an economic theory of self control the concept of self control is incorporated in a theory of individual intertemporal choice by modeling the individual as an organization the individual at a point in time is assumed to be both a farsighted planner and a myopic doer the resulting conflict is seen to be fundamentally similar to the agency conflict between the owners and managers of a firm both individuals and firms use the same techniques to mitigate the problems which the conflicts create this paper stresses the implications of this agency model and discusses as applications the effect of pensions on saving saving and the timing of income flows and individual discount rates

robust portfolio optimization with derivative insurance guarantees robust portfolio optimization aims to maximize the worst case portfolio return given that the asset returns are allowed to vary within a prescribed uncertainty set if the uncertainty set is not too large the resulting portfolio performs well under normal market conditions however its performance may substantially degrade in the presence of market crashes that is if the asset returns materialize far outside of the uncertainty set we propose a novel robust optimization model for designing portfolios that include european style options this model trades off weak and strong guarantees on the worst case portfolio return the weak guarantee applies as long as the asset returns are realized within the prescribed uncertainty set while the strong guarantee applies for all possible asset returns the resulting model constitutes a convex second order cone program which is amenable to efficient numerical solution procedures we evaluate the model using simulated and empirical backtests and analyze the impact of the insurance guarantees on the portfolio performance

rational heuristics expectations and behaviors in evolving economies with heterogeneous interacting agents we analyze the individual and macroeconomic impacts of heterogeneous expectations and action rules within an agent based model populated by heterogeneous interacting firms agents have to cope with a complex evolving economy characterized by deep uncertainty resulting from technical change imperfect information coordination hurdles and structural breaks in these circumstances we find that neither individual nor macroeconomic dynamics improve when agents replace myopic expectations with less naive learning rules our results suggest that fast and frugal robust heuristics may not be a second best option but rather rational responses in complex and changing macroeconomic environments jel c63 d8 e32 e6 o4

uncertainty and incentives in crisis bargaining game free analysis of international conflict we study two different varieties of uncertainty that countries can face in international crises and establish general results about the relationship between these sources of uncertainty and the possibility of peaceful resolution of conflict among our results we show that under some weak conditions there is no equilibrium of any crisis bargaining game that has voluntary agreements and zero probability of costly war we also show that while uncertainty about the other side s cost of war may be relatively benign in peace negotiations uncertainty about the other side s strength in war makes it much more difficult to guarantee peaceful outcomes along the way we are able to assess the degree to which particular modeling assumptions found in the existing literature drive the well known relationship between uncertainty the incentive to misrepresent and costly war we find that while the theoretical connection between war and uncertainty is quite robust to relaxing many modeling assumptions whether uncertainty is about costs or the probability of victory remains important

testing the stationarity of interest rates using a sur approach abstract using data on average yields to maturity of german bonds with different time to maturity it is shown that the time series contain a unit root if the standard augmented dickey fuller test is applied separately to each series to improve the power of the test we carried out a recently developed approach estimating the regressions for each time to maturity jointly using a seemingly unrelated regressions approach

information rigidities inflation perceptions and the media lessons from the euro cash changeover the objective of theoretical models of information rigidities is to capture the fact that people are constrained in their ability to acquire and process all available information given that most people obtain their information about the economy from the media press coverage of the economy may exert an influence on peoples attitudes this paper tests for this influence by examining consumers inflation perceptions in the aftermath of the euro cash changeover which serves as a natural experiment using a new data set that quantifies the intensity and tone of media reports we document that media reporting has had a statistically significant and economically meaningful impact on inflation perceptions and contributed to their sharp rise in the aftermath of the euro cash changeover and to the divergence between inflation perceptions and actual inflation rates jel e53 d83

portfolio optimization with tracking error constraints this article explores the risk and return relationship of active portfolios subject to a constraint on tracking error volatility tev which can also be interpreted in terms of value at risk such a constrained portfolio is the typical setup for active managers who are given the task of beating a benchmark the problem with this setup is that the portfolio manager pays no attention to total portfolio risk which results in seriously inefficient portfolios unless some additional constraints are imposed the development in this article shows that tev constrained portfolios are described by an ellipse on the traditional mean variance plane this finding yields a number of new insights because of the flat shape of this ellipse adding a constraint on total portfolio volatility can substantially improve the performance of the active portfolio in general plan sponsors should concentrate on controlling total portfolio risk

portfolio selection with uncertain exit time a robust cvar approach abstract in this paper we explore the portfolio selection problem involving an uncertain time of eventual exit to deal with this uncertainty the worst case cvar methodology is adopted in the case where no or only partial information on the exit time is available and the corresponding problems are integrated into linear programs which can be efficiently solved moreover we present a method for specifying the uncertain information on the distribution of the exit time associated with exogenous and endogenous incentives numerical experiments with real market data and monte carlo simulation show the usefulness of the proposed model

growth forecasts belief manipulation and capital markets abstract we analyze how a benevolent privately informed government agency would optimally release information about the economy s growth rate when the agents hold heterogeneous beliefs we model two types of agent conforming and dissenting the former has a prior that is identical to that of the government agency whereas the latter has a prior that differs from that of the government agency we identify both informative and uninformative equilibria informative equilibria are equilibria in which the government agency s equilibrium signal leads to a revision of beliefs we demonstrate that the uninformative equilibria can in fact dominate the informative ones in terms of ex post social welfare

