preferred risk habitat of individual investors abstract the preferred risk habitat hypothesis introduced here is that individual investors select stocks whose volatilities are commensurate with their risk aversion the data 1995 2000 holdings of over 20 000 clients at a large german broker are consistent with the predictions of the hypothesis the returns of stocks within each portfolio have remarkably similar volatilities when stocks are sold they are replaced by stocks of similar volatilities and the more risk averse customers indeed hold less volatile stocks greater volatility specialization is associated with lower sharpe ratios primarily because more specialized investors hold fewer stocks and thereby expose themselves to more unsystematic risk

useful fiction or miracle maker the competing epistemological foundations of rational choice theory rational choice theorists have not clearly articulated their epistemological positions and for this reason their arguments in favor of rational choice theory are inconsistent contradictory and unpersuasive to remedy this problem i describe how two of the main positions in the philosophy of science instrumentalist empiricism and scientific realism act as competing epistemological foundations for rational choice theory i illustrate how these philosophical perspectives help political scientists 1 understand what is at stake in the theoretical debates surrounding the rationality assumption self interest and methodological individualism 2 identify inconsistencies in the epistemological positions adopted by rational choice theorists and 3 assess the feasibility and desirability of a universal theory based on the rationality assumption

irrational diversification in multiple decision problems the paper deals with multiple decision problems which are similar to the task of guessing the color outcomes of ve independent spinnings of a roulette wheel 60 of whose slots are red and 40 white each correct guess yields a prize of 1 the guess of 5 reds clearly rst order stochastic dominates any other strategy in contrast subjects diversify their choices when facing a multiple decision problem in which the choice is between lotteries with clear objective probabilities the diversi cation is stronger when the subjects face uncertainty without objective probabilities and weaker when the choice problem involves real life actions c 2002 elsevier science b v

ex day behavior with dividend preference and limitations to short term arbitrage the case of swedish lottery bonds abstract swedish lottery bonds offer a unique opportunity to study ex day effects in an environment where cash distributions are tax advantaged relative to capital gains thus in the lottery bond market we observe a reversal of the preference for capital gains that researchers have cited as an explanation for the ex day behavior of u s equities further in this market there are barriers to short term arbitrage when prices do reflect the tax preferences of individual investors we find the bonds are priced around the ex day to reflect differential tax rates on income and capital gains consistent with the prevailing tax regimes the bonds consistently experience negative returns over the coupon payment period and in fact often sell at negative yields prior to the cash distribution as one would expect given tax motivated trading between high tax investors who buy prior to the distribution and low tax investors who buy after the distribution

economics of a bottleneck abstract drawing on vickrey amer econ rev 59 251 261 1969 and subsequent literature this paper provides a thorough economic analysis of the simplest bottleneck model of road congestion with peak load demand in the morning rush hour a fixed number of identical individuals one per car must travel from home to work between which is a bottleneck of given capacity the costs of travel include queuing time and schedule delay time early or late for work the frequency distribution of departure times adjusts so that in equilibrium all individuals have the same travel costs the paper extends the previous literature by examining a coarse toll and solving for optimal capacities the application of congestion tolls can generate efficiency gains by altering the frequency distribution of departure times previous estimates of the efficiency gains from congestion tolling are likely to be substantially downward biased because they have ignored this effect

the ramsey problem for congestible facilities abstract in recent years a new set of models drawing on vickrey 1969 has been developed to analyze the economics of congestible facilities these models are structural in that they derive the cost function from consumers time of use decisions and the congestion technology standard models in contrast simply assume the general form of the cost function we apply the new approach to analyze the ramsey problem for a congestible facility and show that the solution generally entails cost inefficiency standard models have failed to reveal this result because they treat the cost function as completely determined by technology

rationality and deterrence this essay explores the relationship between deterrence theory and two distinct notions of rationality associated with it the author argues that the concept of procedural irrationality which is the basis of many critiques of contemporary deterrence theory is not necessarily inconsistent with the instrumental definition of rationality implicit in many models of deterrence he also argues that some recent rational choice models of deterrence are nonetheless deficient in their application of the rationality postulate finally he provides an outline of a possible resolution of the paradox of deterrence

ipos signalling effects for speculative stock detection evidence from the stock exchange of thailand abstractusing a unique data set from the thai stock market about the so called turnover list tol of speculative stocks spanning the period 2004 2012 we investigate and provide new evidence on the relationship between ipos pricing effects and subsequent classification as speculative investments to be more specific we examine the signalling effects for the detection of speculative stocks in relation to the degree of their prior ipos underpricing we also employ the market feedback hypothesis to investigate this signalling process our results reveal a significant positive relationship between the magnitudes of the ipo underpricing and the probability of an ipo firm being classified officially as speculative on the tol furthermore we find that a 6 month abnormal return after going public increases the probability of speculative dealing in the ipos next we consider all listed firms in the thai stock market and highlight the role of both abnormal return and trading volume in the transmission of pr

