the effect of ambiguity aversion on insurance and self protection in this article we derive a set of simple conditions such that ambiguity aversion always raises the demand for self insurance and the insurance coverage but decreases the demand for self protection we also characterise the optimal insurance design under ambiguity aversion and exhibit a case in which the straight deductible contract is optimal as in the expected utility model

financial markets and growth the last five years have witnessed a resurgence of interest in the relationship between financial intermediation and economic growth this issue had been extensively studied nearly two decades earlier by goldsmith 1969 mckinnon 1973 shaw 1973 and others who produced considerable evidence that financial development correlates with growth but their work though insightful lacked analytical foundations in traditional growth theory financial intermediation could be related to the level of the capital stock per worker or to the level of productivity but not to their respective growth rates the latter were ascribed to exogenous technical progress the recent revival of interest in the link between financial development and growth stems mainly from the insights and techniques of endogenous growth models which have shown that there can be self sustaining growth without exogenous technical progress and that the growth rate can be related to preferences technology income distribution and institutional arrangements this provides the theoretical underpinning that early contributors lacked tinancial intermediation can be shown to have not only level effects but also growth effects the resulting models have offered important insights into the effect of financial development on growth and vice versa they have also provided new impetus to empirical research on these issues this paper reviews the ground covered so far on the theoretical and empirical front and points to some still unresolved issues

additional aspects of rational insurance purchasing the purchase of insurance provides an individual with the ability to shift risk associated with either timeless or temporal uncertain prospects see dreze and modigliani 1972 previous insurance decision analysis can be further divided into cases in which the insurance contract is exogenously specified see mossin 1968 smith 1968 and cases in which the optimal form of contract is to be determined see raviv 1979 brennan and solanki 1981 this note is concerned with extending some of the results for timeless uncertain prospects with the insurance contract exogenously specified many of the properties associated with the purchase of insurance for timeless uncertain prospects are analyzed by mossin 1968 for different forms of contracts see also gould 1969 utilizing the arrow pratt measure of absolute risk aversion the effect of wealth upon the optimal amount of insurance is determined for the different forms of contracts recent work by ross 1981 demonstrates that in situations where individuals face more than one timeless uncertain prospect and they can purchase insurance only for a subset of these prospects then a more risk averse individual in the arrow pratt this paper examines the use of the arrowpratt and ross measures of risk aversion it is shown that in situations where the individual faces more than one uncertain prospect and can purchase insurance only for a subset of these prospects then in many cases the arrow pratt and ross measures of risk aversion are not sufficient to describe the behavior of the individual in purchasing insurance

the economic growth effect of offshore banking in host territories evidence from the caribbean summary following the success of renowned caribbean offshore centers several small islands have enacted offshore banking policies as a strategy for increasing economic growth several empirical studies have assessed the growth effect of such policies but none accounts for sector size when estimating its growth impact this study contributes to this literature by estimating the magnitude of offshore activity in each territory and using this estimate as a continuous variable in an economic growth model the results provide support for the hypothesis that facilitating offshore banking stimulates economic growth in host islands and that the benefit is proportional to sector size

optimal insurance in incomplete markets this paper examines the theory of optimal insurance purchasing in the presence of uninsurable background risk existing theorems concerning the optimal level of insurance and the optimal form of an insurance contract are shown to hold only under restricted market and risk assumptions in particular conditions sufficient for the optimality of full coverage or sufficient for the optimality of deductible policies depend on the correlation between insurable and uninsurable risks these results may provide a partial explanation why existing theory is often contradicted by observable behavior

welfare comparisons of u s dairy policies with and without mandatory supply control the existence of costly dairy surpluses has led some policy makers to argue in favor of mandatory supply controls as an alternative to existing dairy policy a dynamic econometric model is used to simulate the changes in equilibrium prices quantities producer and consumer welfare and government costs that would occur if mandatory controls were adopted the results show that while such a change in policy would eliminate the costs associated with current price supports the benefits accruing to producers would be achieved at the expense of consumers and processors

financial deepening trade openness and economic growth in latin america and the caribbean this contribution investigates the causal interactions between financial deepening trade openness and economic growth in 13 latin american and caribbean countries we construct a composite indicator for financial deepening and use it to detect granger causality within a modified vector autoregressive vector error correction model var vecm framework we find almost no evidence for the popular hypothesis of finance led growth evidence of bidirectional finance growth causality is stronger but mostly instable in the long run most results indicate a demand following or insignificant causal relationship between finance and growth there is also no evidence that finance indirectly induces growth via the channel of trade openness hence policies that prioritize financial and trade sector development cannot be supported