monetary shocks in models with inattentive producers we study models where prices respond slowly to shocks because firms are rationally inattentive producers must pay a cost to observe the determinants of the current profit maximizing price and hence observe them infrequently to generate large real effects of monetary shocks in such a model the time between observations must be long and or highly volatile previous work on rational inattentiveness has allowed for observation intervals that are either constant but long e g caballero 1989 or reis 2006 or volatile but short e g reis s 2006 example where observation costs are negligible but not both in these models the real effects of monetary policy are small for realistic values of the duration between observations we show that non negligible observation costs produce both of these effects intervals between observations are infrequent and volatile this generates large real effects of monetary policy for realistic values of the average time between observations

asymmetric information and rational expectations when is it right to be wrong abstract in this paper we examine the effects of private agents being less than fully rational in their expectations we examine this in the context of monetary policy where the central bank may have uncertain preferences either by choice or by necessity the new feature is that we allow the public to react in two different ways they either form rational expectations and internalize the uncertainty about the central bank s preferences in full or alternatively and if this process of internalization is costly it forms a best guess regarding those preferences this implies a certainty equivalence strategy applied to the preference parameters as those parameters enter the decisions non linearly a systematic error emerges we examine the magnitude of the resulting error in inflation and output following the assumption of certainty equivalence under all reasonable levels of uncertainty this error turns out to be small but involves trading a deflation bias against the cost of gathering the information needed for the full information rational expectations solution

mean variance portfolio selection of cointegrated assets abstract this paper considers the continuous time mean variance portfolio selection problem in a financial market in which asset prices are cointegrated the asset price dynamics are then postulated as the diffusion limit of the corresponding discrete time error correction model of cointegrated time series the problem is completely solved in the sense that solutions of the continuous time portfolio policy and the efficient frontier are obtained as explicit and closed form formulas the analytical results are applied to pairs trading using cointegration techniques numerical examples show that identifying a cointegrated pair with a high mean reversion rate can generate significant statistical arbitrage profits once the current state of the economy sufficiently departs from the long term equilibrium we propose an index to simultaneously measure the departure level of a cointegrated pair from equilibrium and the mean reversion speed based on the mean variance paradigm an empirical example is given to illustrate the use of the theory in practice

sticky information phillips curves european evidence we estimate the sticky information phillips curve model of mankiw and reis 2002 using survey expectations of professional forecasters from four major european economies our estimates imply that in ation expectations in france germany and the united kingdom are updated about once a year in italy about once each six months

bounds on elasticities with optimization frictions a synthesis of micro and macro evidence on labor supply how can price elasticities be identified when agents face optimization frictions such as adjustment costs or inattention i derive bounds on structural price elasticities that are a function of the observed effect of a price change on demand the size of the price change and the degree of frictions the degree of frictions is measured by the utility losses agents tolerate to deviate from the frictionless optimum the bounds imply that frictions affect intensive margin elasticities much more than extensive margin elasticities i apply these bounds to the literature on labor supply the utility costs of ignoring the tax changes used to identify intensive margin labor supply elasticities are typically less than 1 of earnings as a result small frictions can explain the differences between micro and macro elasticities extensive and intensive margin elasticities and other disparate findings pooling estimates from existing studies i estimate a hicksian labor supply elasticity of 0 33 on the intensive margin and 0 25 on the extensive margin after accounting for frictions

bargaining and learning while fighting much of the existing formal work on war models the decision to go to war as a game ending costly lottery this article relaxes this assumption by treating war as a costly process during which the states run the risk of military collapse the model also allows for uncertainty over either the cost of fighting or the distribution of power the analysis makes four contributions to the growing costly process literature i the present model provides a more general treatment of the learning process that occurs when states are uncertain about the distribution of power ii it explicitly compares the bargaining and learning processes for the two different sources of uncertainty iii it suggests a way to empirically distinguish wars arising from these two sources and iv it shows that the equilibrium dynamics of informational accounts of war may be quite sensitive to the underlying bargaining environment through which information is conveyed

optimal monetary policy and transparency under informational frictions this paper examines the optimal monetary policy and central bank transparency in an economy where firms set prices under informational frictions the economy is subject to two types of shocks determining the efficient output level and firms desired markups to minimize the welfare reducing output gap and price dispersion between firms the central bank controls firms incentives and expectations by using a monetary instrument and disclosing information on the realized shocks this paper shows that an optimal policy comprises the disclosure of a linear combination of the two shocks and the adjustment of monetary instruments contingent on the disclosed information

mean reversion in g 10 nominal exchange rates according to conventional wisdom industrial country floating exchange rates contain unit roots sur tests on panels of monthly group of ten g 10 log nominal rates reject the null of unit roots for various samples over the current float with significance levels from 0 5 to 15 on average in out of sample forecasts mean reversion models beat random walks significantly in some forecast periods for monthly data the range of expected usd dem appreciation rates exceeds 15 per year in the mean reversion model mean reversion places strong restrictions on international models over the sample period the g 10 had to run monetary policies consistent with stable long run nominal rates