cautious risk takers investor preferences and demand for active management actively managed mutual funds have distinct return distributions from their passive benchmarks and our theoretical analysis using tail sensitive risk preferences suggests that active value and growth funds may serve to reduce downside risk and capture upside potential respectively furthermore tail sensitivity measures estimated from the empirical pricing kernel have significant explanatory power for active fund flows even after controlling for business cycles and market wide sentiment finally active funds unlike their passive counterparts have exposures to option strategies hedging downside risk or capturing upside potential

uniform versus peak load pricing of a bottleneck with elastic demand abstract this paper considers commuting to work across a bottleneck such as a bridge or tunnel with elastic demand with no toll there is wasteful queueing the optimal peak load toll eliminates queueing and leaves total traffic unchanged the second best uniform toll cannot eliminate queueing but reduces total traffic the second best uniform toll may be larger or smaller than the maximum value of the optimal peak load toll

risk preferences and pesticide use by cotton farmers in china abstract despite that insect resistant bt cotton has been lauded for its ability to reduce the use of pesticides studies have shown that chinese bt cotton farmers continue to use excessive amounts of pesticides using results from a survey and an artefactual field experiment we find that farmers who are more risk averse use greater quantities of pesticides we also find that farmers who are more loss averse use lesser quantities of pesticides this result is consistent with our conceptual framework and suggestive evidence where farmers behave in a loss averse manner in the health domain and place more weight on the importance of health over money in the loss domain

why does junior put all his eggs in one basket a potential rational explanation for holding concentrated portfolios abstract empirical studies of household portfolios show that young households with little financial wealth hold underdiversified portfolios that are concentrated in a small number of assets a fact often attributed to behavioral biases we present a potential rational alternative we show that investors with little financial wealth who receive labor income rationally limit the number of assets they invest in when faced with financial constraints such as margin requirements and restrictions on borrowing we provide theoretical and numerical support for our results and identify the ratio of financial wealth to labor income as a useful control variable for household portfolio studies

the rationale of the mean standard deviation analysis skewness preference and the demand for money publisher summary this chapter discusses the rationale of the mean standard deviation analysis skewness preference and the demand for money in january 1969 issue of the review of economic studies karl borch and martin feldstein separately criticized the widely used mean variance analysis of portfolio selection borch contended that any system of upward sloping mean standard deviation e s indifference curves can be shown to be inconsistent with the basic axiom of choice under uncertainty he pointed out that one can always pick any two points on an upward sloping indifference curve to represent two bernoulli distributions with probability 1 p of gaining the same amount x in both the cases and probability p of gaining y1 in the case of one distribution and y2 in the case of the second distribution with y2 y1 if the second distribution represents the point to the northeast of the other point then by the dominance axiom the second distribution must be preferred to the first which contradicts the basic meaning of indifference curves feldstein by using a log utility function and a lognormal distribution for investment outcome showed that e s indifference curves for a risk averter need not be convex downwards though upward sloping they would change from convex to concave once the standard deviation of the outcome exceeds the mean multiplied by on the face of it this seems to suggest that risk aversion might decrease as risk is increased beyond a certain extent

the costs and beliefs implied by direct stock ownership this paper develops and estimates an economic model of the costs and beliefs required to rationalize household direct stock ownership in the model investors believe they can learn information about individual stock returns through costly research the model identifies the distributions of both research costs and beliefs about the predictability of individual stock returns identification depends only on households wealth and portfolio choices the model also provides a novel explanation for many empirical features of household portfolios parameter estimates suggest that most households have modest beliefs about the benefits of individual stock research although a minority must expect extraordinary returns data are available at https doi org 10 1287 mnsc 2017 2791 this paper was accepted by neng wang finance

do investors put their money where their mouth is stock market expectations and investing behavior there is a large gap between what finance models predict for individual investor behavior and what can be observed in their actual behavior portfolio theory assumes that investors form expectations about return and risk of securities and select portfolios according to their expectations and risk preferences as a consequence they should hold broadly diversified portfolios and trade very little but instead private investors have been shown to hold underdiversified portfolios to trade frequently to take high idiosyncratic risk and to gamble in the stock market to understand this striking differences the investment process itself needs greater scrutiny how do real investors use their beliefs and preferences in investing decisions we examine this question using a panel survey of self directed online investors at a uk bank the survey asks for return expectations risk expectations and risk tolerance of these investors in three month intervals between 2008 and 2010 we combine the survey data with investors actual trading data and portfolio holdings we find that investor beliefs have little predictive power for immediate trading behavior however portfolio risk levels and changes are systematically related to return and risk expectations in line with financial theory risk taking increases with return expectations and decreases with risk expectations

