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.     

The welfare implications of resource allocation policies under uncertainty: The case of public education spending

In this paper, we examine whether policy interventions, aimed at improving resource allocation, also have important stabilization effects over the business cycle. To this end, we employ a dynamic stochastic general equilibrium model in which public education expenditures, financed by distorting taxes, enhance the productivity of private education choices. We then calculate the welfare implications of competing operating targets using a state-contingent instrument rule for public education spending. Our main findings are: (i) there can be important cyclical effects of different resource allocation policies depending on the operating target used and the degree of macroeconomic uncertainty; (ii) it is important to use an operating target which is as close as possible to the heart of the market imperfection that justifies policy action; (iii) policy action should not be monotonic in the degree of macroeconomic uncertainty.     

Exposure order effects and advertising competition

This paper applies the theories of exposure order effects, developed in the psychology literature, to an industrial organization model to explore their role in advertising competition. There are two firms and infinitely many identical consumers. The firms produce a homogeneous product and distribute their brands through a common retailer. Consumers randomly arrive at the retailer and buy their most preferred brands. The order in which a consumer sees the advertising messages affects his brand preferences. Under the primacy effect the consumer prefers the brand he first saw advertised, under the recency—the last encountered brand. The equilibrium of the advertising game is characterized separately under the primacy and the recency effects. In the first setting all consumers are initially unaware of the product existence. The equilibrium advertising intensities, remarkably, do not depend on the type of exposure order effect. In the other two settings some consumers have already formed their brand preferences. The primacy and the recency effects give rise to different equilibrium outcomes.     

Optimal choice of prevention and cure under uncertainty on disease effect and cure effectiveness

This paper studies optimal prevention and cure when an agent copes with two different sources of uncertainty: uncertainty on disease effect and uncertainty on cure effectiveness. We first analyze how optimal choices are affected by uncertainty when prevention and cure do not interact. Under both types of uncertainty, we obtain that the optimal level of prevention rises. Furthermore, we characterize for each source of uncertainty the conditions for the optimal level of cure to increase. We show that these conditions are related to different measures of prudence in health and cross-prudence in wealth. Lastly, we generalize our results to the case where prevention and cure interact and characterize for each source of uncertainty the conditions for the optimal level of prevention and cure to jointly increase. These conditions are similar to those obtained in the case without uncertainty but, in this context, Edgeworth–Pareto complementarity is also required.     

Weighted and quadratic models of choice under uncertainty

This paper extends the weighted and quadratic utility models of choice under risk to the context of choice under uncertainty. An important characteristic of the models is that they admit ‘dynamically consistent’ updating rules.     

Sustainability and its relation to efficiency under uncertainty

Evaluating the long-run consequences of present actions, as in the context of sustainability, requires information about the actions’ outcomes and about future preferences that is often uncertain. We analyze a risk-based criterion of sustainability and a corresponding efficiency concept that cover these uncertainties. We derive several properties of these criteria and formally characterize the trade-off between sustainability and efficiency. Furthermore, we show that maximizing the probability of ex post efficiency under a sustainability constraint provides an interesting choice rule and that, for a special case, this rule is connected to portfolio theory. We are indebted to an anonymous referee whose comments helped substantially to improve the article.     

Bankable emission permits under uncertainty and optimal risk-management rules

This article proposes a theory of banking of emission permits under conditions of regulatory uncertainty. Based on a two-period partial equilibrium framework, we examine the effects of increasing risk–in the sense of a mean preserving spread–regarding a future permit allocation at the firm level. We also examine the role of an agency to pool risks by re-allocating permits for a group of firms. Our results are twofold. First, an increase in risk may lead to changes in a firm’s banking strategy, depending on the third partial derivative of its production function with respect to pollution. Second, we define an optimal risk-sharing rule between agents to respond to political decision changes. Our results overall suggest that the bankability of permits may be used as a risk-management tool.     