information power and war ultimatum bargaining models of international interactions suggest that when conflict is costly and the actors are fully informed the probability of conflict goes to zero however conflict occurs with some positive probability when the challenger is uncertain about the defender s reservation value i employ a simple ultimatum game of bargaining to evaluate two traditional power centric theories of world politics balance of power and power transition theory the formal and empirical analyses demonstrate that as states approach power parity information asymmetries are greatest thus enhancing the probability of militarized conflict uncertainty is a central cause of conflict emergence and is correlated with the distribution of observable capabilities recognizing the relationship between the distribution of power and the uncertainty offers a more sophisticated interpretation of power centric explanations of world politics

robust portfolio selection using linear matrix inequalities abstract in this paper we consider the problem of robust optimal portfolio selection for tracking error when the expected returns of the risky and risk free assets as well as the covariance matrix of the risky assets are not exactly known we assume that these parameters belong to a convex polytope defined by some known elements which form the vertices of this polytope we consider two problems the first one is to find a portfolio of minimum worst case volatility of the tracking error with guaranteed fixed minimum target expected performance the second one is to find a portfolio of maximum worst case target expected performance with guaranteed fixed maximum volatility of the tracking error we show that these two problems are equivalent to solving linear matrix inequalities lmi optimization problems so that the powerful numerical packages nowadays available for this class of problems can be used a numerical example in the sao paulo stock exchange bovespa is presented

the principle of convergence in wartime negotiations if war results from disagreement about relative strength then it ends when opponents learn enough about each other learning occurs when information is revealed by strategically manipulable negotiation behavior and nonmanipulable battlefield outcomes i present a model of simultaneous bargaining and fighting where both players can make offers and asymmetric information exists about the distribution of power in the markov perfect sequential equilibrium making and rejecting offers has informational value that outweighs the one provided by the battlefield however states use both sources of information to learn and settle before military victory the principle of convergence posits that warfare ceases to be useful when it loses its informational content and that belief in defeat victory is not necessary to terminate initiate hostilities thus the standard puzzle in international relations that seeks to account for prewar optimism on both sides may not be that relevant

a quantitative comparison of sticky price and sticky information models of price setting i estimate sticky price and sticky information models of price setting for the united states via maximum likelihood techniques reaching several conclusions first the sticky price model fits best and captures inflation dynamics as well as reduced form equations once hybrid behavior is allowed second the importance of hybrid behavior in sticky price models is potentially consistent with a role for some information imperfections such as sticky information as a complement to nominal price rigidities finally the favorable results herein for the hybrid sticky price model when evaluated by statistics that summarize the relative fit of different models is consistent with the existing literature that is both supportive and dismissive of such models as this literature has largely ignored fit in evaluating such models many previous studies have focused on ancillary issues such as the standard errors associated with certain parameters or granger causality tests that may not provide much information about sticky price models

war is in the error term at least since thucydides students of international relations have sought rational explanations for the advent of war rationalist explanations assume purposive action states are said to make reasoned decisions about the use of force although rationalist explanations have proven persuasive durable and offer the basis for cumulative theorizing they also imply substantial limits on what we can know about war i show that the most general rationalist explanation for war also dictates that the onset of war is theoretically indeterminate we cannot predict in individual cases whether states will go to war because war is typically the consequence of variables that are unobservable ex ante both to us as researchers and to the participants thinking probabilistically continues to offer the opportunity to assess international conflict empirically however the realization that uncertainty is necessary theoretically to motivate war is much different from recognizing that the empirical world contains a stochastic element accepting uncertainty as a necessary condition of war implies that all other variables however detailed the explanation serve to eliminate gradations of irrelevant alternatives we can progressively refine our ability to distinguish states that may use force from those that are likely to remain at peace but anticipating wars from a pool of states that appear willing to fight will remain problematic for example we may achieve considerable success in anticipating crises but our ability to predict which crises will become wars will probably prove little better than the naive predictions of random chance the need for uncertainty to account for war means that the same conditions thought to account for war must also exist among states not destined to fight otherwise states themselves will differentiate between opponents in a way that either removes the motives for war or restores uncertainty it has long been accepted that social processes possess an element of uncertainty but the centrality of uncertainty to rationalist explanations for war means that the advent of war is itself stochastic war is literally in the error term

mean reversion in interest rates new evidence from a panel of oecd countries previous studies show that the standard univariate unit root tests cannot reject the hypothesis that interest rates follow integrated processes in this paper the authors pool interest rate data of twelve oecd countries and implement a multivariate test it is found that the unit root hypothesis can be decisively rejected copyright 1996 by ohio state university press

international evidence on the efficacy of new keynesian models of inflation persistence in this paper we take an agnostic view of the phillips curve debate and carry out an empirical investigation of the relative and absolute efficacy of calvo sticky price sp sticky information si and sticky price with indexation models spi with emphasis on their ability to mimic inflationary dynamics in particular we look at evidence for a group of 13 oecd countries and we consider three alternative measures of inflationary pressure including the output gap labor share and unemployment we find that the calvo sp and the si models essentially perform no better than a strawman constant inflation model when used to explain inflation persistence indeed virtually all inflationary dynamics end up being captured by the residuals of the estimated versions of these models we find that spi model is preferable because it captures the type of strong inflationary persistence that has in the past characterized the economies of the countries in our sample however two caveats to this conclusion are that improvement in performance is driven mostly by the time series part of the model i e lagged inflation and that the spi model overemphasizes inflationary persistence thus there appears to be room for improvement via either modified versions of the above models or via development of new models that better track inflation persistence

