interpreting measures of economic loss evidence from contingent valuation and experimental studies abstract from the standpoint of conventional welfare theory it is surprising that responses to contingent valuation studies of environmental goods have shown a consistent difference between willingness to pay and compensation demanded measures of economic loss this paper examines these results in light of four reasons most often given as grounds for their dismissal new experimental evidence supports an interpretation of the observed disparity in payment and compensation based measures as both real and psychologically meaningful an alternative conceptual framework suggested by prospect theory is outlined and its relevance for economic assessments of potential environmental change is discussed briefly

are we risking too much perspectives on risk in farm modelling risk and uncertainty have been extensively studied by agricultural economists in this paper we question a the predominant use of static frameworks to formally analyse risk b the predominant focus on risk aversion as the motivation for considering risk and c the notion that explicitly probabilistic models are likely to be helpful to farmers in their decision making we pose the question for a risk averse farmer what is the extra value of a recommendation derived from a model that represents risk aversion compared to a model based on risk neutrality the conclusion reached is that for the types of the decision problems most commonly modelled by agricultural economists the extra value of representing risk aversion is commonly very little

the methodology of contractarianism in economics the paper explores the methodology of hypotheticalcontractarianism as a means of justifyingrules of social conduct formally thecontractarian argument has the logicalstructure of a familiardeductive nomological rational choice explanation it necessarily requires however that at least some premises usedin its explanans be empiricallyfalse it is argued that in contrast toordinary explanatory arguments thecontractarian thought experiment would bepointless if all assumptions wereempirically true as a consequence even inthe case that a given contract theory canbe proven to be logically consistent itfails to justify binding obligations ofreal individuals due to an insurmountablelogical problem of induction

should we use willingness to pay to elicit community preferences for health care new evidence from using a marginal approach abstract we describe a willingness to pay wtp survey in which values were elicited from the public for three disparate health care programmes previous applications of wtp in this context have revealed a high proportion of preference reversals between wtp values and ordinal ranking of the programmes in view of the doubts these findings raise over the use of wtp in this context our aim was to develop a method of eliciting wtp values which we considered would improve consistency between respondents explicit ranking of the programmes and their wtp values compared to the standard approach the structure of the new design the marginal approach reduced the number of possible preference reversals thus encouraging a degree of consistency among respondents despite this the marginal approach did not result in fewer preference reversal being observed in actuality thus casting doubt on the application of wtp in this context

risk attitude under two alternative theories of choice under risk abstract anticipated utility theory and prospect theory have been proposed as descriptive models of choice under uncertainty this paper examines the concept of risk attitude under these two theories and considers the relationship between risk attitude under von neumann morgenstern expected utility theory and risk attitude under these alternative theories a risk premium analysis is conducted and risk premia are partitioned to characterize the complex nature of risk attitude under these theories comparative risk aversion across individuals is also considered

state and prospect of public choice a european view the victory of public choice may not yet have arrived and the share of european contributions may still be small it has nevertheless been argued that there is a great future in public choice three especially promising areas have been indicated by way of example the theory of economic policy politico economic models and international political economy

the ratchet tautness and managerial behavior in soviet type economies suppose a manager receives a fixed bonus for reaching a target plus an overfulfillment reward each period the target is fixed by the manager s superiors in a manner that takes into account past performance this is the ratchet managers facing this incentive scheme will choose an activity level which takes into account the dynamic effects of current behavior on future earnings the conventional wisdom contends that managers will understate capacity by producing below maximum potential we show that this behavior occurs only under certain conditions more importantly we also show that the ratchet can be used to induce managers to reveal the growth rate of average capacity

market equilibrium with private knowledge the effect of asymmetric information between buyers and sellers on product quality was first explored by akerlof 1970 in his pathbreaking paper on the market for lemons he showed that if all purchasers have imperfect information on quality then a market for the product may not exist or if it does function it may not be efficient these results have led to a number of papers concerning insurance and labor markets under different assumptions regarding how agents discriminate between products of varying quality see pauly 1974 rothschild and stiglitz 1976 wilson 1977 miyasaki 1977 and spence 1978

which factors influence the expansion of bioenergy an empirical study of the investment behaviours of german farmers the german government is planning to increase the share of renewable energy sources in this context it is important to understand the decision making behaviour of farmers regarding investments in renewable energy systems that generate energy from biomass and farmers reactions to investment support measures to study this behaviour we conduct a survey and confront farmers with a hypothetical opportunity to invest in a biogas plant our findings reveal that farmers have heterogeneous investment thresholds their investment decisions are mainly driven by capital costs and the subjective perception of the risk resulting from the investment other decision parameters like sustainability and non monetary objectives that are also examined in this paper play only minor roles however bounded rationality is an important factor moreover the influence of an investment subsidy was analysed only about half of the amount of the subsidy as expected according to normative forecast models is reflected in an increased willingness to invest furthermore farmers who have previously invested in bioenergy plants show lower investment thresholds and have stronger reactions to the subsidy regarding the expansion of renewable energies these findings are meaningful for policy impact analysis

