Economic indices of absolute and relative riskiness

Following Aumann and Serrano (J Polit Econ 116:810–836, 2008) who characterize by axioms an index of riskiness defined on absolute returns, we characterize a new index of riskiness defined on relative returns. Both indices are characterized by a similar principle of duality between risk and risk aversion, but while the index of absolute riskiness refers to absolute risk aversion, the index of relative riskiness refers to relative risk aversion. The similarities and differences between the two indices are studied.     

Equilibrium play and adaptive learning in a three-person centipede game

The two-person centipede game is one of the most celebrated paradoxes of backward induction in complete information extensive form games. An experimental investigation of a three-person centipede game shows that the paradoxical results are strongly affected by the size of the stakes. When the number of players in the game is increased from two to three and the game is played for unusually high stakes with group composition being randomly changed from trial to trial, the paradox is considerably weakened as players approach equilibrium play with multiple iterations of the stage game. When the game is played with low stakes, there is no evidence for equilibrium play or learning across iterations of the stage game. An adaptive learning model that assumes updating of the individual probabilities of choice outperforms alternative static and dynamic models in accounting for the major results observed in the high-stake experiment.     

Why does capital structure choice vary with macroeconomic conditions?

We develop a computable general equilibrium model explaining financing over the business cycle. To avert agency conflicts, managers must hold a high percentage of their firm's equity. During contractions, firms substitute debt for equity in order to maintain managerial equity shares. During expansions, risk-sharing improves, with increases in managerial wealth facilitating substitution of equity for debt. In calibrated simulations, (counter) cyclical variation in leverage is only exhibited by less constrained firms. All firms exhibit financial accelerator effects. However, the effect is decreasing in financial flexibility. The model's predictions regarding financing and investment are consistent with empirical evidence.     

Tacit Coordination in a Decentralized Market Entry Game with Fixed Capacity

We focus on a class of market entry games in which a newly emergent market opportunity may be fruitfully exploited by no more than a commonly known, exogenously determined number of firms. Our results show significant effects of the parameters manipulated in the study, namely, the market capacity, entry fee, and method of subject assignment to groups (fixed vs. random). In contrast to previous market entry games with linear payoff functions, we find no evidence of convergence to equilibrium play on the aggregate level. Shifting the focus of the analysis from the aggregate to the individual level, four clusters of subjects are identified. The patterns are: (1) choice of the same action that is independent of the parameters of the game or the outcome of previous presentations of the same game; (2) random choices with probabilities prescribed by the equilibrium solution for risk-neutral players; (3) random choices with probabilities equal to the individual observed overall proportion of entry; and (4) sequential dependencies that violate any model that assumes randomization. Subjects in the fourth and largest category are shown to adjust their choices in accordance with a simple principle of strategic reasoning.     

Sovereign debt: Reputation, seizure and reputation

The interaction between a creditor and a sovereign debtor is described as a ‘one-shot’ game with discrete actions—total or no debt-repudiation and seizure of asset holding abroad. Possible Nash equilibria where each player chooses an action as to maximize his expected payoff given his beliefs about the other player’s action and the implications of those actions on the players’ trustworthy reputation are identified. However, if reputation losses rise convexly with the players’ relative hostility, partial repudiation and seizure can be the preferred strategies. The preferred repudiation and seizure rates are analyzed under asymmetric and symmetric information about the state of the world. (JEL classification F34)     

An integrative analysis of external debt,capital accumulation and production in Latin America,Asia-Pacific and Sub-Saharan Africa

This paper estimates the nexus of inter-relationships between public and private external debts accumulation, capital accumulation and production with panel data for the period 1970–1988 from highly indebted developing countries clustered into three distinct regions: Latin-America, Asia-Pacific and Sub-Saharan Africa. The simultaneous equations' estimation results indicate that the full effects of the public and private external debts on GNP are small and of an opposite sign, whereas an increase in the GNP level raises substantially the public and private external debts. These findings support Bulow-Rogoff's (1990) proposition that the external debts of developing countries are not a primary cause of economic slowdown.     

Equilibrium solutions for resource dilemmas

Considered in this article is a class of resource dilemma games designed to study interactive decision behavior in the face of both strategic and environmental uncertainty. Groups of n members are asked to share a common resource pool whose exact size, x, is not known. Rather, x is sampled randomly from a uniform probability distribution which is common knowledge. Each group member j(j=1,...,n) requests r _j units from the random resource pool. Individual decisions are made independently and anonymously. Preplay communication is prohibited. If (r ₁+r ₂+...+r _n ) x, each member j is granted his/her request; otherwise, group members get nothing. We derive the Nash equilibrium solution for this resource dilemma game, and compare it to an expected utility model originally proposed by Suleiman and Rapoport (1988). We then show that the equilibrium solution accounts for the major qualitative features of experimental results reported in two previous studies.     

Finding your innovation sweet spot

Most new product ideas are either uninspired or impractical. So how can developers hit the innovation sweet spot--far enough from existing products to attract real interest but close enough that they are feasible to make and market? They can apply five innovation patterns that manipulate existing components of a product and its immediate environment to come up with something both ingenious and viable, say the authors. The subtraction pattern works by removing product components, particularly those that seem desirable or indispensable. Think of the legless high chair that attaches to the kitchen table. The multiplication pattern makes one or more copies of an existing component, then alters those copies in some important way. For example, the Gillette double-bladed razor features a second blade that cuts whiskers at a slightly different angle. By dividing an existing product into its component parts--the division pattern--you can see something that was an integrated whole in an entirely different light. Think of the modern home stereo--it has modular speakers, tuners, and CD and tape players, which allow users to customize their sound systems. The task unification pattern involves assigning a new task to an existing product element or environmental attribute, thereby unifying two tasks in a single component. An example is the defrosting filament in an automobile windshield that also serves as a radio antenna. Finally, the attribute dependency pattern alters or creates the dependent relationships between a product and its environment. For example, by creating a dependent relationship between lens color and external lighting conditions, eyeglass developers came up with a lens that changes color when exposed to sunlight.     

Analyzing the impact of credit migration in a portfolio setting

Credit migration is an essential component of credit portfolio modeling. In this paper, we outline a framework for gauging the effects of credit migration on portfolio risk measurements. For a typical loan portfolio, we find credit migration can explain as much as 51% of volatility and 35% of economic capital. We compare through-the-cycle migration effects, implied by agency rating transitions, with point-in-time migration, implied by EDF? (Expected Default Frequency) transitions, and find that migration of point-in-time credit quality accounts for a greater fraction of total portfolio risk when compared with through-the-cycle dynamics. In a stylized analytic setting, we show that, when controlling for PD term structure effects, higher likelihood of moving away from the current credit state does not necessarily imply greater risk. Finally, we review methods for generating high-frequency transition matrices, needed for analyzing instruments with cash flows or contingencies whose frequencies are asynchronous to an available transition matrix. We further demonstrate that the naïve application of such methods can result in material deviations to portfolio analytics.