peace war and the balance of power every possible relation between the distribution of power and the likelihood of war has been defended somewhere in the literature on international politics war is least likely if power is distributed equally war is least likely if power is distributed unequally and the distribution of power has no effect on the likelihood of war i try to settle this dispute by examining the effect of expectations about the outcome of war on the choice between war and negotiation i argue that each of these mutually contradictory propositions can be derived from some plausible set of premises and thus that which one is correct depends on which set of premises best describes a situation the most important factors affecting the relation between the distribution of power and the likelihood of war are 1 whether the terms of a compromise agreement that might be accepted in lieu of war affect the distribution of power between the antagonists and therefore the probability that the agreement will be enforced and 2 how many states interests will be affected by the outcome

bargaining under incomplete information this paper presents and analyzes a bargaining model of bilateral monopoly under uncertainty under the bargaining rule proposed the buyer and the seller each submit sealed offers that determine whether the good in question is sold and the transfer price the nash equilibrium solution of this bargaining game implies an offer strategy of each party that is monotonic in its own reservation price and depends on its assessment of the opponent s reservation price issues of relative bargaining advantage and efficiency are examined for a number of special cases finally we discuss the appropriateness of the nash solution concept

portfolio management with robustness in both prediction and decision a mixture model based learning approach abstract we develop in this paper a novel portfolio selection framework with a feature of double robustness in both return distribution modeling and portfolio optimization while predicting the future return distributions always represents the most compelling challenge in investment any underlying distribution can be always well approximated by utilizing a mixture distribution if we are able to ensure that the component list of a mixture distribution includes all possible distributions corresponding to the scenario analysis of potential market modes adopting a mixture distribution enables us to 1 reduce the problem of distribution prediction to a parameter estimation problem in which the mixture weights of a mixture distribution are estimated under a bayesian learning scheme and the corresponding credible regions of the mixture weights are obtained as well and 2 harmonize information from different channels such as historical data market implied information and investors subjective views we further formulate a robust mean cvar portfolio selection problem to deal with the inherent uncertainty in predicting the future return distributions by employing the duality theory we show that the robust portfolio selection problem via learning with a mixture model can be reformulated as a linear program or a second order cone program which can be effectively solved in polynomial time we present the results of simulation analyses and primary empirical tests to illustrate a significance of the proposed approach and demonstrate its pros and cons

frictions or mental gaps what s behind the information we don t use and when do we care consumers suffer significant losses from not acting on available information these losses stem from frictions such as search costs switching costs and rational inattention as well as what we call mental gaps resulting from wrong priors worldviews or relevant features of a problem not being top of mind most research studying such losses does not empirically distinguish between these mechanisms instead we show that most highly cited papers in this area presume one mechanism underlies consumer choices and assume away other potential explanations or collapse many mechanisms together we discuss the empirical difficulties that arise in distinguishing between different mechanisms and some promising approaches for making progress in doing so we also assess when it is more or less important for researchers to distinguish between these mechanisms approaches that seek to identify true value from demand without specifying mechanisms behind this wedge are most useful when researchers are interested in evaluating allocation policies that strongly steer consumers towards better options with regulation traditional policy instruments and defaults on the other hand understanding the precise mechanisms underlying consumer losses is essential to predicting the impact of mechanism policies aimed primarily at reducing specific frictions or mental gaps without otherwise steering consumers we make the case that papers engaging with these questions empirically should be clear about whether their analyses distinguish between mechanisms behind poorly informed choices and what that implies for the questions they can answer we present examples from several empirical contexts to highlight these distinctions

choosing between time and state dependence micro evidence on firms price reviewing strategies because of recent findings based on survey data it is now well known that firms differ from each other with respect to their price reviewing strategies while some firms review their prices at fixed intervals of time others prefer to perform price revisions in response to changes in economic conditions some theories have been suggested to explain this however empirical evidence on the relative importance of the factors that determine the different strategies of firms is virtually non existent in this paper we help to fill this gap by investigating the factors that explain why firms follow time dependent state dependent or both time and state dependent price reviewing rules we find that the strategies of firms vary with firm characteristics that have a bearing on the importance of information costs with the variability of the optimal price and with the sensitivity of profits to non optimal prices

the expected price of keeping up with the joneses abstract inflation expectations elicited in surveys have been found to exhibit large dispersion across individuals although several explanations have been proposed none fully explain this puzzle we explore in this paper a new behavioral factor social comparison using original survey data we find that respondents who feel they are falling behind compared to their peers report significantly and substantially higher inflation expectations we argue that this result is consistent with an experience based belief formation model in which those unable to keep up with the joneses overweight the high prices of aspiration goods they are unable to purchase

a quantized approach to rational inattention abstract in this paper i propose a model of rational inattention where the choice variable is a deterministic function of the exogenous variables and still only a finite amount of information is being used this holds provided the choice variable is discrete rather than continuous that is the mapping from the realization of the exogenous variables to the endogenous ones is piece wise constant thus limited information is now a source of lumpiness in behavior rather than a source of noise the approach is applied to a simple static model of price setting where individual price setters face aggregate monetary shocks and idiosyncratic productivity shocks the effect of aggregate money shocks on output and prices is studied it is shown that as the variance of idiosyncratic shocks become large the aggregate log price level converges to a linear function of the aggregate money shock with a coefficient which is strictly between 0 and 1 consequently unanticipated aggregate money shocks have real effects on output in contrast to the sticky price model of caplin and spulber 1987 but these effects are smaller than in standard rational inattention models or in the lucas 1972 misperception model