risk taking preferences of farmers in northern thailand measurements and implications abstract risk taking preferences were elicited from small semi commercial farmers in northern thailand using an experimental procedure that included real monetary payoffs of meaningful magnitudes a total of five sets of lotteries with increasing payoffs were offered the farmers were found to be risk averters and their preferences conformed to the hypothesis of increasing nondecreasing partial relative risk aversion using regression analysis farmers expected variation of rice yields and farm size were found to be directly related to a decrease in risk aversion while the extent of multiple cropping availability of non land household assets and tested mathematical ability were found to be indirectly related to a decrease in risk aversion the variables expected variation of rice prices farmer s age and tested abstract ability scores were not related to risk taking preferences

buyers pricing behavior for risky alternatives encoding processes and preference reversals numerous studies have examined individuals minimum selling prices or certainty equivalents for lotteries as measures of preference but few have examined maximum buying prices because every transaction involves a buyer as well as a seller buyers pricing behavior is of interest in its own right two prospect theory based descriptive models of maximum buying prices the integration and segregation models are developed from different assumptions about cognitive encoding processes the models were tested experimentally using an incentive compatible cash payoff scheme in which maximum buying prices for bets and choices between bets were elicited from subjects surprisingly observed maximum buying prices were far below expected values even for bets with probabilities of winning near 1 0 this suggests buyers are strongly influenced by loss aversion and that the conventional assumption that the buying price for a risky alternative is a reduction in the alternative s payoffs fails to describe behavior instead it appears subjects predominately employed a segregation encoding process in which the buying price was encoded separately from the bet s payoffs and treated as a sure loss however an additional result was not explained adequately by either encoding model buying prices were less risk averse than choices for 3 expected value bets creating preference reversals of the standard kind lichtenstein and slovic 1971 but more risk averse for 100 expected value bets creating reverse preference reversals casey 1991 implications for the scale compatibility principle tversky et al 1988 are discussed two theoretical approaches are outlined which offer promise in the development of a unified model of price judgments and choice preferences under risk

on the conservation of distance in international trade the volume of world trade has grown more than twice as fast as real world income since 1980 surprisingly the effect of distance on trade has increased during this period it could be that countries are trading greater volumes of goods that are highly sensitive to distance an alternative explanation is that distance has become more import for a significant share of goods using highly disaggregated bilateral trade data we find that adjustment in the composition of trade has not influenced the way in which distance affects trade in contrast for about 25 percent of industries distance has become more important this implies that the increased distance sensitivity of trade is a result of a change in relative trade costs that affects many industries as opposed to a shift to more distance sensitive products we also find that homogeneous products are twice as likely to have become more distance sensitive as compared with differentiated goods this is consistent with the hypothesis that falling search costs resulting from improvements in transport and communications are relatively more important for differentiated goods the results offer no evidence of the death of distance rather they suggest that distance related relative trade costs have remained unchanged or shifted in favor of proximate markets

analysis of uncertainty as opposed to risk an experimental approach the paper illustrates the scope for enhancing the conceptual apparatus used by agricultural economists to analyse decision making under conditions of uncertainty selected empirical results from experiments on student subjects from three universities are reported three issues are considered first the reasons for choice and the understanding of a choice problem are examined second attitudes towards different levels of uncertainty are measured third the possibility that apparently non normative psychological factors influence choice is explored the paper serves to illustrate and support a number of methodological points the major points are that a risk uncertainty distinction is useful contrary to the aging conventional wisdom of economic theory that laboratory experiments can potentially provide data of use to agricultural economists and that predictive models of choice under uncertainty may be more accurate if they take account of psychological variables which influence the decision making processes of human subjects

rational behavior and economic theory abstract nowadays it seems almost universally presumed that the fundamental characteristic of homo oeconomicus is his rationality we analyze the role played by the concept of rationality in economic theory and demonstrate that it is necessarily constrained to be an essentially contentless notion we show that the main body of economic theory is firmly grounded and that some contrasting approaches to rationality although leading to heated debates and vivid confusion have no fundamental significance for economics with a refereshed view on the essence of economics we argue that the principles of economic theory form an essential methodological guide for the emergent line of research based on the use of so called evolutive models

framing the allais paradox as a daily farm decision problem tests and explanations the well known allais paradox is reformulated as a daily farm decision problem only 26 of the farmers exhibit violations of the expected utility hypothesis moreover the tendency for violation decreases with the farm operator s education experience and family size no effects of the farm main crop or its scale were detected finally when taking into account the possibility of choice errors we find that the violation rate is statistically insignificant

would a risk averse newsvendor order less at a higher selling price we model a risk averse newsvendor s decision making behavior with some commonly used classes of utility functions within the expected utility theory eut framework under fairly general conditions of eut we show that a risk averse newsvendor will order less than an arbitrarily small quantity as selling price gets larger if price is higher than a threshold value i e the optimal order quantity decreases as the selling price increases