optimal coverage for incompletely reliable insurance abstract optimal actuarially fair coverage of insurance subject to default risk can be less or more than full depending upon the relation between the recovery rate under default and a positive trigger level that is independent of the insured s risk preference

a wavelet analysis of capital markets integration in latin america the continuous wavelet transform analysis may provide a rich and flexible framework for the analysis of time series which exhibit less stable statistical properties such as the ones describing the dynamic trajectory of capital markets in contrast to the fourier analysis wavelet transform preserves information on both time and frequency we provide a summary of the most important features of this framework by involving the concept of coherence as well as its partial and multiple forms we analyse the connections between santiago stock exchange mexican stock exchange and bm fbovespa sao paulo stock exchange for a time span which covers the 23 september 2003 12 march 2014 period we highlight the existence of several significant forces of regional integration and of a short to medium run synchronization process between these markets we conclude that deeper structural and institutional reforms are required in order to enhance the sustainable development and more profound integration of these markets

marketing quotas and random yields marginal effects of inframarginal subsidies on peanut supply the u s peanut program restricts domestic sales with poundage quota but allows surplus production to be exported or crushed empirical analysis of north carolina peanut production reveals that the marginal and lower price received by production above quota that is the world price is far more important in determining acreage than is the inframarginal subsidy of the quota support price

technology choice under changing peanut policies the effect of marketing quotas and price supports on technology adoption are examined for peanut production in the southeastern united states using a real options model of investment with output price and yield uncertainty the optimal choice of peanut production technology dryland versus irrigated in the southeast is shown to depend on price supports and how they change the manner in which price supports change will have an effect on the choice and rates of abandonment or adoption of production technologies

loss aversion and the demand for index insurance abstract this work analyzes if reference dependence and loss aversion can explain the puzzling low adoption rates of rainfall index insurance we present a model that predicts the impact of loss aversion on index insurance demand to vary with different levels of insurance understanding index insurance demand of farmers who are unaware of the loss hedging benefit that insurance provides decreases with loss aversion in contrast insurance demand of farmers who are aware of the loss hedging benefit increases with loss aversion the model further predicts that farmers who are unaware of the loss hedging benefit will not demand an even highly subsidized index insurance using data from a randomized controlled trial involving a sample of indian farmers we provide empirical support for our core conjecture that insurance understanding mitigates the negative impact of loss aversion on index insurance adoption

contract nonperformance risk and uncertainty in insurance markets insurance contracts may fail to perform leading to a default on valid claims we relax the standard assumption of known probabilities for such defaults by allowing for uncertainty within a large behavioral experiment we show that introducing risk and uncertainty each leads to significant reductions in insurance demand and that the effects are comparable in magnitude 17 1 and 14 5 percentage points furthermore risk and ambiguity averse participants are affected most these findings are in line with models incorporating ambiguity attitudes or alternatively pessimistic beliefs an analysis of the belief and decision dynamics suggests persistent pessimistic priors and disregard of peer experiences leading to a stable uncertainty effect

acreage decisions under marketing quotas and yield uncertainty a conceptual model examines how quotas and yield uncertainty affect acreage decisions production in excess of a quota can occur if the price for quota production is large relative to marginal costs increasing risk aversion increases expected production further if the risk of forfeiting quota revenue is given greater weight than avoiding production risk allowing quota carryover decreases production levels simulations indicate the most important factors determining expected production levels are a the existence of a carryover provision b the price differential given to quota production relative to nonquota production and c the level of marginal costs relative to the quota price

the interdependence of individual portfolio decisions and the demand for insurance we analyze the individual s demand for insurance as a special case of general portfolio hedging activity the demand for insurance contracts is determined simultaneously with the demands for other assets in the portfolio we demonstrate that when the payoffs of the policy are correlated with the payoffs to the individual s other assets the demand for insurance contracts is generally not a separable portfolio decision we argue that this separability condition is not generally met because of significant interdependence of claims across different insurance policies furthermore our generalizations can reverse the standard prediction that wealthier individuals will demand less insurance