foundations for optimal inattention abstract this paper models an agent who has a limited capacity to pay attention to information and thus conditions her actions on a coarsening of the available information an optimally inattentive agent chooses both her coarsening and her actions by maximization of an underlying subjective expected utility preference relation net of a cognitive cost of attention the main result axiomatically characterizes the conditional choices of actions by an agent that are necessary and sufficient for her behavior to be seen as if it is the result of optimal inattention observing these choices permits unique identification of the agent s utility index the information to which she pays attention her attention cost and her prior whenever information is costly

risk uncertainty and option exercise many economic decisions can be described as an option exercise or optimal stopping problem under uncertainty motivated by experimental evidence such as the ellsberg paradox we follow knight 1921 and distinguish risk from uncertainty to capture this distinction we adopt the multiple priors utility model we show that the impact of ambiguity on the option exercise decision depends on the relative degrees of ambiguity about continuation payoffs and termination payoffs consequently ambiguity may accelerate or delay option exercise we apply our results to investment and exit problems and show that the myopic npv rule can be optimal for an agent having an extremely high degree of ambiguity aversion

active portfolio management with benchmarking adding a value at risk constraint abstract we examine the impact of adding a value at risk var constraint to the problem of an active manager who seeks to outperform a benchmark while minimizing tracking error variance tev by using the model of roll 1992 a mean variance analysis of tracking error journal of portfolio management 18 13 22 we obtain three main results first portfolios on the constrained mean tev boundary still exhibit three fund separation but the weights of the three funds when the constraint binds differ from those in roll s model second the constraint mitigates the problem that when an active manager seeks to outperform a benchmark using the mean tev model he or she selects an inefficient portfolio finally when short sales are disallowed the extent to which the constraint reduces the optimal portfolio s efficiency loss can still be notable but is smaller than when short sales are allowed

what can survey forecasts tell us about information rigidities a lot we derive common and conflicting predictions from models in which agents face information constraints and then assess their validity using surveys of consumers firms central bankers and professional forecasters we document that mean forecasts fail to completely adjust on impact to shocks leading to statistically and economically significant deviations from the null of full information the dynamics of forecast errors after shocks are consistent with the predictions of models with information rigidities the conditional responses of forecast errors and disagreement among agents can also be used to differentiate between some of the most prominent models of information rigidities

inattentive professional forecasters abstract using the ecb survey of professional forecasters to characterize expectations at the micro level we emphasize two new facts forecasters i fail to systematically update their forecasts and ii disagree even when updating it is moreover found that forecasters have predictable forecast errors these facts are qualitatively supportive of recent models of inattention and suggest a setup where agents imperfectly process information due to both sticky information a la mankiw reis and noisy information a la sims however building and estimating such an expectation model we find that it cannot quantitatively replicate the error and disagreement observed in the data

asset allocation in a downside risk framework 1991 asset allocation in a downside risk framework financial analysts journal vol 47 no 5 pp 28 40

index tracking model downside risk and non parametric kernel estimation abstract in this paper we propose an index tracking model with the conditional value at risk cvar constraint based on a non parametric kernel npk estimation framework in theory we demonstrate that the index tracking model with the cvar constraint is a convex optimization problem we then derive npk estimators for tracking errors and cvar and thereby construct the npk index tracking model monte carlo simulations show that the npk method outperforms the linear programming lp method in terms of estimation accuracy in addition the npk method can enhance computational efficiency when the sample size is large empirical tests show that the npk method can effectively control downside risk and obtain higher excess returns in both bearish and bullish market environments

actively learning by pricing a model of an experimenting seller this article presents a model of a rational seller who is actively learning the slope of his demand curve via his pricing strategy consequently this seller optimally experiments with his price resulting price patterns show a tendency for discreteness as observed in the data which has proved to be a major challenge to most price setting models the experimentation motive can also replicate the observation that prices are more volatile than costs as well as the presence of many idiosyncratic price changes in the data it can do so without a need to assume the existence of large idiosyncratic shocks

bargaining in the shadow of war when is a peaceful resolution most likely this article derives the optimal bargaining strategies of the belligerents when each side has private but incomplete information about the expected outcome of a war should it take place i show that the aggressor s demand curve can be below the defender s offer curve that wars are possible even when both sides are jointly pessimistic and that the relative cost of a war can radically alter the types of disputes that end in war a simple diagram provides the intuition for most of the major propositions