risk efficient irrigation strategies for wheat abstract agricultural production is risky when farmers are risk averse they are likely to put a premium on production methods that reduce perceived risks irrigation is generally believed to be a risk reducing input by using the concept of stochastic dominance risk efficient irrigation policies for wheat grown in central india are identified and quantitative estimates of benefits due to risk reduction are obtained such benefits were found to be of a large order of magnitude the more common methods such as mean variance analysis tended to over estimate the benefits

the fourfold pattern of risk attitudes in choice and pricing tasks we examine the robustness of the fourfold pattern of risk attitudes under two elicitation procedures we find that individuals are on average risk seeking over low probability gains and high probability losses and risk averse over high probability gains and low probability losses when we elicit prices for the gambles however a choice based elicitation procedure where participants choose between a gamble and its expected value yields individual decisions that are indistinguishable from random choice sensitivity to elicitation procedure holds between and within participants and remains when participants are allowed to review and change decisions the price elicitation procedure is more complex this finding may be further evidence that an increase in cognitive load exacerbates behavioural anomalies

how should responsible investors behave keynes s distinction between entrepreneurship and speculation revisited this paper deals with keynes s distinction between entrepreneurship and speculation regarding business people in general and especially investors behaviour based on keynes s thoughts about financial markets it analyses how different motivations influence the decision making process of investors and its consequences for stock markets and the real economy and clarifies that keynes s considerations are still useful for understanding contemporary developments and risks in the financial system furthermore it points out that keynes s theories and policy recommendations should be understood in the context of his moral considerations especially relating to individual responsibility of investors finally keynes s moral thoughts can be taken as a foundation for a contemporary approach to investors responsibility

preference paradoxes and lexicographic choice abstract results of various experiments reported in the literature have shown repeated violations of expected utility theory this paper presents a model of lexicographic choice under uncertainty that has the probability of gain or at least no loss and the best possible outcome as well as expected utility as determinants of choice under different conditions the model easily explains the observed violations and other curious preference patterns including the allais and ellsberg paradoxes probalistic insurance preference reversals preference cycles and the reflection isolation and translation effects despite its explanatory power the model is as testable as the expected utility hypothesis

the use of risk and return models for multiattribute decisions with decomposable utilities normatively oriented approaches to decision making under uncertainty occupy a major portion of the literature of decision analysis among the proposed approaches the von neumann morgenstern expected utility eu theory has been the most prominent model of rational choice despite some controversies that surround this model with respect to its descriptive ability as well as the plausibility of utility assessment in actual decision situations 6 10 although most applications of the eu model have been concerned with decisions involving monetary outcomes its scope is not limited to any particular class of conse quences the basic appeal of the model is attributable partly to its generality in this regard and more importantly to the apparent reasonableness of its preferentialaxioms in the context of decisions with monetary outcomes several alternatives to the eu model have been proposed including the mean variance and mean semivariance models that have found popularity in the economies and finance litera ture see 4 8 and 9 in contrast to the eu theory where a decision maker s preferences among uncertain prospects are assumed given preferences in these models are formulated in terms of two attributes that are presumed to character ize all available choices in the mean semivariance model for example uncer tain prospects are viewed entirely in terms of their means and below target semivariances a generalization of this model was examined by fishburn 2 who showed that the general mean risk model exhibits a certain degree of compatibility with the eu model more recently holthausen 5 showed that this compatibility is significantly enhanced when mean is replaced by a return measure de fined as a probability weighted function of above target deviations specifically holthausen proved that this model yields the same preferences as the eu model whenever the expected utility function has the form

prospect theory and the risk return association an empirical examination in 85 industries a new sample of 85 industries about 3 300 firms defined in terms of homogenous products provides strong evidence that prospect theory can explain the tradeoff between two of the most researched parameters in evaluating organizations namely risk and return in particular organizations below their target level are found to be risk takers hl while organizations above their target level are risk averters h2 moreover the below target tradeofl was generally steeper than the above target with a median below to above slope ratio of about 3 l h3 risk and return are probably the two single parameters most researched by the various and related disciplines of economics finance and management although each one of them has looked at these two parameters from different aspects and for different purposes they have provided a wide understanding of these two factors in the contest of the theory of the firm the purpose of this study is to look closely at the relationship between these two important parameters in order to understand firm s competitive behavior using the recent development in behavioral decision theory namely prospect theory kahneman and tversky 1979 although march 1988 has criticized the discipline of management for its later adaptation in considering risk elements for evaluating organization performance and decision making processes recent studies e g bettis 1981 rumelt 1974 singh 1986 jemison 1987 and baird and thomas 1986 have paid considerable attention to risk aspects in evaluating the performance of firms in general these studies have concluded that the characteristics of the firms environment strategy and implementation processes have significant and important influence on the firm s risk level and its associated rate of return bowman 1980 has looked closely at 85 u s industries and explored the