ambiguity aversion and incompleteness of financial markets it is widely thought that incomes risks can be shared by trading in financial assets but financial assets typically carry some risk idiosyncratic to them hence disposing incomes risk using financial assets will involve buying into the inherent idiosyncratic risk however standard theory argues that diversification would reduce the inconvenience of idiosyncratic risk to arbitrarily low levels this argument is less robust than what standard theory leads us to believe ambiguity aversion can exacerbate the tension between the two kinds of risks to the point that classes of agents may not want to trade some financial assets thus theoretically the effect of ambiguity aversion on financial markets is to make the risk sharing opportunities offered by financial markets less complete than it would be otherwise

growth and adjustment in east asia and latin america this paper compares the experience of growth performance and macroeconomic adjustment between east asia and latin america over the period from 1970 to 2000 we find that the difference in growth performance between two regions are largely attributed to the differences in fundamental growth factors such as investment rate human resources fertility institutional quality macroeconomic stability and the degree of trade openness we also discuss the role of quality of education and differences in inequality between the two regions balance of payments crisis shocks have also contributed significantly to the differences of growth performance across regions the adjustment from balance of payments crises shows that the growth rates tend to be lowered only temporarily following a crisis and then rebound to the pre crisis levels thereby existing the typical v type pattern of adjustment from crises has been in both east asia and latin american crisis episodes however often a balance of payments crisis is associated with a large decline of growth rates and developed into another crisis in the future we estimate the determinants of the output costs of crises and find that international liquidity financial soundness real exchange rate depreciation and monetary policy play a critical role in reducing output losses from crises

cross hedging under multiplicative basis risk cross hedging price risk in an incomplete financial market creates basis risk we propose a new way of modeling basis risk where price risk and basis risk are combined in a multiplicative way under this specification positive prudence is a necessary and sufficient condition for underhedging in an unbiased market using the example of cross hedging jet fuel price risk with crude oil futures we show that the new specification is superior in describing the price series and that optimal cross hedges differ significantly from those derived under the traditional additive cross hedging model

financial development and economic growth the case of taiwan this paper examines the relationship between financial development and economic growth in taiwan from 1962 to 1998 using a four variable var model the competing hypotheses of demand following versus supply leading are empirically tested the results from granger causality tests based on vector error correction models vecm suggest unidirectional causality running from financial development measured as the ratio of m2 to gdp to economic growth this result supports the supply leading hypothesis for taiwan this finding highlights the importance of financial development in taiwan s recent growth

financial markets the pattern of industrial specialization and comparative advantage evidence from oecd countries due to underlying technological and organizational differences industries differ in their need for external finance since services provided by the financial sector are largely immobile across countries the pattern of industrial specialization should be influenced by the level of financial development among oecd countries we find a strong causal effect of the financial sector on industrial specialization further the financial sector is a source of comparative advantage in a way consistent with the hecksher ohlin vanek model results are also presented on which aspects of financial systems are important for specialization and comparative advantage

moral hazard and background risk in competitive insurance markets we examine the effect of background risk on competitive insurance markets with moral hazard if policy holders have non negative prudence then background risk does not decrease effort and when effort increases expands the set of feasible policies however the effect of background risk on equilibrium is indeterminate we analyse the choice between stock and mutual insurance mutual insurance is equivalent to a fair policy plus background risk our results imply that competitive insurance markets with moral hazard should be dominated by stock insurers

does financial development lead economic growth a vector auto regression appraisal using a vector autoregression var approach several hypotheses are re examined suggested by the literature concerning the relationship between financial development and economic growth investment and productivity the models use quarterly time series data from ten oecd countries and china innovation accounting or variance decomposition and impulse response function analysis is applied to examine interrelationships between variables in the var system and therefore differs from the more usual granger causality approach in particular it examines the relationship between financial development proxied by total credit at best weak support is found for the hypothesis that financial development leads economic growth

insurance cycles interest rates and the capacity constraint model insurance profits exhibit cyclical behavior that has been attributed to capital market constraints the authors show that changes in interest rates simultaneously affect the insurer s capital structure and the equilibrium underwriting profit depending upon asset and liability maturity structure capital market access and reinsurance availability insurers will be differently affected by changing interest rates the authors find that the average market response to changing interest rates roughly tracks market clearing prices these cyclical effects are enhanced for firms with mismatched assets and liabilities and more costly access to new capital and reinsurance this evidence supports the capacity constraint hypothesis copyright 1995 by university of chicago press

