Contracting with Present-Biased Consumers in Insurance Markets

Present bias challenges consumers with self-control problems when they implement precautionary efforts in insurance markets. To explore how rational insurance companies respond to this bias, this paper analyzes a contract design problem in a monopolistic insurance market with ex ante moral hazard. We consider two types of consumers with this bias: the “naifs”, who do not foresee the present bias and make decisions in a myopic way, and the “sophisticates”, who foresee the bias and incorporate it in the decision process. Relative to the benchmark case where consumers are time-consistent, we show that (i) present bias reduces the monopoly profit, regardless of the consumer type; (ii) present bias can either reduce or increase the coverage of the profit-maximizing insurance contract depending on the extent of the bias; and (iii) when present bias is severe, the insurance company can profitably exploit naifs but not sophisticates. These results still hold when consumers are heterogeneous and their types are unknown to the insurance company.     

Loan Market Competition and Bank Risk-Taking

Recent literature (Boyd and De Nicoló, J Finance 60:1329–1343, 2005) has argued that competition in the loan market lowers bank risk by reducing the risk-taking incentives of borrowers. Using a model where competition arises from falling switching costs for entrepreneurs, we show that the impact of loan market competition on banks is reversed if banks can adjust their loan portfolios. The reason is that when borrowers become safer, banks want to offset the effect on their balance sheet and switch to higher-risk lending. They even overcompensate the effect of safer borrowers because loan market competition erodes their franchise values and thus increases their risk-taking incentives.     

A framework for understanding the evolution of relationship quality and the customer relationship development process

This paper attempts to develop and empirically test a conceptual model of relationship quality (RQ) in the financial sector from the perspective of the individual consumer (B2C). Based on a review of RQ research, the paper proposes a model of RQ from the customer perspective using the constructs most often examined in empirical RQ research (customer satisfaction, trust and commitment) and considers the relative importance of these dimensions within the stages of the relationship development process (RDP). A survey of 150 bank customers was undertaken in Egypt and the results tested using structural equation modelling. Respondents were selected on a convenience sampling basis and administered a questionnaire instrument for completion. The findings show that there is a strong relationship between the customer’s perceived relationship development phase and the perceived RQ. An important contribution of this paper lies in the alternative conceptualization of RQ as composed of three dynamic dimensions which are dependent on the RDP phase or stage. A second contribution is methodological and relates to the development of a modified scale to identify the relationship phases of customers. To the best of the researchers’ knowledge, these contributions are unique and have not been made previously to the body of knowledge on service relationship management.     

What do accruals tell us about future cash flows?

Our model, which is adapted from Feltham and Ohlson (Contemp Account Res 11:689–731, 1995) and Ohlson (Contemp Account Res 11:661–687, 1995) and extends Dechow and Dichev (Account Rev 77:35–59, 2002), characterizes the information about future cash flows reflected in accruals. It reveals investors can extract from accruals information about next period’s economic factor and the transitory part of one component of next period’s cash flow. The extent to which each accrual provides this information depends on whether the accrual aligns future or past cash flows and current period economics and whether it relates to the current or prior period. Thus each type of accrual has a different coefficient in valuation and forecasting cash flows or earnings. Each coefficient combines an information weight reflecting the information that accrual type provides and a multiple reflecting how that information is used in valuation and cash flow and earnings forecasting. The empirical evidence supports our main insight, namely that partitioning accruals based on their role in cash-flow alignment increases their ability to forecast future cash flows and earnings and explain firm value.     