aspiration level effects an empirical investigation abstract theories of aspiration level effects predict that decisions under uncertainty will depend on whether performance is above or below some target level of performance a sample of 5000 quarterly earnings announcements by publicity held companies listed on the compustat and crsp data bases is examined to test this hypothesis four models from the current accounting literature are used as alternative estimates of the target level of earnings for these firms when earnings are announced the difference between actual and forecast earnings here called a forecast error can be computed the data indicate that the relationship between valuation and forecast error differs conditional on the sign of the forecast error

g e moore and j m keynes a missing chapter in the history of the expected utility model in his posthumous essay my early beliefs john maynard keynes outlined his mental history in the dozen years before the war and asserted their importance to his later life yet despite keynes s assertion of the importance of this part of his mental history to who he was and what he did in 1938 the year the essay was written and two years after he published the general theory there is virtually no treatment in the history of economic thought of this period of his life or of its impact on his economic theory the purpose of this essay is to treat an episode of that period of his life which has particular analytical importance and to suggest some ways in which it might contribute to a clearer understanding of his later work in economics the episode in keynes s early life which the essay examines is his role in g e moore s changing opinion about the importance of rules in ethics in his classic principia ethica 1903 moore had originally asserted that obeying certain rules is a necessary part of ethically correct behavior but in his ethics 1912 he makes exactly the opposite argument saying that individuals are always justified in judging a case for themselves and are under no obligation to follow general rules of conduct in the parlance of modern philosophy moore switched from a rule utilitarian argument to an act utilitarian argument the first four sections of the essay detail the role which keynes played in moore s change of heart the final section discusses how the episode affects our understanding of keynes s work in economics

impact of cost uncertainty on pricing decisions under risk aversion abstract this paper studies cost uncertainty in services despite the fact that the service sector has become the largest component of gross domestic products in most developed economies cost uncertainty and its impact on pricing decisions have not received much attention in the literature in this paper we first identify the root causes of cost uncertainty in services using the distinctive characteristics of services defined in the literature we show why cost uncertainty which has been widely neglected in the manufacturing dominated literature is pervasive in services next we investigate how cost uncertainty affects a risk averse service provider s pricing decisions in a make to order setting using the expected utility theory framework we show that cost uncertainty increases the optimal price whereas demand uncertainty reduces it as a result of the countervailing impacts the optimal price under risk aversion may be larger or smaller than the optimal risk neutral price next we study the problem of optimizing cost contingency in service contract pricing we show that the optimal cost contingency decreases as the profit of the contract increases even when the utility function exhibits an increasing absolute risk aversion finally we introduce various strategies to mitigate the risk of cost uncertainty observed in practice and propose new research problems

strategic reference point theory how can executives achieve a match between expected external environmental conditions and internal organizational capabilities that facilitates improved performance this paper argues that a firm s choice of reference points can help achieve strategic alignment capable of yielding improved performance and potentially even a sustainable competitive advantage building upon prospect theory and other relevant theoretical perspectives the strategic reference point srp matrix is developed a firm s srp consists of three dimensions internal capability external conditions and time a theory is developed which posits an optimal srp structure and propositions are offered which articulate the expected relationships between the srp strategic choice behavior and firm performance the paper closes with some suggestions for using strategic reference points in both research and practice

some econometric problems in the measurement of utility econometric problems in the measurement of utility are noted and solutions provided when lotteries which are used to elicit risk preferences are chained or linked they compound error terms if a utility index is constructed to estimate the utility function the estimates will be inefficient and possibly biased an econometric model that attaches an additive error term to the response of the decision maker and does not require indexing is shown to be a better alternative the measurement of utility functions in the context of risk and uncertainty is usually performed when testing the expected utility hypothesis lin dean and moore or for prescriptive analysis keeney and raiffa elicitation procedures typically have involved pre

decision making when choices are complex a test of heiner s hypothesis this paper explores heiner s hypothesis concerning a gap between the cognitive ability of decision makers and the difficulty of decisions the c d gap we discuss the implications of decision heuristics for coefficient estimates when uncertainty is faced by decision makers where the level of uncertainty varies with complexity statistical analysis strongly supports the presence of a c d gap and provides evidence supporting the use of decision heuristics the results of both direct and indirect methods suggest that mixed decision strategies may be used we also find that complexity effects can have important implications for welfare analysis

choices involving uncertain probabilities abstract this paper contains an analytic and empirical component the analytic one examines how people should value information on probabilities versus payoffs according to expected utility theory it also examines under what conditions various generalized utility models such as subjective expected utility theory prospect theory and rank dependent utility entail testable predictions for preference for information the empirical component examines people s actual information preferences and to what extent they fit the various models after describing two experiments and their findings it is concluded that generalized utility models are unlikely to offer much insight into risky decision making

evidence of public spending crowding out from a panel of oecd countries the empirical relationship between government spending and private investment is examined using a panel of 14 oecd countries the evidence suggests the existence of a significant crowding in effect of private investment by public investment through the positive impact of infrastructure on private investment productivity moreover government consumption appears to crowd out private investment the implications of these results are of foremost importance when it comes to fiscal consolidation deficit reductions engineered through cuts in public investment could severely impinge on private capital accumulation and growth prospects

