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By
Traeger, Christian P.
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15 Citations
Uncertainty has an almost negligible impact on project value in the standard economic model. I show that a comprehensive evaluation of uncertainty and uncertainty attitude changes this picture fundamentally. The illustration of this result relies on the discount rate, which is the crucial determinant in balancing immediate costs against future benefits, and the single most important determinant of optimal mitigation policies in the integrated assessment of climate change. First, the paper removes an implicit assumption of (intertemporal or intrinsic) risk neutrality from the standard economic model. Second, the paper introduces aversion to non-risk uncertainty (ambiguity). I show a close formal similarity between the model of intertemporal risk aversion, which is a reformulation of the widespread Epstein–Zin–Weil model, and a recent model of smooth ambiguity aversion. I merge the models, achieving a threefold disentanglement between risk aversion, ambiguity aversion, and the propensity to smooth consumption over time.
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By
D’Alpaos, Chiara; Moretto, Michele; Valbonesi, Paola; Vergalli, Sergio
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10 Citations
We consider the supplier’s strategic choice on delivery time in a public procurement setting as the result of the firm’s opportunistic behavior on the optimal investment timing when production costs are uncertain. We model the supplier’s trade-off between the option value to defer the contract execution and the penalty payment in the event of delays. We also take into account the issue of penalty enforcement, which in turn depends on both the discretion of the court of law in voiding contractual clauses and the “efficiency” of the judicial system (i.e. the average length of civil trials). We test our main results on Italian public procurement data showing that the supplier’s incentive to delay is greater the higher the volatility of production costs and the lower the “efficiency” of the judicial system. We then calibrate the model using parameters that mimic the Italian scenario on public works procurement and calculate the maximum amount that a supplier is “willing to pay” (per day) to postpone the delivery date and infringe the contract provisions. Our calibration results are consistent with the theoretical model’s predictions and the empirical findings.
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By
Jindapon, Paan; Whaley, Christopher A.
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5 Citations
In this paper, we prove existence and uniqueness of equilibrium in a rent-seeking contest given a class of heterogeneous risk-loving players. We explore the role third-order risk attitude plays in equilibrium and find that imprudence is sufficient for risk lovers to increase rent-seeking investment above the risk-neutral outcome. Moreover, we show that rent can be fully dissipated in a standard Tullock contest played by a large number of risk-lovers.
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By
Aloqeili, M.; Carlier, G.; Ekeland, I.
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We consider
$$H$$
expected utility maximizers that have to share a risky aggregate multivariate endowment
$$X\in {\mathbb {R}}^{N}$$
and address the following two questions: does efficient risk-sharing imply restrictions on the form of individual consumptions as a function of
$$X$$
? Can one identify the individual utility functions from the observation of the risk-sharing? We show that when
$$H\ge \frac{2N}{N-1}$$
efficient risk sharings have to satisfy a system of nonlinear PDEs. Under an additional rank condition, we prove an identification theorem.
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By
Xepapadeas, Anastasios; Roseta-Palma, Catarina
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Most renewable natural resources exhibit marked demographic and environmental stochasticities, which are exarcebated in management decisions by the uncertainty regarding the choice of an appropriate model to describe system dynamics. Moreover, demand and supply analysis often indicates the presence of instabilities and multiple equilibria, which may lead to management problems that are intensified by uncertainty on the evolution of the resource stock. In this paper the fishery management problem is used as an example to explore the potential of robust optimal control, where the objective is to choose a harvesting rule that will work under a range of admissible specifications for the stock-recruitment equation. The paper derives robust harvesting rules leading to a unique equilibrium, which could be helpful in the design of policy instruments such as robust quota systems.