a theory of disappointment aversion an axiomatic model of preferences over lotteries is developed it is shown that this model is consistent with the allais paradox includes expected utility theory as a special case and is only one parameter beta richer than the expected utility model allais paradox type behavior is identified with positive values of beta preferences with positive beta are said to be disappointment averse it is shown that risk aversion implies disappointment aversion and that the arrow pratt measures of risk aversion can be generalized in a straight forward manner to the current framework copyright 1991 by the econometric society

financial complexity and trade what are the implications on trading activity if investors are not sophisticated enough to understand and evaluate trades that have a complex payoff structure can frictions generated by this type of financial complexity be so severe that they lead to a complete market freeze like that of the recent financial crisis starting from an allocation that is not pareto optimal we find that whether complexity impedes trade depends on how investors perceive risk and uncertainty for smooth convex preferences such as subjective expected utility complexity cannot halt trade even in the extreme case where each investor is so unsophisticated that he can only trade up to one arrow debreu security without being able to combine two or more in order to construct a complex trade however for non smooth preferences which allow for kinked indifference curves such as maxmin expected utility complexity can completely shut down trade

first order risk aversion and the equity premium puzzle abstract this paper integrates yaari s dual theory of choice under uncertainty into a multiperiod context and examines its implications for the equity premium puzzle an important property of these preferences is that of first order risk aversion which implies in our model that the risk premium for a small gamble is proportional to the standard deviation rather than the variance since the standard deviation of the growth rate in aggregate consumption is considerably larger than its variance the model can generate both a small risk free rate and a moderate equity premium

what makes deterrence work cases from 1900 to 1980 the use of military force to achieve foreign policy objectives is an enduring feature of international politics force or the threat of force may be used either to change the status quo or to maintain it threatening the use of force to maintain the status quo often takes the form of deterrence defined by patrick morgan as the threat to use force in response as a way of preventing the first use of force by someone else 1 deterrence sometimes succeeds and sometimes fails failures are attested to by numerous international wars of history in the nuclear age a failure could cost us our lives the conditions of successful deterrence thus require thorough logical and empirical analysis

individual preferences monetary gambles and stock market participation a case for narrow framing we argue that narrow framing whereby an agent who is offered a new gamble evaluates that gamble in isolation may be a more important feature of decision making than previously realized our starting point is the evidence that people are often averse to a small independent gamble even when the gamble is actuarially favorable we find that a surprisingly wide range of utility functions including many nonexpected utility specifications have trouble explaining this evidence but that this difficulty can be overcome by allowing for narrow framing our analysis makes predictions as to what kinds of preferences can most easily address the stock market participation puzzle

cumulative prospect theory option returns and the variance premium the variance premium and the pricing of out of the money otm equity index options are major challenges to standard asset pricing models we develop a tractable equilibrium model with cumulative prospect theory cpt preferences that can overcome both challenges the key insight is that the variance premium can be written as the expected return on a portfolio of otm call and put options and the probability weighting feature of cpt can explain the puzzlingly low returns observed for these options using gmm on a sample of u s index option returns between 1996 and 2010 we show that the cpt model ts well observed option prices and therefore the variance premium in a dynamic setting probability weighting and time varying equity return volatility combine to match the observed time series pattern of the variance premium

experimental tests of the separation theorem and the capital asset pricing model a computer controlled multistage portfolio selection task was devised to test experimentally basic assumptions underlying the separation theorem and the capital asset pricing model although most of the subjects diversified among the three risky assets the introduction of a riskless asset did not have the effect predicted by the separation theorem nor were the subjects affected by systematic changes in the variance covariance matrix of the risky returns however performance improved as the reward was increased tenfold the capital asset pricing model capm proposed by william sharpe 1964 john lintner 1965 and jan mossin 1966 has been the predominant normative as well as positive theory for determining assets returns and prices in financial markets the capm has a wide range of implications for various financial issues including the allocation of risky assets price predictions performance indices and market efficiency tests as well as tools for corporate finance decisions such as capital structure costs of financial sources and prices of new issues during the last decade numerous theoretical studies have examined and extended the capm a most recent development is the