alternative models of choice under uncertainty and demand for health insurance the authors test a standard expected utility model and alternative models about how people evaluate risky prospects using data about individuals preferences among health insurance plans a model that assumes people evaluate gains and losses relative to a reference rather than final outcomes treat gains and losses asymmetrically and process certain and uncertain outcomes separately provides a better fit than the standard utility model these findings suggest inertia in health insurance plan choice and that individuals are more responsive to decreases than to increases in the price of insurance copyright 1996 by mit press

negotiation analysis a characterization and review negotiation analysis seeks to develop prescriptive theory and useful advice for negotiators and third parties it generally emphasizes the parties underlying interests as distinct from the issues on the table and the positions taken alternatives to negotiated agreement approaches to productively manage the inherent tension between competitive actions to claim value individually and cooperative ones to create value jointly as well as efforts to change perceptions of the game itself since advice to one side does not necessarily presume the full game theoretic rationality of the other side s negotiation analysts often draw on the findings of behavioral decision analysts and economists further this approach does not generally assume that all the elements of the game are common knowledge thus the negotiation analytic approach tends to de emphasize the application of game theoretic solution concepts or efforts to find unique equilibrium outcomes instead to evaluate possible strategies and

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

syndication institutionalization and lottery play1 why do people play the lottery since lottery tickets are assets with negative expected return lottery play challenges the basic assumptions of economic theory this article approaches lottery play from a networks perspective and focuses on syndicate play a comparison of the development of lottery markets in germany austria spain and portugal from the 17th century onward shows that lottery play declined with rising incomes except in countries in which syndicate play diffused widely namely spain and to a lesser extent portugal although syndicating originated among the relatively poor as a response to an increase in lottery prices it persisted even when individual play became affordable this article contends that syndicating endured because of an institutionalization process by which lottery tickets have transformed from purely economic assets into symbolic carriers of interpersonal ties that convey membership and status position in relevant social networks

testing for regret and disappointment in choice under uncertainty much of the experimental evidence concerning violations of von neumann morgenstern expected utility theory has been collected fr om experiments designed with conventional theory in mind and does not provide direct tests of alternative models such as regret theory and disappointment theory this paper reports and discusses recent evidence produced by an exp erimentspe cifically designed to test for the impacts of regret and disappointment and to indicate their relative importance copyright 1987 by royal economic society

strategy complexity and economic rent this paper discusses important friction forces that future theories of strategy must incorporate some of these are technological and environmental but the most important ones it is argued are psychological the view is developed that strategy at its core concerns the development and testing of heuristics for high stake decisions in environments too unstable and complex to be optimized the paper especially highlights the behavioral dimension in the belief that strategies should incorporate both the rational and suboptimal aspects of human behavior the rational approach is in many ways the easier as there may be only one way to be right yet the great variety in which people and companies can err gives strategy its creative and real world challenge the tension between the rational and behavioral components is what the field of strategy should seek to exploit

strength of preference and risky choice this paper provides conditions under which a utility function under risk can be legitimately interpreted to measure strength of preference between consequences these conditions require that if a decision maker regards the preference difference between acts a and b to be the same as the preference difference between acts a and b for every state of the world then the preference difference between a and b should be regarded as equivalent to the preference difference between a and b a key assumption is that a decision maker s preference differences between acts given one state of the world should be independent of common consequences given other states of the world usefulness of this result is discussed

formal choice models in marketing the paper gives an overview and evaluates the theoretical traditions underlying choice models that are used in marketing in particular the emphasis of this essay is on the underlying assumptions limitations and empirical demands of these choice models four fundamental choice models are used as a basis to analyze this complex field the neoclassical economic theory as extended by lancaster the risk preference theory of choices under uncertainty the strict utility theory and the random utility theory these four choice models and their extensions are compared and contrasted along the three critical steps in the model building process theory generation parameterization and estimation

is public expenditure productive abstract this paper considers the relationship between aggregate productivity and stock and flow government spending variables the empirical results indicate that i the nonmilitary public capital stock is dramatically more important in determining productivity than is either the flow of nonmilitary or military spending ii military capital bears little relation to productivity and iii a core infrastructure of streets highways airports mass transit sewers water systems etc has most explanatory power for productivity the paper also suggests an important role for the net public capital stock in the productivity slowdown of the last fifteen years