Sustained output growth under uncertainty: A simple model with human capital

In a model where agents use their labour/education choice to adjust their consumption profile over time, I show that the impact of uncertainty on growth depends, critically, on agents’ attitudes towards risk, reflected by the coefficient of relative risk aversion. In this respect, the well known result from the literature on ‘saving under uncertainty’ can be extended into a broader context, whereby the intertemporal profile of consumption is determined via human capital accumulation rather than saving and physical capital investment.     

Preferences for environmental quality under uncertainty

Although the expected effects of environmental policies and interventions are rarely known with certainty, stated preference surveys rarely elicit preferences over uncertain environmental outcomes. This article presents empirical results challenging the view that ignoring such uncertainty during preference elicitation is of no consequence so long as people only care about final environmental states. We show that measured preferences for final environmental states, water quality in this case, depend on whether people choose between final states or between lotteries over final states. In contrast to the typical finding for monetary lotteries, we find significant under-weighting of low probability events related to water quality.     

Subsidies under uncertainty: Modeling of input- and output-oriented policies

Agricultural subsidies play an essential role in agricultural and rural development in many developed economies. Countries have implemented agricultural subsidy policies with a focus on food security and environmental protection. Agricultural production is risky and uncertain, influencing the efficiency of agricultural subsidies. This study develops a theoretical framework to analyze the effects of production uncertainties on the efficiency of agricultural subsidy policies under the double constraints of food security and environmental protection. The basic model is investigated under six different conditions, and expanded research also is presented. Our models show that uncertainty, including output, cost, and price uncertainties, and technology conversion efficiency significantly affects the efficiency of agricultural subsidies. Under high technology conversion efficiency, output-oriented subsidies are appropriate for food security and environmental protection goals. Policymakers should take both uncertainty and production efficiency into consideration when choosing between input-oriented and output-oriented subsidy policies.     

The effects of information on strategic investment and welfare

Summary. The paper analyses the influence of uncertainty and competition on the strategic considerations of a firm’s investment decision, where the firm receives imperfect signals about the profitability of an investment project. We find a preemptive or an attrition equilibrium depending on a trade-off between first and second mover advantages. We show that welfare can be negatively affected by decreasing uncertainty, i.e. more and/or better information. Furthermore, simulations indicate that duopoly leads to higher welfare than monopoly if there are few and relatively non-informative signals, whereas the opposite holds if there are many and relatively informative signals.Received: 13 May 2004, Revised: 22 March 2005, JEL Classification Numbers: C61, D43, D81.Jacco J. J. Thijssen: Correspondence toDolf Talman is acknowledged for many inspiring discussions and meticulous proof-reading. Jan Boone, Thomas Sparla, participants in the workshop on “Recent Topics in Real Options Valuation”, July 2002, Krems, Austria, and an anonymous referee are thanked for helpful comments. The usual disclaimer applies.     

The effectiveness of pre-release advertising for motion pictures: An empirical investigation using a simulated market

We use data on a movie’s stock price as it trades on the Hollywood Stock Exchange, a popular online market simulation, to study the impact of movie advertising. We find that advertising has a positive and statistically significant effect on expected revenues, but that the effect varies strongly across movies of different “quality”. The point estimate implies that the returns to advertising for the average movie are negative.     

Substantive and procedural uncertainty

Different sources of uncertainty are analysed and a representation of decision-making in principle consistent with behavioural evidence is proposed. The endogenous emergence of innovations, in the forms of unexpected events and novel behaviours is also examined.     

The role of uncertainty in forecasting employment by skill and industry

We show that the macroeconomic uncertainty series from Jurado, Ludvigson, and Ng (2015) contains information to forecast employment. The results indicate that the uncertainty measure is weak at forecasting the skilled labour but significantly carries forecasting information on the unskilled labour. The forecasting information increases if the sample is restricted to construction and manufacturing industries. Using rolling regressions to conduct a simulated out-of-sample forecasting exercise, we find that the uncertainty measure contains forecasting information for the unskilled labour in those industries for two quarters ahead. By providing detailed information about the forecasting power of uncertainty by skill and industry, this study will be helpful in designing more efficient labour market policies.     

