Model introduced by Milgrom and Weber [P. Milgrom, R. Weber, A theory of auctions and competitive bidding, Econometrica 50 (1982) 1089-1122] we characterize the full set of separating equilibria that are symmetric among buyers and with a strategic seller being able to bid in the same way as any buyer through a so-called shill bidding activity. The revenue ranking between first and second price auctions is different from the one arising in Milgrom and Weber: the benefits from the highlighted ‘Linkage Principle’ are counterbalanced by the ‘Shill Bidding Effect.’     

Theories of behavior in principal-agent relationships with hidden action

In a laboratory experiment, we investigate behavior in a principal-agent situation with moral hazard. We evaluate the predictive success of two theories. One is the standard agency theory, which assumes that the agent will accept any contract offer that satisfies his participation constraint, typically requiring zero expected utility. The other is the “fair-offer” theory suggested by Keser and Willinger [2000. Principals’ principles when agents’ actions are hidden. International Journal of Industrial Organization 18 (1), 163-185], which requires that the principal provide full insurance against losses to the agent and leave him a share of at most 50% of the generated surplus. The treatment variable of our experiment is the cost of effort. As effort costs increase, expected net surplus of a contract decreases. We observe that fair-offer theory generally predicts observed contract offers better than standard agency theory. However, the predictive success of the fair-offer theory decreases, while the one of standard agency theory increases with decreasing expected net surplus.     

The monetary utility premium and interpersonal comparisons

The utility premium is generally defined as the pain or reduction in expected utility caused by an n$n$th-degree risk increase, where n≥2$n\ge 2$. While it is a very useful concept in understanding a decision maker’s choice in uncertain situations, the utility premium is not interpersonally comparable. This note shows that the monetary utility premium–the utility premium divided by the expected marginal utility at the random starting wealth–is interpersonally comparable, and the comparison is characterized by Ross more risk aversion of the corresponding degree.     

Solidarity among the poor

We conduct a field experiment with low-income subjects in Dallas, Texas. We examine voluntary, informal risk sharing using a visual representation of the solidarity game developed for low-literacy populations. We find substantially more ‘fixed gift to loser’ behavior and less ‘egotistical’ behavior than in previous studies. Individuals who display ‘egotistical’ behavior are more risk tolerant. The amount of the conditional gifts is positively related to age, income, and connection to the community. However, trust and empathy, which are commonly discussed as drivers for solidarity, are not significantly related to the amount given.     

Interim efficient allocations under uncertainty

This paper considers an exchange economy under uncertainty with asymmetric information. Uncertainty is represented by multiple priors and posteriors of agents who have either Bewley's incomplete preferences or Gilboa-Schmeidler's maximin expected utility preferences. The main results characterize interim efficient allocations under uncertainty; that is, they provide conditions on the sets of posteriors, thus implicitly on the way how agents update the sets of priors, for non-existence of a trade which makes all agents better off at any realization of private information. For agents with the incomplete preferences, the condition is necessary and sufficient, but for agents with the maximin expected utility preferences, the condition is sufficient only. A couple of necessary conditions for the latter case are provided.     

Non-Walrasian equilibria and the law of one price

We present a market game which features multiple posts for each commodity. We use this framework to illustrate the idea that in non-Walrasian markets, where individual activities influence market clearing prices, there are equilibria where commodities are exchanged simultaneously in two posts at different prices, thus defying the ‘law of one price’. Such equilibria are compatible with an apparent arbitrage possibility, which dissipates whenever individuals try to take advantage of it.     

Unpriced quality

A monopolist charges the same price for differentiated products when high quality products are likely to be assigned to low valuation consumers. The argument explains the use of ‘unpriced quality’ for concert tickets, movie theaters, and elsewhere.     

Financial expectations and the ‘left-right’ political value scale: Testing for the POUM hypothesis

Using a uniquely defined indicator of political ideology we test whether expectations of future financial well-being have an effect on an individual’s position on the political ‘left-right’ spectrum. We find evidence of a significant “prospect of upward mobility” effect.     

A note on Kuhn’s Theorem with ambiguity averse players

Kuhn’s Theorem shows that extensive games with perfect recall can equivalently be analyzed using mixed or behavioral strategies, as long as players are expected utility maximizers. This note constructs an example that illustrates the limits of Kuhn’s Theorem in an environment with ambiguity averse players who use a maxmin decision rule and full Bayesian updating.     

On the stability of the constant relative risk aversion (CRRA) utility under high degrees of uncertainty

Growth models under uncertainty and constant relative risk aversion (CRRA) utility are fragile in explaining consumers’ choice, as equilibrium consumption is dependent on distributional assumptions. We show that, under semi-nonparametric distributions, general equilibrium models are stable, as the existence of expected utility is guaranteed.