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

das maynard keynes problem one of the classic questions in the history of ideas first arose one hundred years ago in germany reading adam smith s two great works the theory of moral sentiments and the wealth of nations late 19th century german economists were struck by an apparent puzzle how could the theorist who made sympathy the mainspring of human action in the first book argue in the second that calculating self interest was the primary motive force thus arose das adam smith problem how could one reconcile the advocate of sympathy with the advocate of self interest the history of the attempts to answer this question is instructive in many ways it is instructive in part as a lesson in the fertility of the history of economic thought as a source of ideas a o hirschman is an outstanding example of an original and creative theorist who has come to fresh insights on the basis of his research on the question see hirschman 1977 1986 the history is also instructive in pointing out the indeterminate nature of the solution to the problem despite the stature of the scholars who have worked in the field and the high quality of their work one must ultimately accept that we shall never know the true answer to the question smith left few papers and the context of his thought is itself a puzzle for us careful reconstruction of the unfolding social cultural and philosophical worlds that smith inhabited would certainly be hallmarks of any acceptable answer to the question but authorities on each of these background areas themselves disagree about what was happening in the worlds in which smith lived reasonable persons must agree to disagree about the answer to the question

auctions experiments and contingent valuation laboratory experiments are a welcome development that promise to make a significant contribution to the study of economic behavior heiner 1985 plott 1982 smith 1982 1985 while relatively new to economics controlled laboratory studies of human behavior have long constituted the core of experimental psychology where there is a wealth of methodological experience from which experimental economists might profitably draw in particular current attempts to apply laboratory auction methods to valuing nonmarket environmental goods would be improved by more rigorous experimental design and data analysis procedures

empirical measures of factors affecting social rates of discount economists have long considered possible divergences between private and social rates of time preferences in this paper we investigate factors hypothesized to affect this potential divergence results indicate that time preferences of individuals may be influenced by 1 whether the resource in question is publicly or privately managed respondents tend to have lower rates of time prefernce for publicly managed resources and 2 the type of good being managed respondents tend to have lower rates of time preference for income derived from a forest than for income derived from a portfolio of stocks and bonds additional factors which may influence the revealed rate of time preference include the pattern of benefits derived over time and various personal characteristics of the respondent although numerous methodological problems cloud the issues our results suggest that capital markets may fail to aggregate utility over individuals and between goods and that it may therefore be appropriate for governments to consider using lower rates of discount than the private sector and to vary the rate used according to the type of good being evaluated

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

attractive compounds of unattractive investments and gambles a compound of many independent replicas of an investment or gamble may be attractive to some risk averters who do not accept the individual investment or gamble this can happen if there is a chance that the compound leads to a wealth level where the degree of risk aversion is lower than at the initial wealth level it can also happen if the investor has some sort of limited liability the von neumann morgenstern utility functions with the property that sufficiently long sequences of repetitions of any fair gamble are preferred to all finite wealth levels are characterized in this paper

uncertainty risk and trust russian and american credit card markets compared the strategies that russian and american banks use to evaluate the creditworthiness of prospective credit card holders are compared drawing on knight s theory of risk and uncertainty the authors argue that uncertainty inherent in any credit transaction can only be reduced to measurable risk if there are institutions that create stability over time categorize events properly and allow for verification and accumulation of information in the united states the gradual evolution of institutions underpinning rational calculation permits the transformation of uncertainty into risk in russia however such institutions are absent and a great degree of uncertainty prevails in consumer credit using data from original fieldwork in moscow this study demonstrates that when actors face uncertainty and are unable to calculate risk they rely on trust russian banks use and extend their existing social ties or in some cases build new ties they also exploit cardholders own networks unrelated to the bank to increase their accountability through anchoring these strategies however keep the market embedded limited in size and uninsurable the authors conclude that calculation of probabilities and economic rationality in its formal sense is not an innate human ability but a social capacity that exists courtesy of institutional arrangements

the apostles justice cambridge reflections on economic inequality from moore s principia ethica to keynes s general theory 1903 36 this article explores economic justice in the writings of the cambridge authors g l dickinson g shove r hawtrey d h robertson h o meredith j h bell and f ramsey who were either members of the apostles discussion society or like hugh dalton lay followers of its philosophical leader g e moore the article challenges the prevalent view depicting the apostles as uninterested in social problems their analyses of economic inequality are reviewed in connection with the marshallian tradition the impact of fabianism and j m keynes s views of social justice special attention is paid to some neglected aspects of moore s principia ethica which were debated in the society and influenced the apostles social awareness they believed that large inequalities were both unjust and inefficient and as moore s disciples they rejected the hedonistic perspective and considered justice not as an end in itself but as a means to the good

note further tests of aspiration level effects in risky choice behavior this note extends the work reported in payne laughhunn and crum payne j w d j laughhunn r crum 1980 translation of gambles and aspiration level effects in risky choice behavior management sci 26 1039 1060 on the need to incorporate a target return reference point or aspiration level concept in the analysis of risky choice behavior two experiments are reported the first experiment provides a more complete test of the model of reference point effects developed by payne laughhunn and crum a translation of outcomes procedure which adds a constant to all outcomes was used to vary the relationship of pairs of gambles to an assumed target or reference point the results fully support the model the second experiment provides evidence of the conceptual validity of the model by using explicit instructions to vary the target levels of managers while holding gamble values constant

ambiguity aversion with three or more outcomes abstract ambiguous choice problems which involve three or more outcome values can reveal aspects of ambiguity and ambiguity aversion which cannot be displayed in the classic two outcome ellsberg urn problems and hence are not always captured by models designed to accommodate them these aspects include allais type preferences over purely subjective acts attitudes toward different sources involving different amounts of ambiguity and attitudes toward ambiguity at different outcome levels this paper presents a few such examples and examines the standard models predictions and performance in such cases jel d81