clubs local public goods and transportation models a synthesis abstract clubs local public goods and transportation models are analyzed within a unified model the emphasis is on the derivation of optimal allocation pricing and the size of the sharing group we derive the conditions under which optimal prices will yield surplus or deficit as well as those under which competitive provision will be efficient given heterogeneous tastes we prove that segregation according to tastes is generally efficient although several cases where this result does not hold are also discussed we show that the existing literature is unnecessarily restrictive and that the unified approach suggested here considerably extends the existing analysis of clubs local public goods and the transportation problems

naive diversification strategies in defined contribution saving plans there is a worldwide trend toward defined contribution saving plans and growing interest in privatized social security plans in both environments individuals are given some responsibility to make their own asset allocation decisions raising concerns about how well they do at this task this paper investigates one aspect of the task namely diversification it is shown that some investors follow the 1 n strategy they divide their contributions evenly across the funds offered in the plan consistent with this naive notion of diversification it is found that the proportion invested in stocks depends strongly on the proportion of stock funds in the plan

home bias in open economy financial macroeconomics standard theory would predict that investors hold a well diversified portfolio of equities across the world but despite the process of financial globalization investors still hold a disproportionate share of local equities in their portfolio the equity home bias french and poterba 1991 we review the various explanations of this puzzling phenomenon in the context of recent developments in macroeconomic modelling that have allowed to incorporate sophisticated international portfolio choices in standard two country general equilibrium models we refer to this literature as open economy financial macroeconomics we focus on three broad classes of explanations i hedging motives in frictionless financial markets real exchange rate and non tradable income risk ii asset trade costs in international financial markets such as transaction costs differences in tax treatments between national and foreign assets iii informational frictions and behavioural biases these recent developments raise the need for new portfolio facts beyond the equity home bias and we will present some new evidence on cross border asset holdings across different types of assets equities bonds and bank lending we also present some new micro data on institutional holdings of equity at the fund level these data should inform macroeconomic modelling of the open economy and a growing literature of models of delegated investment

culture and r2 abstract consistent with predictions from the psychology literature we find that stock prices co move more less in culturally tight loose and collectivistic individualistic countries culture influences stock price synchronicity by affecting correlations in investors trading activities and a country s information environment both market wide and firm specific variations are lower in tighter cultures individualism is mostly associated with higher firm specific variations trade and financial openness weakens the effect of domestic culture on stock price comovements these results hold for various robustness checks our study suggests that culture is an important omitted variable in the literature that investigates cross country differences in stock price comovements

behavioral portfolio theory we develop a positive behavioral portfolio theory bpt and explore its implications for portfolio construction and security design the optimal portfolios of bpt investors resemble combinations of bonds and lottery tickets consistent with friedman and savage s 1948 observation we compare the bpt efficient frontier with the mean variance efficient frontier and show that in general the two frontiers do not coincide optimal bpt portfolios are also different from optimal capm portfolios in particular the capm twofund separation does not hold in bpt we present bpt in a single mental account version bpt sa and a multiple mental account version bpt ma bpt sa investors integrate their portfolios into a single mental account while bpt ma investors segregate their port folios into several mental accounts bpt ma portfolios resemble layered pyramids where layers are associated with aspirations we explore a two layer portfolio where the low aspiration layer is designed to avoid poverty while the high aspiration layer is designed for a shot at riches

do finance professors invest like everyone else comparing the results of the fed s survey of consumer finances with those of a survey of finance professors at u s universities the authors found that finance professors are significantly more likely than others to invest in equities they also found that finance professors are less prone to behavioral biases because their decision not to invest in equities is based on neither the outcome of their past investments nor their short term expectations of the market see comments and response on this article

rational deterrence theory and comparative case studies several recent books have argued that comparative case studies of crises demonstrate the failure of rational deterrence theory they have offered certain empirical generalizations as substitutes this paper shows that such contentions are unwarranted first the empirical generalizations are impressive as historical insights but they do not meet the standards for theory set out by the most sophisticated case study analysts themselves second the tests of rational deterrence used in the case studies violate standard principles of inference and the ensuing procedures are so biased as to be useless rational deterrence then is a more successful theory than portrayed in this literature and it remains the only intellectually powerful alternative available case studies are essential to theory building more efficiently than any other methods they find suitable variables suggest middle range generalizations for theory to explain and provide the prior knowledge that statistical tests require their loose constraints on admissible propositions and suitable evidence are appropriate and even necessary for these tasks these same characteristics however inevitably undermine all attempts to construe case study generalizations as bodies of theory or tests of hypotheses