financial intermediation and economic performance historical evidence from five industrialized countries this paper examines the nature of links between the intensity of financial intermediation and economic performance that operated in the united states the united kingdom canada norway and sweden over the 1870 1929 period after describing the coevolution of the financial and real sectors in these countries vector error correction models vecms establish the quantitative importance of long run relationships among measures of financial intensity and real per capita levels of output and the monetary base granger causality tests then suggest a leading role for the intermediation variables in real sector activity while feedback effects are largely insignificant the results suggest an important role for intermediation in the rapid industrial transformations of all five countries

price regulation in property liability insurance a contingent claims approach a discrete time option pricing model is used to derive the fair rate of return for the property liability insurance firm the rationale for the use of this model is that the financial claims of shareholders policyholders and tax authorities can be modeled as european options written on the income generated by the insurer s asset portfolio this portfolio consists mostly of traded financial assets and is therefore relatively easy to value by setting the value of the shareholders option equal to the initial surplus an implicit solution for the fair insurance price may be derived unlike previous insurance regulatory models this approach addresses the ruin probability of the insurer as well as nonlinear tax effects

markets for risk and openness to trade how are they related if protectionist trade policies aim to insure domestic industries against swings in world market prices the development of financial markets could lead to trade liberalization likewise trade lib

strategic risk taking when there is a public good to be provided privately abstract we describe a situation where a risk averse individual has a preference for risk taking in the literature we find this strategic risk behaviour in an altruistic framework where the individual actually benefits from his noninsurance only in the loss outcome in our model all agents are perfectly selfish when a public good is to be provided privately after the insurance decision the player facing greater uncertainty can expect an income transfer from the other individuals through the commitments to the public good this ex ante income transfer is not conditional on the loss

a note on insurance coverage in incomplete markets in this paper full insurance coverage on average is defined as the coinsurance rate that eliminates all insurable risk when the uninsurable risk is evaluated at its mean the regressibility assumption is used to derive the conditions on the correlation between background and insurable risks and the actuarial unfairness of insurance under which full over or underinsurance on average is optimal these conditions are compared to those for the case of default risk together they explain intuitively the different results under the cases of background risk and default risk obtained in the literature

price volatility and risk exposure on market based environmental policy instruments abstract we explore the efficacy of price and quantity controls as environmental policy instruments in a stochastic setting in which agents are risk averse we demonstrate that the assumption of risk aversion may improve the performance of a tax relative to that of a system of tradable quotas and that restricting quota trade may enhance efficiency even though risk aversion in itself limits volumes of trade the government may be able to improve the performance of a tradable quota system by judicious choice of distribution and amount of initial quotas and by trading pro actively in the quota market

financial development and economic growth abstract this paper examines the empirical relationship between long run growth and financial development proxied by the ratio between bank credit to the private sector and gdp we find that this proxy is positively correlated with growth in a large cross country sample but its impact changes across countries and is negative in a panel data for latin america we argue that the latter findings is the result of financial liberalization in a poor regulatory environment our findings also show that the main channel of transmission from financial development to growth is the efficiency rather than the volume of investment

cointegration how short is the long run abstract when testing for cointegration and faced with short sample periods it is common for researchers to turn to more frequently sampled observations that is to move from annual to quarterly or monthly data in order to increase the number of observations we argue that such a gain in the degrees of freedom is more apparent than real essentially cointegration is a long run concept and hence requires long spans of data to give tests for cointegration much power rather than merely large numbers of observations using monte carlo simulations we demonstrate this for four popular tests for cointegration

the optimal deductible for an insurance policy when initial wealth is random individual wealth typically includes risky assets often some of these risks are insurable but other risks such as market valuation of stocks inflation and other general economic conditions are usually not insurable a series of recent papers by kihlstrom romer and williams 1981 ross 1981 nachman 1982 and pratt 1982 have shown that the introduction of background risk requires stronger definitions of risk aversion we will use some of these results to examine the choice of the optimal deductible in an insurance contract when initial wealth is random an examination of insurance purchases within a broader portfolio is considered by doherty 1981 and by mayers and smith 1983 these papers use a mean variance framework to examine the separability of the insurance decision in general portfolio relationships have nontrivial implications for insurance buying strategies in particular correlation between insurable and noninsurable risk may affect the optimal level of insurance coverage deductible insurance is considered mainly because of its widespread use by many insurers furthermore deductibles the literature concerning the choice of optimal deductibles for insurance policies assumes that wealth is nonstochastic except for the value being insured however a decision maker s asset portfolio might easily contain other sources of risk some of which might be uninsurable this paper examines the choice of a deductible insurance contract in the presence of uninsurable background risk existing theorems concerning the optimality of full coverage are shown to hold only under restricted conditions concerning the correlation of insurable risk with other risky assets more general propositions are established and the effects of risk aversion are considered