thinking economically about climate change abstract uncertainty over both the regional impacts and timing of climatic changes the way they tend to magnify the likelihood of so called natural disasters and their irreversibility require careful analysis of policy options from an economic standpoint the best approach is to apply cost benefit thinking the essential trade off is between doing nothing now and investing in either important preventive or adaptive measures the choices involve analysis of incurring costs now against the benefits of reducing vulnerability and future damage costs for any given level of warming the aim is to minimize the sum of policy costs and costs of adaptation by individuals any resulting policy decision will have to address issues of international cooperation and compensation these considerations may in turn influence the resulting policy choices between carbon taxes marketable permits and regulatory restrictions

the normative economics of health care finance and provision whereas in many countries the crisis in medical care has been seen in terms of excess spending on health services in the uk it has been seen at least by most of those who manage and work in the nhs as a crisis of underfunding this has come about as the result of the government s successful attempts to restrain the rate of growth of real spending on the nhs which in turn reflects the government s belief that its principal effective weapon against what it perceives to be inefficiency in the nhs is to challenge management itself reformed and to some extent liberated by systematic financial squeezes the same concern has given rise to a host of proposals for reform of the nhs most of which involve a much greater role for private insurance private finance of other kinds such as out of pocket payments and private provision of health care itself

multi attribute utility function or statistical inference models a comparison of health state valuation models using the hui2 health state classification system a key issue in health state valuation modelling is the choice of functional form the two most frequently used preference based instruments adopt different approaches one based on multi attribute utility theory maut the other on statistical analysis there has been no comparison of these alternative approaches in the context of health economics we report a comparison of these approaches for the health utilities index mark 2 the statistical inference model predicts more accurately than the one based on maut we discuss possible explanations for the differences in performance the importance of the findings and implications for future research

the marginal utility of income does not increase borrowing lending and friedman savage gambles there has been a great deal of discussion about whether the marginal utility of income rises with income most notably milton friedman and leonard j savage argued in their classic paper that the willingness to gamble implies that the marginal utility of income is rising over a range the discussions of rising marginal utility and of friedman savage gambles have proceeded independently of the literature on time preference although the issues are in fact related logically drawing on this logical relationship we shall show 1 that at least when intertemporal utility is separable the stable levels of consumption that are usually observed imply that the marginal utility of income decreases as income rises 2 even if the marginal utility of income does increase friedman savage gambles normally will not maximize utility saving and dissaving can attain the levels of consumption which generate the most utility per dollar of income at a lower cost than gambles unless imperfections in the capital market are severe 3 even when the utility function is not temporally separable repeated gambling cannot be a rational way of dealing with a rising marginal utility of income we therefore conclude that observed gambling is seldom if ever explained by the logic set out in friedman and savage s seminal paper in view particularly of the stability of consumption levels and the lack of friedmansavage gambles we conclude that marginal utility of income does not rise with income i a conceptual framework

a risk return model with risk and return measured as deviations from a target return two attribute risk and return models are very popular in the economics and finance literature for analyzing decisions under uncertainty their popularity stems primarily from the intuitive appeal of the dichotomy into risk and return and from the ease with which the concepts can be diagrammed in two dimensions the most commonly used risk return model is the mean variance model in which risk is measured as the variance and return by the mean of the probability distribution over outcomes the mean variance model has a number of shortcomings which are widely known but of particular concern here are the facts that 1 mean variance dominance is neither necessary nor sufficient for second degree stochastic dominance 2 unless the form of the probability distribution is restricted mean variance is consistent with von neumann morgenstern utility theory only if the utility function is quadratic and 3 as peter fishburn has noted

estimating time preferences from convex budgets experimentally elicited discount rates are frequently higher than what seems reasonable for economic decision making such high rates are often attributed to present biased discounting a well known bias of standard measurements is the assumption of linear consumption utility attempting to correct this bias using measures of risk aversion to identify concavity researchers find reasonable discounting but at the cost of exceptionally high utility function curvature we present a new methodology for identifying time preferences both discounting and curvature from simple allocation decisions we find reasonable levels of both discounting and curvature and surprisingly dynamically consistent time preferences jel c91 d12 d81 understanding and estimating time preferences is obviously of great importance to economists marketers and policy makers consumers decide how much to invest in savings education real estate and life insurance how much to diet exercise and smoke whether to marry when to have children and what to leave in their wills while there has been substantial research estimating time preferences using aggregate consumption data 1 the bulk of the effort has occurred in laboratory environments 2 among the many laboratory techniques employed recent studies have favored multiple price lists mpl with monetary payments 3 with mpls individuals are asked multiple times to choose between smaller payment amounts closer to the present and larger amounts further into the future the interest rate increases monotonically in a price list such that the point where an individual switches from preferring sooner payments to later payments carries interval