queues rations and market comparisons of outcomes for the poor and the rich this paper presents a positive comparison of the outcomes of several alternative allocation systems the queue system convertible and nonconvertible rations and the unhindered market to distribute the limited quantity of a deficit good among heterogeneous individuals the authors show that for the poor the ranking of systems from better to worse is convertible rations nonconvertible rations the queue system and nonintervention the rich are found to be better off under nonintervention than under other systems these and other results are notably robust not only to many parameters of the economy but also to certain types of commodity taxes and administrative costs copyright 1987 by american economic association

life cycle portfolio choice the role of heterogeneous under diversification the empirical work on household portfolio choice documents two facts one the stock market participation rate is low and hump shaped over the life cycle two the conditional share of stocks is also low but does not appear to change much during the life cycle in contrast the standard life cycle portfolio choice model predicts high and monotonically increasing participation rates and conditional stock shares that are low and exhibit dramatic changes with age in this paper i consider a number of extensions to this basic framework i find that a small per period participation cost is needed to generate a hump shaped life cycle profile of participation rates under a realistic calibration the quantitative effect is minor progressive social security and the assumption that the risk of stock portfolios is declining in household wealth as a consequence of better diversification opportunities an assumption that has some empirical support though provide substantial amplification and significantly improve the ability of the model to match the data under diversification also reduces the average portfolio share of stocks conditional on participation and together with the intergenerational transmission of wealth makes it insensitive to age consistent with the empirical evidence

a theory of anticipated utility abstract a new theory of cardinal utility with an associated set of axioms is presented it is a generalization of the von neumann morgenstern expected utility theory which permits the analysis of phenomena associated with the distortion of subjective probability

diversification versus optimality is there really a diversification puzzle abstractin this paper we provide a general valuation of the diversification attitude of investors first we empirically examine the diversification of mean variance optimal choices in the us stock market during the 11 year period 2003 2013 we then analyze the diversification problem from the perspective of risk averse investors and risk seeking investors second we prove that investors optimal choices will be similar if their utility functions are not too distant independent of their tolerance or aversion to risk finally we discuss investors attitude towards diversification when the choices available to investors depend on several parameters

an asset allocation puzzle this paper examines popular advice on portfolio allocation among cash bonds and stocks it documents that this advice is inconsistent with the mutual fund separation theorem which states that all investors should hold the same composition of risky assets in contrast to the theorem popular advisors recommend that aggressive investors hold a lower ratio of bonds to stocks than conservative investors the paper explores various possible explanations of this puzzle and finds them unsatisfactory copyright 1997 by american economic association

rationalist explanations for war realist and other scholars commonly hold that rationally led states can and sometimes do fight when no peaceful bargains exist that both would prefer to war against this view i show that under very broad conditions there will exist negotiated settlements that genuinely rational states would mutually prefer to a risky and costly fight popular rationalist and realist explanations for war fail either to address or to explain adequately what would prevent leaders from locating a less costly bargain essentially just two mechanisms can resolve this puzzle on strictly rationalist terms the first turns on the fact that states have both private information about capabilities and resolve and the incentive to misrepresent it the second turns on the fact that in specific strategic contexts states may be unable credibly to commit to uphold a mutually preferable bargain historical examples suggest that both mechanisms are empirically plausible

externalities in economies with imperfect information and incomplete markets this paper presents a simple general framework for analyzing externalities in economies with incomplete markets and imperfect infonnation by identifying the pecuniary effects of these externalities that net out the paper simplifies the problem of determining when tax interventions are pareto improving the approach indicates that such tax interventions almost always exist and that equilibria in situations of imperfect information are rarely constrained pareto optima it can also lead to simple tests based on readily observable indicators of the efficacy of particular tax policies in situations involving adverse selection signaling moral hazard incomplete contingent claims markets and queue rationing equilibria traditional discussions of externalities have emphasized the distinction between technological externalities in which the action of one individual or firm directly affects the utility or profit ofanother and pecuniary externalities in which one individual s or firm s actions affect another only through effects on prices while the presence of technological externalities imply in general that a competitive equilibrium may not be pareto efficient pecuniary externalities hy themselves are not a source of inefficiency the fact that prices change has of course important consequences there are both distributional and allocational effects but the distribution effects net out gains for example hy firms whose prices increase are precisely offset by losses e g to individuals who must pay higher prices and there are no welfare losses from the allocation effects as long as the price changes involved are small if firms are maximizing profits and individuals are maximizing utility both facing prices that correctly refiect opportunity costs then standard envelope theorem arguments imply that changes in profits or utility induced by changes in allocations resulting from any small change in prices are negligible