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

optimal mean variance portfolio selection using cauchy schwarz maximization fund managers highly prioritize selecting portfolios with a high sharpe ratio traditionally this task can be achieved by revising the objective function of the markowitz mean variance portfolio model and then resolving quadratic programming problems to obtain the maximum sharpe ratio portfolio this study presents a closed form solution for the optimal sharpe ratio portfolio by applying cauchy schwarz maximization and the concept of kuhn tucker conditions an empirical example is used to demonstrate the efficiency and effectiveness of the proposed algorithms moreover the proposed algorithms can also be used to obtain the optimal portfolio containing large numbers of securities which is not possible or at least is complicated via traditional quadratic programming approaches

robustly strategic consumption portfolio rules with informational frictions this paper provides a tractable continuous time constant absolute risk aversion gaussian framework to explore how the interactions of fundamental uncertainty model uncertainty due to a preference for robustness and state uncertainty due to information processing constraints rational inattention affect strategic consumption portfolio rules and precautionary savings in the presence of uninsurable labor income specifically after solving the model explicitly i compute and compare the elasticities of strategic asset allocation and precautionary savings to risk aversion robustness and inattention furthermore for plausibly estimated and calibrated model parameters i quantitatively analyze how the interactions of model uncertainty and state uncertainty affect the optimal share invested in the risky asset and show that they can provide a potential explanation for the observed stockholding behavior of households with different education and income levels this paper was accepted by neng wang finance

the effects of professional forecast dissemination on macroeconomic volatility abstract this paper explores the role that professional forecast announcements can have on macroeconomic volatility bounded rational agents are used inside a medium scale dynamic stochastic general equilibrium dsge model with financial frictions modeled agents must form expectations about endogenous variables by selecting between three simple linear forecasting specifications some of which contain the inclusion of a professionally announced forecast of the economic variable historically calibrated simulations of the model show that the usage of the announced professional forecast by the agents in their adaptive learning forecast specifications can reduce the volatility in consumption inflation and wages by as much as 26 23 and 22 respectively however if the professional forecast is not disseminated well to the agents or biased in its dissemination agents will learn to ignore the announcement and macroeconomic volatility will increase further the inclusion of very noisy professional forecast signals can result in coordinated volatility cascades where agents could reduce macroeconomic volatility by ignoring the professional forecast but choose not to because of its previous forecast performance

investment dynamics with information costs investment in physical capital at the micro level is infrequent and large or lumpy the most common explanation for this is that firms face non convex physical adjustment costs the model developed in this paper shows that information costs make investment lumpy at the micro level even in the absence of non convex adjustment costs when collecting and processing information is costly the firm optimally chooses to do it sporadically and to be inactive most of the time this behavior results in infrequent and possibly large capital adjustments the model fits plant level investment rate moments well and it also matches some higher order moments of aggregate investment rates keywords investment dynamics information costs inattentiveness lumpy investment jel classification d21 d83 d92 e22

imperfect credibility and inflation persistence in this paper we formulate a dynamic general equilibrium model with staggered nominal contracts in which households and rms use optimal ltering to disentangle persistent and transitory shifts in the monetary policy rule the calibrated model accounts quite well for the dynamics of output and insation during the volcker disinsation and implies a sacri ce ratio very close to the estimated value our approach indicates that insation persistence and substantial costs of disinsation can be generated in an optimizing agent framework without relaxing the assumption of rational expectations or relying on arbitrary modi cations to the aggregate supply relation jel classi cation e31 e32 e52

price adjustments in a general model of state dependent pricing we study the distribution of retail price adjustments under the assumption that firms are more likely to adjust their prices when doing so is more valuable our setup nests calvo 1983 at one extreme and a fixed menu cost model at the other all parameterizations are ranked by a measure of state dependence high state dependence implies counterfactually that there are no small price changes and that the variance of price changes falls sharply with trend inflation the parameterization that best fits microdata has low state dependence implying a phillips curve coefficient 60 as large as that of the calvo model but is nonetheless well behaved at high inflation rates

macroeconomic expectations and time varying heterogeneity evidence from individual survey data the goal of this paper is to investigate forecast heterogeneity and time variability in the formation of expectations using disaggregated monthly survey data on macroeconomic indicators provided by

does the real exchange rate follow a random walk the pacific basin perspective abstract in this paper we present evidence that dispels the view that ppp has broken down during the 1970s and 1980s evidence from unit root tests of the real exchange rate indicate that ppp held as a long run equilibrium condition for eight pacific basin countries over the period 1974 to 1987 in contrast we find the nominal exchange rates to be non stationary additional evidence however shows that strong trend components bind the nominal exchange rates of that set of countries together jel f31

focusing effect and the poverty trap abstract i build a dynamic consumption savings model in which agents choices are distorted by the focusing effect agents overweight the utility of goods in which their options differ more i show that the consumption savings choice depends both on the marginal return on savings and on the total return on savings implying that the incentive to save may increase with the initial level of wealth as a consequence a salience based poverty trap may exist when the marginal return on savings is sufficiently high and sufficiently flat i also consider the case of a perfect credit market and show that a poverty trap may emerge when the salience of consumption is bounded above i discuss policy implications in particular imposing upon an agent a punishment for decreasing savings below a threshold leads to a higher level of savings even when the threshold triggering the punishment is not binding

when little things mean a lot on the inefficiency of item pricing laws abstract item pricing laws ipls require a price tag on every item sold by a retailer we study ipls and assess their efficiency by quantifying their costs and comparing them to previously documented benefits on the cost side we posit that ipls should lead to higher prices because they increase the costs of pricing and price adjustment we test this prediction using data collected from large supermarket chains in the tri state area of new york new jersey and connecticut we find that ipl store prices are higher by about 20 25 per item on average as a control we use data from stores that use electronic shelf labels and find that their prices fall between ipl and no ipl store prices we compare the costs of ipls to existing measures of the benefits and find that the costs are an order of magnitude higher than the upper bound of the estimated benefits