a new database on the structure and development of the financial sector this article introduces a new database of indicators of financial structure and financial development across countries and over time the database is unique in that it combines a wide variety of indicators that measure the size activity and efficiency of financial intermediaries and markets it improves on previous efforts by presenting data on the public share of commercial banks introducing indicators of the size and activity of nonbank financial institutions and constructing measures of the size of bond and primary equity markets this article introduces a new database the first to provide comprehensive measures of the development structure and performance of the financial sector this database is the first to define and construct indicators of the size and activity of nonbank financial intermediaries such as insurance companies pension funds and non deposit money banks it is also the first to include indicators of the size of primary equity markets and primary and secondary bond markets in constructing the database authors carefully deflate measures and match stock and flow variables

second best insurance contract design in an incomplete market the optimal form of insurance contracts for multiple risks is examined a well known result in the literature is that under fairly general conditions an insurance policy with a deductible for aggregate losses is optimal real world markets however are typically incomplete in that they require separate contracts for separate loss exposures for instance insurable damage to one s home is not generally allowed to affect the insurance indemnity for unrelated insurable damage to one s automobile we show that separate deductibles are second best optima in this setting we compare the indemnity provided in this second best setting with first best solutions the effect of second best contracts on the individual s total insurance demand is also examined

the design of an optimal insurance policy almost every phase of economic behavior is affected by uncertainty the economic system has adapted to uncertainty by developing methods that facilitate the reallocation of risk among individuals and firms the most apparent and familiar form for shifting risks is the ordinary insurance policy previous insurance decision analyses can be divided into those in which the insurance policy was exogenously specified see john gould jan mossin and vernon smith and those in which it was not see karl borch 1960 and kenneth arrow 1971 1973 in this paper the pioneering work of borch and arrow the derivation of the optimal insurance contract form from the model is synthesized and extended

the economic effects of supply controls the simple analytics of the u s peanut program a gricultural commodity programs employ a wide variety of policy tools to regulate u s agriculture price supports are the most common form of intervention but rights to sell at the supported price are allocated very differently under different commodity programs under recent feed grain programs for example the right to sell at the supported price is linked to acreage set asides agreements not to produce on certain acres in other programs sales by individual farmers are controlled under marketing orders sponsored by the u s department of agriculture usda 2 a third method is through permanent maketing quotas that directly limit output only two major commodity programs those for tobacco and peanuts currently allocate the right to sell in this way the peanut program is the subject of this article 3

the grain sector of the european community policy formation price determination and implications for trade a coresponsibility levy was added to high domestic prices and export subsidies in the ec levels for policy instruments could result from negotiations which favor producers but are acceptable to the public higher domestic prices and levies but lower export subsidies would occur if levy exemptions cover domestic marketings if exemptions are excluded low domestic prices producer subsidies and export taxes would occur with exemptions improved farm income and treasury surpluses would be achieved without injury to the public exemptions might be excluded because producers are better off and public cost is about the same with either program but producer subsidies require expanded public financing export reductions would occur under either program given prevailing market conditions

natural catastrophe insurance when should the government intervene this paper develops a theoretical framework for analyzing the decision to provide or buy insurance against the risk of natural catastrophes in contrast to conventional models of insurance the insurer has a non zero probability of insolvency which depends on the distribution of the risks the premium rate and the amount of capital in the company when the insurer is insolvent each loss reduces the indemnity available to the victims thus generating negative pecuniary externalities our model shows that government provided insurance will be more attractive in terms of expected utility as it allows these negative pecuniary externalities to be spread equally among policyholders however when heterogeneous risks are introduced a government program may be less attractive in safer areas which could yield inefficiency if insurance ratings are not chosen appropriately