loss aversion in aggregate macroeconomic time series abstract prospect theory has been the focus of increasing attention in many fields of economics however it has scarcely been addressed in macroeconomic growth models neither on theoretical nor on empirical grounds in this paper we use prospect theory in a stochastic optimal growth model thereafter the focus lies on linking the euler equation obtained from a prospect theory growth model of this kind to real macroeconomic data we will use generalized method of moments gmm estimation to test the implications of such a non linear prospect utility euler equation our results indicate that loss aversion can be traced in aggregate macroeconomic time series

household portfolio diversification a case for rank dependent preferences the proliferation of novel preference theories in financial economics is hampered by a lack of non experimental evidence and by the theories additional complexity which has not been shown to be critical in applications in this article i present arguments in support of preferences with rank dependency using the survey of consumer finances data i document two widespread patterns inconsistent with expected utility i many households simultaneously invest in well deversified funds and in poorly diversified portfolios of stocks and ii some households with substantial savings do not invest anything in equities i show that portfolio choice models with rank dependent preferences plausibly parameterized and under fully rational assumptions are quantitatively consistent with the observed diversification these results call for further efforts to integrate the models of rank dependent preferences in portfolio theory and asset pricing the decision theoretic literature has long acknowledged the shortcomings of the expected utility theory of von neumann and morgenstern 1944 several generalizations of the theory are inspired by the experimental evidence and aimed at improving its descriptive accuracy however there are few applications of new models of preferences in finance and expected utility continues to dominate the field 1 two principal hurdles slow the proliferation of novel preferences in financial economics first the lack of empirical non experimental or field data confirming that the behavior motivating non expected utilities is widespread outside the laboratory settings second the additional and often significant complexity of the alternative preferences which has not been shown to be critical in applications where the models based on expected utility fall short of reasonable predictions this article presents empirical and theoretical this paper was previously circulated under the title household portfolio diversification the paper has benefited from the comments of shlomo benartzi luca benzoni markus brunnermeier john dickhaut maria perozek raj singh hersh shefrin and workshop participants at minnesota finance bag lunch 2003 wharton conference household financial decision making and portfolio choice and 2003 summer meetings of econometric society i would like to thank cam harvey the editor and an anonymous referee for many helpful comments and suggestions a special thanks to jack kareken for comments and editorial help on an earlier draft i am grateful to donna zerwitz for editorial assistance the views expressed herein are those of the author and not necessarily of the federal reserve bank of minneapolis or the federal reserve system all errors and omissions are the sole responsibility of the author address correspondence to valery polkovnichenko finance 3 122 csom 319 19 th

rising power on the mind a prominent explanation of war claims that international conflict can result when shifts in bargaining power induce the declining power to behave aggressively today because the rising power cannot credibly commit to not behave aggressively tomorrow this paper asks whether individuals respond to shifting power in ways assumed by these models rather than use abstract laboratory based bargaining games as in other work i use vignettes describing the united states in an international bargaining situation to explore the microfoundations of power transitions models empirically the vignettes vary whether the individual is a member of a declining or a rising power and whether there are previous public commitments to the status quo division of territory subjects propose a response the united states should make and then explain their decision in their own words i apply new methods for analyzing these open ended responses consistent with predictions from the behavioral literature i find important asymmetries in behavior across these conditions as well as substantial heterogeneities in individuals motivations for their decisions the results of the experiments suggest potential ways that power transition models should be refined to have a firmer behavioral basis

keynes meets markowitz the trade off between familiarity and diversification we develop a model of portfolio choice to nest the views of keynes who advocates concentration in a few familiar assets and markowitz who advocates diversification we use the concepts of ambiguity and ambiguity aversion to formalize the idea of an investor s familiarity toward assets the model shows that for any given level of expected returns the optimal portfolio depends on two quantities relative ambiguity across assets and the standard deviation of the expected return estimate for each asset if both quantities are low then the optimal portfolio consists of a mix of familiar and unfamiliar assets moreover an increase in correlation between assets causes an investor to increase concentration in familiar assets flight to familiarity alternatively if both quantities are high then the optimal portfolio contains only the familiar asset s as keynes would have advocated in the extreme case in which both quantities are very high no risky asset is held nonparticipation this paper was accepted by brad barber teck ho and terrance odean special issue editors