bounded rationality lifecycle consumption and social security abstract this paper explores an overlapping generations model of bounded rationality in which consumers only foresee the future over a subset of their life span we focus in particular on whether the model can in general equilibrium produce a hump shaped lifecycle consumption profile with a peak that matches data for the average u s consumer for a simple four period model we show that an increasing income profile along with exogenously imposed retirement are sufficient to induce a hump with no other mechanism that can account for a hump besides bounded rationality the model best fits the salient features of consumption data with a planning horizon of 20 years which is well supported by the behavioral evidence found in surveys on retirement planning finally we show that the age of the consumption peak is robust to the introduction of social security mortality risk and another species of bounded rationality quasihyperbolic discounting moreover social security can be welfare improving with a short planning horizon we can calibrate the model to jointly explain the timing of the consumption hump and the optimality of the current social security system with quasihyperbolic discounting instead we can calibrate the model so the current social security system is optimal but we cannot also account for the timing of the consumption hump if we add quasihyperbolic discounting in addition to a short planning horizon the present bias has a negligible effect in equilibrium

balance of power and the propensity of conflict we study the role of an imbalance in fighting strengths when players bargain in the shadow of conflict our experimental results suggest in a simple bargaining game with an exogenous mediation proposal the likelihood of conflict is independent of the balance of power if bargaining involves endogenous demand choices however the likelihood of conflict is higher if power is more imbalanced even though endogenous bargaining outcomes reflect the players unequal fighting strengths strategic uncertainty causes outcomes to be most efficient when power is balanced in turn the importance of exogenous mediation proposals depends on the balance of power

capabilities uncertainty and resolve a limited information model of crisis bargaining this paper presents and solves a crisis bargaining game under limited information the sides alternate offers from three possible offers with war and its costs starting if the target s counteroffer is rejected the equilibrium of the model falls into four different cases these four cases are analyzed to determine how the sides communicate through their offers and how the costs of war initial beliefs misperceptions and distribution of capabilities drive the probabilities of a crisis and war the model demonstrates a joint selection bias misspecification problem in empirical studies of crises arising from the unobservable nature of beliefs several empirical studies of crisis bargaining are discussed in the light of this methodological problem new patterns of evidence are found that support the presence of the selection problem and their conclusions are reexamined

robust tracking error portfolio selection with worst case downside risk measures abstract this paper proposes downside risk measure models in portfolio selection that captures uncertainties both in distribution and in parameters the worst case distribution with given information on the mean value and the covariance matrix is used together with ellipsoidal and polytopic uncertainty sets to build up this type of downside risk model as an application of the models the tracking error portfolio selection problem is considered by lifting the vector variables to positive semidefinite matrix variables we obtain semidefinite programming formulations of the robust tracking portfolio models numerical results are presented in tracking sse50 of the shanghai stock exchange compared with the tracking error variance portfolio model and the equally weighted strategy the proposed models are more stable have better accumulated wealth and have much better sharpe ratio in the investment period for the majority of observed instances

setting the right prices for the wrong reasons we consider a model of nominal price adjustment with firm specific and aggregate shocks to economic fundamentals and incomplete dispersed information firms update their expectations about fundamentals based on their own cash flows revenues and wages we show that in a model with realistic levels of product level price dispersion the firms inference about aggregate shocks is very gradual yet in the aggregate prices adjust rapidly in response to aggregate nominal shocks when an aggregate shock occurs firms mistakenly attribute it to firm specific shocks but adjust prices nevertheless since the exact nature of the shock matters little for its optimal pricing decision

statistical testing of bounded rationality with applications to the newsvendor model abstract in this paper we define bounded rationality in terms of probabilistic cost efficiency this establishes a framework where bounded rationality can be examined rigorously by statistical methods we apply this theory to data from laboratory experiments on the newsvendor model we enter into a theoretical discussion of the classical pull to center effect and explain why underorders are typically larger than overorders