pricing in microinsurance markets summary microinsurance markets have exhibited strong growth rates in recent years great parts of the industry are however challenged by fundamental issues of providing insurance products one of the most significant of which is pricing risk in this paper we provide a nontechnical analysis of insurance pricing problems and a review of the set of opportunities that can address some of the specific pricing constraints in microinsurance markets a key contribution of this paper is the investigation of conventional techniques as potential solutions for improving the pricing of insurance risk in microinsurance markets

ambiguity aversion decreases the impact of partial insurance evidence from african farmers indemnifying smallholder farmers against crop loss is thought to play an important role in encouraging the adoption of new technologies and facilitating productivity growth but to be infeasible due to information problems consequently there is interest in developing alternative partial insurance products examples include rainfall insurance and the limited liability inherent in credit contracts i argue that although these products may reduce information asymmetry ambiguity averse farmers struggle to assess whether the contracts reduce risk this problem is most pronounced when the production technology is ambiguous as is likely the case for new technologies i formalize this argument and test the theory using data from two rcts conducted in malawi and kenya comparative statics from the theory are consistent with both sets of data and i argue that income losses from ambiguity aversion may be substantial

financial development and economic growth nexus a time series evidence from india this study examines the relationship between financial development and economic growth in india for the period 1951 52 to 1995 96 the long run equilibrium and short run dynamic models are estimated using financial interrelations ratio and new issue ratio as the measures of financial development a la goldsmith 1969 the johansen 1991 estimator rejects the null of zero cointegrating vector and shows the presence of long run equilibrium relationship between financial development and economic growth the error correction model impulse response and variance decomposition analyses sims 1980 and the toda and yamamoto 1995 estimator show the presence of bidirectional granger causality between financial development and economic growth the presence of bidirectional granger causality suggested by these estimators points towards the possible problem of endogeneity and simultaneity bias in the growth models that examine the contemporaneous effect of financial development on economic growth the economic

exclusive vs independent agents a separating equilibrium approach abstract we provide a separating equilibrium explanation for the existence of the independent insurance agent system despite the potentially higher costs of this system compared to those of the exclusive agents system or direct underwriting a model is developed assuming asymmetric information between insurers and insureds the former do not know the riskiness of the latter we also assume that the claims service provided by the independent agent system to its clients is superior to that offered by direct underwriting system that is insureds using the independent agent system are more likely to receive reimbursement of their claims competition compels the insurers to provide within their own system the best contract to the insured it is shown that in equilibrium the safer insureds choose direct underwriting whereas the riskier ones choose independent agents the predictions of the model agree with previous research demonstrating that the independent agent system is costlier than direct underwriting the present model suggests that this does not result from inefficiency but rather from self selection the empirical implication of this analysis is that ceteris paribus the incidence of claims made by clients of the independent agents system is higher than that of clients of direct underwriting implications for the coexistence of different distribution systems due to unbundling of services in other industries such as brokerage houses and the health care industry are discussed

rational insurance purchasing consideration of contract nonperformance much of the analysis of rational insurance purchasing and hedging strategies has been undertaken on the basis of the expected utility hypothesis this decision framework has been used to reformulate the bernoulli principle that a risk averter rationally would fully insure at a fair premium other applications include the analysis of insurance at unfair premiums mossin 1968 and smith 1968 the effects of state dependent utility on the rational insurance purchase cook and graham 1977 the effects of risky background wealth doherty and schlesinger 1983 and mayers and smith 1983 and the design of the optimal insurance policy raviv 1979 such analyses have been conducted on the assumption that insurance policies are free of insolvency default risk this assumption stands in sharp contrast to the actuarial literature in which the insolvency risk or probability of ruin is a central focus of attention

responsiveness of rural and urban land uses to land rent determinants in the u s south ricardian and von thunen land rent models are combined into a single land use share model including farm forest and urban land uses the land share model is applied to the southern united states and elasticities are extracted that measure land share response to changes in population income land values prices and costs in counties with different degrees of urbanizationt he study explores the effect of treating either rural or urban land as a residual use while this practice is common in existing land use studies it is found to significantly affect parameter estimates in this county level analysis