homo diplomaticus mixed method evidence of variation in strategic rationality psychology is traditionally used in political science to explain deviations from rationality lost in the debate between rationalists and their critics however is a sense of whether the kinds of strategic self interested behavior predicted by these models has psychological microfoundations what would homo economicus look like in the real world we argue that strategic rationality varies across individuals and is characterized by a pro self social value orientation and a high level of epistemic motivation testing our argument in the context of international relations we employ a laboratory bargaining game and integrate it with archival research on german foreign policy making in the 1920s we find in both contexts that even among those interested in maximizing only their own egoistic gains those with greater epistemic motivation are better able to adapt to the strategic situation particularly the distribution of power our results build a bridge between two approaches often considered to be antithetical to one another

a dispositional theory of reputation costs politicians frequently turn to reputational arguments to bolster support for their proposed foreign policies yet despite the prevailing belief that domestic audiences care about reputation there is very little direct evidence that publics care about reputation costs and very little understanding of how we propose a dispositional theory of reputation costs in which citizens facing ill defined strategic situations turn to their core predispositions about foreign affairs in order to weigh competing reputational dimensions employing a diverse array of methodological tools from vignette based survey experiments to automated text analysis we show that the mass public has a taste for reputation but understands it in fundamentally different ways with hawks concerned about the negative reputational consequences of inconsistency and doves equally concerned with the negative reputational consequences of belligerence and interventionism in illustrating how reputation costs are in our heads our findings offer both good and bad news for theories of reputation in ir

developments in non expected utility theory the hunt for a descriptive theory of choice under risk this article reviews recent developments in the economic theory of individual decision making under risk since the 1950s it has been known that individual choices violate the standard model of expected utility in predictable ways considerable research effort has now been devoted to the project of developing a superior descriptive model following an overview of non expected utility theories which distinguishes between conventional and non conventional approaches the paper seeks to assess these alternative models in terms of empirical success using laboratory and field data and theoretical usefulness the closing sections reflect on some new directions emerging in this literature

contrasting rational and psychological analyses of political choice we contrast the rational theory of choice in the form of expected utility theory with descriptive psychological analysis in the form of prospect theory using problems involving the choice between political candidates and public referendum issues the results showed that the assumptions underlying the classical theory of risky choice are systematically violated in the manner predicted by prospect theory in particular our respondents exhibited risk aversion in the domain of gains risk seeking in the domain of losses and a greater sensitivity to losses than to gains this is consistent with the advantage of the incumbent under normal conditions and the potential advantage of the challenger in bad times the results further show how a shift in the reference point could lead to reversals of preferences in the evaluation of political and economic options contrary to the assumption of invariance finally we contrast the normative and descriptive analyses of uncertainty in choice and address the rationality of voting

probability weighting and employee stock options this paper documents that riskier firms with higher idiosyncratic volatility grant more stock options to nonexecutive employees standard models in the literature cannot easily explain this pattern a model in which a risk neutral firm and an employee with prospect theory preferences bargain over the employee s pay package can the key feature which makes stock options attractive is probability weighting the model fits the data on option grants well when calibrated using standard parameters from the experimental literature the results are the first evidence that risky firms can profitably use stock options to cater to an employee demand for long shot bets

international diversification a copula approach abstract the viability of international diversification involves balancing benefits and costs this balance hinges on the degree of asset dependence in light of theoretical research linking diversification and dependence we examine international diversification using two measures of dependence correlations and copulas we document several findings first dependence has increased over time second we find evidence of asymmetric dependence or downside risk in latin america but less in the g5 the results indicate very little downside risk in east asia third east asian and latin american returns exhibit some correlation complexity interestingly the regions with maximal dependence or worst diversification do not command large returns our results suggest international limits to diversification they are also consistent with a possible tradeoff between international diversification and systemic risk

examining risk preferences under high monetary incentives experimental evidence from the people s republic of china several experimental sessions were conducted to elicit certainty equivalents for a sequence of lotteries involving real monetary outcomes the opportunity to conduct sessions in the people s republic of china afforded the ability to offer very large monetary incentives relative to subjects living costs in the highest payoff condition subjects earned three times their normal monthly revenue in the course of a two hour experiment results indicate a statistically significant impact of the level of monetary incentives on revealed risk preferences however even under extreme monetary incentives subjects demanded amounts well in excess of expected value for low probability gain prospects copyright 1992 by american economic association

a simple preference foundation of cumulative prospect theory with power utility most empirical studies of rank dependent utility and cumulative prospect theory have assumed power utility functions both for gains and for losses as it turns out a remarkably simple preference foundation is possible for such models tail independence a weakening of comonotonic independence which underlies all rank dependent models together with constant proportional risk aversion suffice in the presence of common assumptions weak ordering continuity and first stochastic dominance to imply these models thus sign dependence the different treatment of gains and losses and the separation of decision weights and utility are obtained free of charge