Species preservation versus development: An experimental investigation under uncertainty

The safe minimum standard (SMS) is a decision rule to preserve renewable resources, unless the social costs of doing so are intolerable. While unpersuasive to many, support for the SMS has been advocated by some economists for settings involving irreversibility and a high degree of uncertainty. The objective of this paper is to explore decision-making involving species preservation versus development within an experimental laboratory setting, and involving uncertainty. The experimental design implements a number of prior game-theoretic investigations of the SMS (Bishop, 1978; Ready and Bishop, 1991; Palmini, 1999), involving insurance, and lottery or combined games against nature. The choices are between species preservation, which possibly provides a cure for a disease, or developing habitat, leading to irreversible depletion. Econometric results from a random parameters logit model, using responses from 117 participants (across both U.S. and Mexican university student samples) and 9 treatment choices, indicate that support for the SMS varies across the type of game, the imposed maximum regret condition concerning the relative magnitude of the costs of disease and net benefits of development, a constructed measure of respondents' risk aversion, and other factors. There is also strong evidence of unobservable heterogeneous preferences for preservation within our sample.     

Revenue raising trade-restricting policies under uncertainty: The sub-optimality of the expected welfare criterion and some safety-first results

The analysis of trade-restricting policies under uncertainty has typically argued in favour of the specific tariff over alternative commercial policies such as the ad valorem tariff and the quota, when the raising of revenue and maintenance of consumer's welfare are the policy objectives. This paper reconsiders this result. It is demonstrated that, when the shape of the welfare probability distribution is considered explicitly, the quota may be the dominant trade-restricting policy. In addition, the analysis of trade-restricting instruments is analysed for the case where the principle of safety-first is applied to the revenue-raising objective.We should like to thank an anonymous referee for helpful comments on an earlier draft.     

Optimal intensity targets for greenhouse gas emissions trading under uncertainty

Uncertainty is an obstacle for commitments under cap and trade schemes for emission permits. We assess how well intensity targets, where each country’s permit allocation is indexed to its future realized GDP, can cope with uncertainties in international greenhouse emissions trading. We present some empirical foundations for intensity targets and derive a simple rule for the optimal degree of indexation to GDP. Using an 18-region simulation model of a cooperative, global cap-and-trade treaty in 2020 under multiple uncertainties and endogenous commitments, we show that optimal intensity targets could reduce the cost of uncertainty and achieve significant increases in global abatement. The optimal degree of indexation to GDP would vary greatly between countries, including super-indexation in some advanced countries, and partial indexation for most developing countries. Standard intensity targets (with one-to-one indexation) would also improve the overall outcome, but to a lesser degree and not in all individual cases. Although target indexation is no magic wand for a future global climate treaty, gains from reduced cost uncertainty and the potential for more stringent environmental commitments could justify the increased complexity and other potential downsides of intensity targets.      

Managerial flexibility, uncertainty, and corporate investment: The real options effect

This paper examines how changes in uncertainty affect corporate investment and how managerial flexibility influences this effect. Consistent with existing evidence, this study shows that increased uncertainty reduces a firm's capital expenditures even after controlling for investment opportunities and fund availability. It further shows that the negative effect of increased uncertainty on corporate investment is more pronounced for firms with fewer financial constraints and larger size. Overall, the results suggest that managerial flexibility proxied by certain firm characteristics affects the negative relation between uncertainty and investment.     

A welfare analysis of tariffs and equivalent quotas under demand uncertainty: Implications for tariffication

Under market demand uncertainty, we show that quotas can result in a welfare advantage over tariffs for an importing country despite that its government does not capture any quota rents. Specifically, the conditions under which an equivalent quota yields higher expected welfare than a tariff are shown to depend on a set of economic variables. These variables include the initial tariff rate, the relative efficiency in production between home and foreign firms, the probability distribution of random demand shocks that make the quota binding or non-binding under uncertainty, as well as the variance of the stochastic market demand. The analysis of this paper has welfare implications for tariffication.