the pricing of options with default risk this paper considers the pricing of options with default risk the comparative statics of such options can differ from those of ordinary options and early exercise of such american call options can be optimal several examples of options with default risk are considered traditionally it has been assumed that options have no default risk such an assumption is reasonable when one studies options traded on an organized exchange in the u s default on such options would require as cox and rubinstein 5 put it a very sudden and strong movement in stock prices one considerably more extreme than any on record p 71 however many options and financial assets containing option like payoffs are sold by firms that have limited assets for such options default is often a possibility that must be taken seriously in this paper we study how options subject to default risk which we hereinafter call vulnerable options are priced it turns out that many of the well established results of the option pricing literature see e g smith 12 and references therein do not hold for vulnerable options in particular the value of a vulnerable european option can fall with time to maturity with the interest rate and with the variance of the underlying asset furthermore it may pay to exercise early a vulnerable american option on a non dividend paying asset

choice under uncertainty problems solved and unsolved ffifteen years ago the theory of choice under uncertainty could be considered one of the success stories of economic analysis it rested on solid axiomatic foundations it had seen important breakthroughs in the analytics of risk risk aversion and their applications to economic issues and it stood ready to provide the theoretical underpinnings for the newly emerging information revolution in economics 1 today choice under uncertainty is a field in flux the standard theory is being challenged on several grounds from both within and outside economics the nature of these challenges and of our profession s responses to them is the topic of this paper

insurance as a giffen good abstract can insurance be a giffen good this can never happen if the coefficient of relative risk aversion is less than or equal to one if this coefficient is greater than one it is possible but not empirically plausible

positive time preference the case for positive time preference is absolutely compelling unless there is an infinite time horizon with the expectation of unending technological advance combined with what we call drastically diminishing marginal utility this finding holds both in the positive and normative senses a corollary is that savings are interest elastic

some stronger measures of risk aversion in the small and the large with applications the arrow pratt measures of risk aversion for von neumann morgenstern utility functions have become workhorses for analyzing problems in the microeconomics of uncertainty they have been used to characterize the qualitative properties of demand in insurance and asset markets to examine the properties of risk taking in taxation models and to study the interaction between risk and life cycle savings problems to name just a few applications equally importantly they have generated the linear risk tolerance class of utility functions which has provided canonical examples in such diverse areas as portfolio theory and the theory of teams despite these successes there have been a number of areas for which the results have been weaker than hoped it is natural to use the risk aversion measures to compare the behavior of individuals in risky choice situations for example consider the individual portfolio choice problem in a two asset world with a riskless asset and a risky asset if individual a has a uniformly higher arrow pratt coefficient of risk aversion than individual b then b will always choose a portfolio combination with more wealth invested in the risky asset but suppose that both assets are risky now there is no obvious sense in which the more risk averse individual can be said to hold a less risky portfolio but it seems strange that such a simple alteration should destroy the analytics which support the basic intuition similarly consider the basic insurance problem if one individual a is more risk averse than another b in the arrow pratt sense it follows that a will pay a larger premium to insure against a random loss than will b typically though an individual evaluates partial rather than total insurance that is only some gambles can be insured against and others must be retained in this case even when the gambles which are retained are independent from those which are insured it is no longer true that the individual whose arrow pratt measure of risk aversion is higher will pay a larger insurance premium the situation is no better when we consider comparative statics exercises for a single individual decreasing absolute risk aversion in the sense of arrow and

implications of incomplete performance for optimal insurance we investigate the demand for insurance when contracts are subject with positive probability to two distinct types of incomplete performance when partial performance means payment of some fraction of the indemnity under full performance the latter exhibits a disappearing deductible when partial performance is due to insufficient financial capacity optimal insurance contracts for any given level of financial capacity offer full marginal coverage above a deductible for either type of non performance the optimal deductible under full performance is positive when insurance is offered at an actuarially fair price

ambiguity attitudes in a large representative sample using a theorem showing that matching probabilities of ambiguous events can capture ambiguity attitudes we introduce a tractable method for measuring ambiguity attitudes and apply it in a large representative sample in addition to ambiguity aversion we confirm an ambiguity component recently found in laboratory studies a insensitivity the tendency to treat subjective likelihoods as 50 50 thus overweighting extreme events our ambiguity measurements are associated with real economic decisions specifically a insensitivity is negatively related to stock market participation ambiguity aversion is also negatively related to stock market participation but only for subjects who perceive stock returns as highly ambiguous this paper was accepted by james smith decision analysis