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By
Charness, Gary; Karni, Edi; Levin, Dan
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36 Citations
This paper reports the results of experiments testing prevalence of non-neutral ambiguity attitudes and how these attitudes change as a result of interpersonal interactions. To address the first question we conducted experiments involving individual choice between betting on ambiguous and unambiguous events of the subject’s choice. We found that a large majority of subjects display ambiguity neutral attitudes, many others display ambiguity incoherent attitudes, and few subjects display either ambiguity-averse attitudes or ambiguity-seeking attitudes. To address the second question we designed a new experiment with a built-in incentive to persuade. We found that interpersonal interactions without incentives to persuade have no effect on behavior. However, when incentives were introduced, the ambiguity neutral subjects were better able to persuade ambiguity seeking and ambiguity incoherent subjects to adopt ambiguity neutral choice behavior and, to a lesser extent, also ambiguity averse subjects.
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By
Macé, Serge
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1 Citations
When utility is health state dependent, saving decisions depend on how perceived future health will affect the marginal utility of consumption. In consequence, people’s failure to anticipate hedonic adaptation to adverse health changes leads them to save more if consumption and health are Edgeworth complements, but to save less if they are Edgeworth substitutes. When we add a zero-mean risk on future health, a new effect occurs. Since underestimating hedonic adaptation to health change also increases the individual’s sensitivity to health risk, cross-prudence, which corresponds to the willingness to accumulate wealth in the face of future health risks may, depending on the case in question, amplify but also limit the change in savings. These effects add another source of variability among observed saving behaviors. They also singularly complicate the estimation of the health state dependence of the utility function.
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By
Blackburn, Keith; Chivers, David
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4 Citations
We present an overlapping generations model in which aspirational agents face uncertainty about the returns to human capital investment. This uncertainty implies the prospect that aspirations will not be fulfilled, the probability of which is greater the lower is the human capital endowment of an agent. We show that agents with sufficiently low human capital endowments may experience such a strong influence of loss aversion that they abstain from human capital investment. We further show how this behaviour may be transmitted through successive generations to cause initial inequalities to persist. These results do not rely on any credit market imperfections, though they may appear as if they do.
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By
Ordoñez, Guillermo
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2 Citations
Principals usually try to elicit the quality and behavior of agents from their performance. While sometimes success or failure in production does not provide accurate information about the agents, there may be activities not directly related to production that constitute a more precise signal. I show that, when agents face reputation concerns, introducing these activities after a success improves efficiency, while introducing them after a failure reduces efficiency. Hence, nesting activities in the right way may offer a cheap toolbox to provide incentives. As an illustration, I consider a model where reputation concerns drive the hiring decisions of managers in a firm and I show how scapegoating, an activity “nested” after failures in production, generates inefficiencies. While hiring efficient workers increases the probability of success, hiring less efficient workers provides a buffer against reputation loses from failures, since managers can blame them more easily.
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By
Cohen, Michèle; Meilijson, Isaac
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3 Citations
Victor prefers safety more than Ursula if whenever Ursula prefers a constant to an uncertain act, so does Victor. This paradigm, whose expected utility (EU) version is Arrow and Pratt’s more risk aversion concept, will be studied in the Choquet expected utility (CEU) model. Necessary condition Pointwise inequality between a function of the utility functions and another of the capacities is necessary and sufficient for the preference by Victor of safety over a dichotomous act whenever such is the preference of Ursula. However, increased preference for safety versus dichotomous acts does not imply preference by Victor of safety over a general act whenever such is the preference of Ursula. A counterexample will be provided, via the casino theory of Dubins and Savage. Sufficient condition Separation of the two functions by some convex function is sufficient for Victor to prefer safety more than Ursula, over general acts. Furthermore, a condition on the capacities will be presented for simplicity seeking, the preference by Victor over any act for some dichotomous act that leaves Ursula indifferent. This condition is met in particular if Victor’s capacity is a convex function of Ursula’s capacity. For these cases, the pointwise inequality (necessary) condition is a characterization of greater preference for safety, extending the Arrow–Pratt notion from EU to CEU and rank-dependent utility (RDU). These inequalities preserve the flavor of the “more pessimism than greediness” characterization of monotone risk aversion by Chateauneuf, Cohen and Meilijson in the RDU model and its extension by Grant and Quiggin to CEU. Preferences between safety and dichotomous acts are at the core of the biseparable preferences model of Ghirardato and Marinacci.
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