Further examination of the demographic and social factors affecting risk aversion

In this paper we examine how social and demographic factors explain risk aversion. Specifically, we focus on how an individual’s place of residence effects his level of risk aversion. Israel is a natural experiment field for such an investigation since the majority of its population lives either in big or small cities, moshavs, or kibbutzim, where the last two forms of settlement being unique to Israel. The kibbutz follows the prototype of a collectivist culture; the moshav follows the prototype of an individualistic culture. This environment also allows us to reexamine the contradiction between the “cushion hypothesis” and previous findings regarding the risk aversion of Israeli kibbutz residents. In general, we find that the moshav respondents demonstrate the lowest level of risk aversion and the kibbutz (and the small city) respondents demonstrate the highest. However, further examination reveals that the risk aversions are domain specific. The urban residents of both big and small cites are similar to each other than they are to residents of the kibbutz and the moshav, who, in turn, are more similar to each other than they are to the urban residents. For example, kibbutz and moshav respondents are less risk averse in insurance and gambling, but more risk averse in driving and sport, compared to urban residents. Interestingly, on average, the respondents demonstrate the highest level of risk aversion for extreme sports and the lowest level of risk aversion for irresponsible driving.     

Consumption-based equity valuation

Using a CCAPM-based risk-adjustment model, we perform yearly valuations of a large sample of stocks listed on NYSE, AMEX, and NASDAQ over a 30-year period. The model differs from standard valuation models in the sense that it adjusts forecasted residual income for risk in the numerator rather than through a risk-adjusted cost of equity in the denominator. The risk adjustments are derived based on assumptions about the time-series properties of residual income returns and aggregate consumption rather than on historical stock returns. We compare the performance of the model with several implementations of standard valuation models, both in terms of median absolute valuation errors (MAVE) and in terms of excess returns on simple investment strategies based on the differences between model and market prices. The CCAPM-based valuation model yields a significantly lower MAVE than the best performing standard valuation model. Both types of models can identify investment strategies with subsequent excess returns. The CCAPM-based valuation model yields time-series of realized hedge returns with more and higher positive returns and fewer and less negative returns compared with the time-series of realized hedge returns based on the best performing standard valuation model for holding periods from 1 to 5 years. In a statistical test of 1-year-ahead excess return predictability based on the models’ implied pricing errors, the CCAPM-based valuation model is selected as the better model. Using the standard series of aggregate consumption and the nominal price index, a reasonable level of relative risk aversion, and calibrated growth rates in the continuing value at each valuation date, the CCAPM-based valuation model produces small risk adjustments to forecasted residual income and low continuing values. Compared with standard valuation models, it relies less on estimated parameters and speculative elements when aggregating residual earnings forecasts into a valuation.     

On the implied market price of risk under the stochastic numéraire

This papers addresses the stock option pricing problem in a continuous time market model where there are two stochastic tradable assets, and one of them is selected as a numéraire. An equivalent martingale measure is not unique for this market, and there are non-replicable claims. Some rational choices of the equivalent martingale measures are suggested and discussed, including implied measures calculated from bond prices constructed as a risk-free investment with deterministic payoff at the terminal time. This leads to possibility to infer a implied market price of risk process from observed historical bond prices.     

Targeting public services through the unequal treatment of unequals

When private goods are publicly provided, government authorities have to determine the distribution of in-kind benefits to recipients. In this paper, the public service provider is assumed to maximize utility defined over public service supply to different target groups, given a budget constraint. The production technology is target-group-specific and depends on the ability of each target group to produce service outcomes. Three benchmark allocation principles are identified: equality of treatment (ET), equality of outcome (EO), and equality of marginal cost (EMC). These principles can be considered to be consistent with special cases of a public preference model, which allows for compromises between different allocation principles. The condition of technological dominance implies that there is a clear-cut equity–productivity trade-off, whereas violations of this condition may reduce the significance of the trade-off.     

Balancing Power Markets in Germany: Timing Matters

This paper analyzes timing issues on the German balancing power market. We focus the analysis on the length of the bidding period, i.e. the length of the time period a supplier has to provide balancing power capacities, and the question of how far before the beginning of a bidding period the auction should be carried out. We show that different load levels require different plants for the optimal provision of balancing power. In a longer bidding period, the power plants that have the lowest average cost in the bidding period are unlikely to be efficient in all hours of the bidding period. Hence, shortening bidding periods can increase efficiency. Furthermore, we show that an early commitment on a power plant’s mode of operation (when uncertainty about resulting spot prices is still relatively high) also reduces efficiency. This suggests that the auction should be held relatively close to the beginning of the bidding period. Furthermore, we discuss some advantages of a liquid real time market.