preference reversals for ambiguity aversion this paper finds preference reversals in measurements of ambiguity aversion even if psychological and informational circumstances are kept constant the reversals are of a fundamentally different nature than the reversals found before because they cannot be explained by context dependent weightings of attributes we offer an explanation based on sugden s random reference theory with different elicitation methods generating different random reference points then measurements of ambiguity aversion that use willingness to pay are confounded by loss aversion and hence overestimate ambiguity aversion this paper was accepted by teck ho decision analysis

effects of ambiguity in market experiments prior studies have shown that individuals are averse to ambiguity in probability many decisions are however made in market settings where an individual s decision is influenced by decisions of others participating in the market in this paper we extend the previous research to evaluate the effect of ambiguity on individual decisions and the resulting market price in market settings we therefore examine an important issue whether ambiguity effects persist in the face of market incentives and feedback two different market organizations the sealed bid auction and the double oral auction were employed the subjects in the experiments were graduate business students and bank executives our results show that the individual bids and market prices for lotteries with ambiguous probabilities are consistently lower than the corresponding bids and market prices for equivalent lotteries with well defined probabilities the aversion to ambiguity therefore does not vanish in market settings our results provide insights into what a manager can expect in bidding situations where the object of the sale oil leases mineral rights involves ambiguity in probability due to for example lack of information or prior experience the results may also be useful in understanding some phenomena in insurance and equity markets

a definition of uncertainty aversion a definition of uncertainty or ambiguity aversion is proposed it is argued that the definition is well suited to modelling within the savage as opposed to anscombe and aumann domain of acts the defined property of uncertainty aversion has intuitive empirical content behaves well in specific models of preference multiple priors and choquet expected utility and is tractable tractability is established through use of a novel notion of differentiability for utility functions called eventwise differentiability

financial liberalisations in latin america in the 1990s a reassessment this paper studies the experience of latin america latam with financial liberalisation in the 1990s the rush towards financial liberalisations in the early 1990s was associated with expectations that external financing would alleviate the scarcity of saving in latam thereby increasing investment and growth yet the data and several case studies suggest that the gains from external financing are overrated the bottleneck inhibiting economic growth is less the scarcity of saving and more the scarcity of good governance a possible interpretation for these findings is that in countries where private savings and investments were taxed in an arbitrary and unpredictable way the credibility of a new regime could not be assumed or imposed instead credibility must be acquired as an outcome of a learning process consequently increasing the saving and investment rates tends to be a time consuming process this also suggests that greater political instability and polarisation would induce consumers to be more cautious in increasing their saving and investment rates following a reform hence reaching a sustained take off in latin america is a harder task to accomplish than in asia

portfolio choices and asset prices the comparative statics of ambiguity aversion we investigate the comparative statics of more ambiguity aversion as defined by klibanoff marinacci and mukerji 2005 in the context of the static two asset portfolio problem it is not true in general that more ambiguity aversion reduces the demand for the uncertain asset we exhibit some sufficient conditions to guarantee that ceteris paribus an increase in ambiguity aversion reduces the demand for the ambiguous asset and raises the equity premium for example this is the case when the set of plausible distributions of returns can be ranked according to the monotone likelihood ratio order we also show how ambiguity aversion distorts the price kernel in the alternative portfolio problem with complete markets for contingent claims

financial liberalization financial sector development and growth evidence from malaysia abstract the objective of this paper is to examine whether financial development leads to economic growth or vice versa in the small open economy of malaysia using time series data from 1960 to 2001 we conduct cointegration and causality tests to assess the finance growth link by taking the real interest rate and financial repression into account the empirical evidence suggests that financial liberalization through removing the repressionist policies has a favorable effect in stimulating financial sector development financial depth and economic development are positively related but contrary to the conventional findings our results support robinson s view that output growth leads to higher financial depth in the long run

price and quantity controlled agricultural markets and disequilibrium econometrics a survey abstract this survey reviews the literature on estimating single markets in disequilibrium in the presence of regulated price and or quantity controls e g minimum price regimes and or marketing quotas most of the literature is found to describe pure econometric technique with only a few applications having emerged to date various reasons for the broad non acceptance of this literature are offered including a perceived lack of realism proposals to close this econometric theory application gap are put forward including the use of effective demand concepts in specifying demand and supply functions synthesizing some closely related literature on agricultural price quantity controls with disequilibrium econometrics i e endogenous government policy and the effects controls have on yield uncertainty and price risk and outlining more applicable econometric technique extensions