on the death of distance and borders evidence from the nineteenth century abstract we investigate time dependent border and distance effects in the nineteenth century and document clear declines in these variables over time this suggests that trade costs may have not declined as dramatically in the late twentieth century as has been supposed

relative concave utility for risk and ambiguity this paper presents a general technique for comparing the concavity of different utility functions when probabilities need not be known it generalizes a yaari s comparisons of risk aversion by not requiring identical beliefs b kreps and porteus information timing preference by not requiring known probabilities c klibanoff marinacci and mukerji s smooth ambiguity aversion by not using subjective probabilities which are not directly observable and by not committing to violations of dynamic decision principles d comparative smooth ambiguity aversion by not requiring identical second order subjective probabilities our technique completely isolates the empirical meaning of utility it thus sheds new light on the descriptive appropriateness of utility to model risk and ambiguity attitudes

venture theory a model of decision weights several theories suggest that people replace probabilities by decision weights when evaluating risky outcomes this paper proposes a model called venture theory of how people assess decision weights it is assumed that people first anchor on a stated probability and then adjust this by mentally simulating other possible values the amount of mental simulation is affected by the absolute size of payoffs the extent to which the anchor deviates from the extremes of 0 and 1 and the level of perceived ambiguity concerning the relevant probability the net effect of the adjustment i e up or down vis i vis the anchor reflects the relative weight given in imagination to values above as opposed to below the anchor this in turn is taken to be a function of both individual and situational variables and in particular the sign and size of payoffs cognitive and motivational factors therefore both play important roles in determining decision weights assuming that people evaluate outcomes by a prospect theory value function kahneman and tversky 1979 and are cautious in the face of risk fourteen predictions are derived concerning attitudes toward risk and ambiguity as functions of different levels of payoffs and probabilities the results of three experiments are reported whereas only a subset of the model s predictions can be tested in experiment 1 all fourteen are tested in experiments 2 and 3 using hypothetical and real payoffs respectively several of the model s predictions are not supported in experiment 2 but almost all are validated in experiments 1 and 3 the failures relate to the exact nature of probability payoff interactions in attitudes toward risk and ambiguity for losses the theory and results are discussed in relation to other experimental evidence future tests of the theory alternative models of risky choice and implications of venture theory for explaining further phenomena

three variants on the allais example three variants on the famous allais example were administered to student subjects two variants involved small changes in the example yet greatly diminished the qualitative behavior known as the allais paradox the third variant is almost a direct test of daniel kahneman and amos tversky s certainty effect against mark machina s fanning out hypothesis the results favor the certainty effect over the fanning out hypothesis for at least the case of straight line indifference curves copyright 1989 by american economic association

the estimation of marginal utility of income for application to agricultural policy analysis abstract a quality of life index qli a proxy measure of utility is constructed by factor weighted and simple summation weighted aggregation of socio psychological measures of well being the socio psychological measures were constructed from quality of life domains taken from selected years of the general social surveys general social surveys 1972 1993 cumulative code book principal investigator james a davis director and co principal investigator tom w smith chicago national opinion research center 1993 national data program for the social sciences series no 13 the quality of life indices qli indices are regressed on selected socio demographic variables using quadratic cobb douglas square root and semilog functional forms qli is much influenced by income education and health as measured here qli is not much influenced by year of measurement sector or by region of residence much variability in the qli is unique to individuals and our results are suited to predict group rather than individual well being practitioners computing the benefit cost ratio for a public program project or policy can weight dollars by income groups with marginal utilities derived from this study that methodology will matter even the conservative quadratic equation indicates that the marginal utility of income mui for families with very low incomes is half as large as for families with median incomes

death of distance and the distance puzzle abstract despite the onset of globalization year by year cross country regressions of the gravity model usually suggest that the impediment of geographical distance on bilateral trade is rising and not declining over time this effect of distance is dubbed the distance puzzle in this paper we argue that prima facie evidence of the distance effect from the year by year regressions may not be a good indicator of the true impact of distance on trade

commodity choice behavior with pigeons as subjects starting from an initial baseline budget line income compensated price changes always resulted in substitution effects consistent with the slutsky hicks theory this behavior cannot be explained by a simple random behavior model similar changes in relative prices that did not originate from the initial baseline budget line resulted in undersubstitution effects the composition of consumption changed in the expected direction but the magnitude of change was not large enough to be consistent with the initial commodity bundle chosen these undersubstitution effects are not explainable by shifting preference patterns or anchoring effects found in inconsistent choice sequences with human subjects

investimento publico e privado no brasil evidencias dos efeitos crowding in e crowding out no periodo 1995 2006 this study analyzed the evidences of the crowding in and crowding out effects in the brazilian economy for the period of 1995 2006 using of the vectorial error correction model vecm the variables interest rate tax burden and average price of the capital goods have negative effect on the investments indicating that politics seeking to reduction of the tax burden subsidies to capital goods and reduction of interest rates can influence the investments positively in order to leverage the sustained growth of the economy the existence of effects crowding out is observed among the public investments and private in the brazilian economy