all their eggs in one basket portfolio diversification of us households abstract this paper uses data from the survey of consumer finances to assess how well mean variance efficiency describes the portfolio diversification of us households it does not seem to work well the median stockholder owns a single publicly traded stock often in the company where he works looking at a sample of high income households who accounted for one third of all publicly traded stock the median holding is only ten stocks indirect stock ownership through mutual funds defined contribution pension plans ira s and trust funds is shown to have little power in explaining this poor diversification

diversification and its discontents idiosyncratic and entrepreneurial risk in the quest for social status social status concerns influence investors decisions by driving a wedge in attitudes toward aggregate and idiosyncratic risks i model such concerns by emphasizing the desire to get ahead of the joneses which implies that aversion to idiosyncratic risk is lower than aversion to aggregate risk the model predicts that investors hold concentrated portfolios in equilibrium which helps rationalize the small premium for undiversified entrepreneurial risk in the model status concerns are more important for wealthier households consequently these households own a disproportionate share of risky assets particularly private equity and experience greater volatility of consumption consistent with empirical evidence diversification and risk sharing are fundamental principles of modern finance and macroeconomics however empirical evidence suggests that household portfolios are poorly diversified with many people reporting substantial holdings of a single stock for the wealthiest households large shares in closely held businesses constitute a particularly important source of risk e g heaton and lucas 2000a it is not surprising that entrepreneurs bear substantial undiversified risk since it is important for mitigating moral hazard and or adverse selection problems yet from a standpoint of portfolio theory entrepreneurship does not appear to be well compensated implying that many investors are willing to take poorly rewarded risks despite the availability of superior investment opportunities such as public equity that earns a large risk premium e g moskowitz and vissing j0rgensen 2002 hall and woodward 2007

optimal departures from marginal cost pricing focuses on departures from marginal cost pricing optimal allocation or resources level of tax revenue that will be collected by the government theorems developed for resource allocation ebsco

does household finance matter small financial errors with large social costs households with familiarity bias tilt their portfolios towards a few risky assets consequently household portfolios are underdiversied and excessively volatile to understand the implications of underdiversicati on for social welfare we solve in closed form a model of a stochastic dynamic general equilibrium economy with a large number of heterogeneous rms and households who bias their investments toward a few familiar assets we nd that the direct mean variance loss from holding an underdiversied portfolio that is excessively risky is a modest 1 66 per annum consistent with the estimates in calvet campbell and sodini 2007 however we show that in a more general model with intertemporal consumption underdiversied portfolios increase consumption growth volatility amplifying the mean variance losses by a factor of four moreover in general equilibrium where growth is endogenous underdiversied portfolios distort also aggregate investment and growth so that the overall eect on social welfare is about six times as large as the direct mean variance loss we demonstrate that even when forcing the familiarity biases in portfolios to cancel out across households their implications for consumption and investment choices do not cancel individual household biases can have signicant aggregate eects our results illustrate that nancial markets are not a mere sideshow to the real economy and that nancial literacy regulation and innovation that improve the nancial decisions of households can have a signicant positive impact on social welfare

non gaussian diversification when size matters abstract classical portfolio theory informs investors that they should have a large number of assets in their portfolios in order to diversify risk we show that the non gaussian features of stock return distribution may not allow for this risk protection in times of crisis moreover we demonstrate empirically that if investors are risk averse and consider higher order moments they have numerous incentives not to diversify their portfolios fully this is caused by the evolution of both large losses and asymmetry of returns when the numbers of assets in a portfolio change

self selection and pareto efficient taxation abstract this paper analyses the set of pareto efficient tax structures the formulation of the problem as one of self selection not only shows more clearly the similarity between this problem and a number of other problems such as the optimal pricing of a monopolist which have recently been the subject of extensive research but also allows the derivation of a number of new results we establish i under fairly weak conditions randomization of tax structures is desirable ii if different individuals are not perfect substitutes for one another in production then the general equilibrium effects until now largely ignored in the literature of changes in the tax structure may be dominant in determining the optimal tax structure in particular if the relative wage of high ability and low ability individuals depends on the relative supplies of labor the optimal tax structure entails a negative marginal tax rate on the high ability individuals and a positive marginal tax rate on the low ability individuals the marnitude of which depends on the elasticity of substitution iii if individuals differ in their preferences pareto efficient taxation may entail negative marginal tax rates for high incomes while iv if wage income is stochastic the marginal tax rate at the upper end may be 100 our analysis thus makes clear that the main qualitative properties of the optimal tax structure to which earlier studies called attention are not robust to these attempts to make the theory more realistic