Optimal Beliefs, Asset Prices, and the Preference for Skewed Returns by Markus K. Brunnermeier, Christian Gollier and Jonathan A. Parker. Published in volume 97, issue 2, pages 159-165 of American Economic Review, May 2007
In textbook expositions of the equity-premium, riskfree-rate and equity-volatility puzzles, agents are sure of the economy's structure while growth rates are normally distributed. But because of parameter uncertainty the thin-tailed normal distribution conditioned on realized data becomes a thick-tailed Student-t distribution, which changes the entire nature of what is considered “puzzling” by reversing every inequality discrepancy needing to be explained. This paper shows that Bayesian updating of unknown structural parameters inevitably adds a permanent tail-thickening effect to posterior expectations. The expected-utility ramifications of this for asset pricing are strong, work against the puzzles, and are very sensitive to subjective prior beliefs—even with asymptotically infinite data.
In contrast to the believed similarity in their health outcomes, workers in different Western countries report very different rates of work disability. Using new data from the United States and the Netherlands, we offer a partial resolution to this paradox. We find that observed differences in reported work disability largely stem from the fact that Dutch respondents have a lower threshold in reporting whether they have a work disability than American respondents. For those who do not suffer from pain, work disability is similar in both countries once thresholds are the same. For respondents with pain, however, a significant difference remains.
Alice and Bob live in the forest. To sustain themselves, they collect fruits and berries and snare an occasional animal. The nights get cold, but Alice is a skillful fire-builder. Bob has never mastered this art. His fires fizzle and he never seems to collect the right kind of wood. Alice divides her time between collecting food and gathering wood. She does this in such a way that her marginal benefit from time spent collecting food is the same as that from gathering wood. Bob does not attempt to build fires. He spends all of his time gathering food, and every night slinks up and huddles beside Alice’s fire. Bob appreciates the fire’s warmth, but wishes it were larger. Bob has learned to leave morsels of food by the fire for Alice. Warmth and food are both “normal goods ” for Alice. The extra food that Bob leaves induces her to increase her total food consumption, but not by the total amount that Bob leaves for her. She uses some of the time saved by Bob’s gifts to gather more firewood. 1.1 Equilibrium with Unilateral Gifts–An Example Alice’s utility function is U(cA, y) = cAy where cA is the amount of food that she eats and y is the amount of wood on the fire. She has T hours to allocate between collecting food and wood. In an hour, she can collect either one unit of wood or πA units of food. If Bob leaves g units of food by the fire, she maximizes her utility by choosing y = 1
This paper studies the relationship between civil war and the value of firms in a poor, resource-abundant country using microeconomic data for Angola. We focus on diamond mining firms and conduct an event study on the sudden end of the conflict, marked by the death of the rebel movement leader in 2002. We find that the stock market perceived this event as “bad news” rather than “good news” for companies holding concessions in Angola, as their abnormal returns declined by 4 percentage points. The event had no effect on a control portfolio of otherwise similar diamond mining companies. This finding is corroborated by other events and by the adoption of alternative methodologies. We interpret our findings in light of conflict-generated entry barriers, government bargaining power, and transparency in the licensing process.
That communication pervades the everyday life of organizations is a statement of the obvious. How this widespread communication affects organization’s performance is less clear. Another truism about organizations is that their members are seldom fully knowledgeable of the exact state of the world in which they operate. To overcome this information uncertainty burden, organizations tend to devote a substantial amount of resources to retrieve information about their environment. Individual experimentation is a natural way to obtain superior information. When the nature and the consequences of the prevailing uncertainty is common to all organization members, a natural substitute for replications of individual experiments is to have agents communicate their private information among themselves. Communication is then a means to save on experimentation costs when they display diminishing returns. In another vein, shared information fosters coordination between individual agents, which is beneficial to the organization as a whole when coordinated actions lead to higher benefits for everyone. Altogether, when each organization member individually ascertains that both uncertainty and coordination are the main driving Networked INteractIoNs
This paper shows that, with (partial) irreversibility, higher uncertainty reduces the impact effect of demand shocks on investment.Uncertainty increases real option values making firms more cautious when investing or disinvesting.This is confirmed both numerically for a model with a rich mix of adjustment costs, time-varying uncertainty, and aggregation over investment decisions and time, and also empirically for a panel of manufacturing firms.These cautionary effects of uncertainty are large -going from the lower quartile to the upper quartile of the uncertainty distribution typically halves the first year investment response to demand shocks.This implies the responsiveness of firms to any given policy stimulus may be much lower in periods of high uncertainty, such as after major shocks like OPEC I and 9/11.
“Hide-and-seek” games are zero-sum two-person games in which one player wins by matching the other's decision and the other wins by mismatching. Although such games are often played on cultural or geographic “landscapes” that frame decisions nonneutrally, equilibrium ignores such framing. This paper reconsiders the results of experiments by Rubinstein, Tversky, and others whose designs model nonneutral landscapes, in which subjects deviate systematically from equilibrium in response to them. Comparing alternative explanations theoretically and econometrically suggests that the deviations are well explained by a structural nonequilibrium model of initial responses based on “level-k” thinking, suitably adapted to nonneutral landscapes.
Much economic growth research has been devoted to determining the explanatory variables that explain cross-country variation in growth rates. A frequently cited problem with this literature is that the number of potential growth regressors is vast, potentially exceeding the number of countries available for study. Thus, researchers are faced with the task of arbitrarily specifying which explanatory variables to include in their growth regressions, raising concerns about how confident we can be in their results. These concerns were magnified by the influential paper of Ross Levine and David Renelt (1992), in which they employ a variation of Edward E. Leamer’s (1983) extreme bounds analysis to test the robustness of conventional growth regression coefficients to changes in the set of conditioning variables. They conclude that the results of this literature are extremely fragile, with the only robust determinants of growth being physical capital investment, initial income, and secondary school enrollment. In contrast, they demonstrate the fragility of a host of fiscal, monetary, and trade policy variables, as well as measures of political and economic stability and economic distortions. There have been two main responses to their findings. The pessimistic response has been to conclude, given the lack of a reliable statistical relationship between conventional
The dynamics of a linear (or linearized) dynamic stochastic economic model can be expressed in terms of matrices (A, B, C, D) that define a state space system for a vector of observables. An associated state space system (A, ^ B,C, ^D) determines a vector autoregression for those same observables. We present a simple condition for checking when these two state space systems match up and when they do not when there are equal numbers of economic and VAR shocks. We illustrate our condition with a permanent income example.