were there regime switches in u s monetary policy working paper 2004 14 june 2004 abstract a multivariate model identifying monetary policy and allowing for simultaneity and regime switching in coefficients and variances is confronted with u s data since 1959 the best fit is with a model that allows time variation in structural disturbance variances only among models that also allow for changes in equation coefficients the best fit is for a model that allows coefficients to change only in the monetary policy rule that model allows switching among three main regimes and one rarely and briefly occurring regime the three main regimes correspond roughly to periods when most observers believe that monetary policy actually differed and the differences in policy behavior are substantively interesting though statistically ill determined the estimates imply monetary targeting was central in the early 80s but was also important sporadically in the 70s the changes in regime were essential neither to the rise in inflation in the 70s nor to its decline in the 80s jel classification e52 e47 c53 key words counterfactuals lucas critique policy rule monetary targeting simultaneity volatility model comparison i the debate over monetary policy change in an influential paper clarida gali and gertler 2000 cgg presented evidence that us monetary policy changed between the 1970 s and the 1980 s indeed that in the 70 s it was drastically worse they found that the policy rule apparently followed in the 70 s was one that when embedded in most stochastic general equilibrium models would imply non uniqueness of the equilibrium and hence vulnerability of the economy to sunspot fluctuations of arbitrarily large size their estimated policy rule for the later period on the other hand eliminated this indeterminacy these results are a possible explanation of the volatile and rising inflation of the 70 s and of its subsequent decline the cgg analysis has two important weaknesses one is that it fails to account for stochastic volatility us macroeconomic variables and particularly the federal funds rate have gone through periods of tranquility and of agitation with forecast error variances varying greatly from period to period ignoring such variation does not lead to inconsistent estimates of model parameters when the forecasting equations themselves are constant but it strongly biases toward a finding of changed parameters tests of the stability of the forecasting equations the other weakness is that the cgg analysis rests on powerful and implausible identifying assumptions they require that we accept that the response of the monetary authority to expected future inflation and output does not depend on the recent history of inflation money growth or output it is hard to understand why this should be so especially in the 70 s when monetarism was a prominent theme in policy debates congress was requiring reports from the fed of projected time paths of monetary aggregates and financial markets were reacting sensitively to weekly money supply numbers the requirement for existence and uniqueness of equilibrium in dynamic models is that the monetary policy rule show a more than unit response of interest rates to the sum of the logs of all nominal variables that appear on the right hand side of the reaction function if we force a particular measure of expected future inflation to proxy for all the nominal variables that actually appear independently in the reaction function we are bound to get distorted conclusions on the one hand because expected future inflation will be a noisy measure of the full set of nominal influences on policy we might get downward bias in our estimates from the usual errorsin variables effect on the other hand to the extent that expected future inflation like most expected future values shows less variation than current nominal variables we could find a mistaken scaling up of coefficients

sticky prices and costly credit we develop a theory of money and credit as competing payment instruments then put it to work in applications agents use cash and credit because the former latter is subject to the inflation tax transaction costs frictions that make the choice of payment method interesting also imply equilibrium price dispersion we derive closed form solutions for money demand and show how to simultaneously account for the price change facts cash credit shares in micro data and money interest correlations in macro data the effects of inflation on welfare price dispersion and markups are discussed as are nonstationary equilibria with dynamics in the price distribution

worst case value at risk and robust portfolio optimization a conic programming approach classical formulations of the portfolio optimization problem such as mean variance or value at risk var approaches can result in a portfolio extremely sensitive to errors in the data such as mean and covariance matrix of the returns in this paper we propose a way to alleviate this problem in a tractable manner we assume that the distribution of returns is partially known in the sense that onlybounds on the mean and covariance matrix are available we define the worst case value at risk as the largest var attainable given the partial information on the returns distribution we consider the problem of computing and optimizing the worst case var and we show that these problems can be cast as semidefinite programs we extend our approach to various other partial information on the distribution including uncertainty in factor models support constraints and relative entropy information

worst case value at risk of nonlinear portfolios portfolio optimization problems involving value at risk var are often computationally intractable and require complete information about the return distribution of the portfolio constituents which is rarely available in practice these difficulties are compounded when the portfolio contains derivatives we develop two tractable conservative approximations for the var of a derivative portfolio by evaluating the worst case var over all return distributions of the derivative underliers with given first and second order moments the derivative returns are modelled as convex piecewise linear or by using a delta gamma approximation as possibly nonconvex quadratic functions of the returns of the derivative underliers these models lead to new worst case polyhedral var wpvar and worst case quadratic var wqvar approximations respectively wpvar serves as a var approximation for portfolios containing long positions in european options expiring at the end of the investment horizon whereas wqvar is suitable for portfolios containing long and or short positions in european and or exotic options expiring beyond the investment horizon we prove that unlike var that may discourage diversification wpvar and wqvar are in fact coherent risk measures we also reveal connections to robust portfolio optimization this paper was accepted by dimitris bertsimas optimization

variance vs downside risk is there really that much difference abstract the popularity of downside risk among investors is growing and mean return downside risk portfolio selection models seem to oppress the familiar mean variance approach the reason for the success of the former models is that they separate return fluctuations into downside risk and upside potential this is especially relevant for asymmetrical return distributions for which mean variance models punish the upside potential in the same fashion as the downside risk the paper focuses on the differences and similarities between using variance or a downside risk measure both from a theoretical and an empirical point of view we first discuss the theoretical properties of different downside risk measures and the corresponding mean downside risk models against common beliefs we show that from the large family of downside risk measures only a few possess better theoretical properties within a return risk framework than the variance on the empirical side we analyze the differences between some us asset allocation portfolios based on variances and downside risk measures among other things we find that the downside risk approach tends to produce on average slightly higher bond allocations than the mean variance approach furthermore we take a closer look at estimation risk viz the effect of sampling error in expected returns and risk measures on portfolio composition on the basis of simulation analyses we find that there are marked differences in the degree of estimation accuracy which calls for further research

implications of rational inattention abstract a constraint that actions can depend on observations only through a communication channel with finite shannon capacity is shown to be able to play a role very similar to that of a signal extraction problem or an adjustment cost in standard control problems the resulting theory looks enough like familiar dynamic rational expectations theories to suggest that it might be useful and practical while the implications for policy are different enough to be interesting

testing the behavior of rationally inattentive consumers in a residential water market abstract rationally inattentive consumers tend to apply simplified heuristics when making decisions we test the hypothesis of rational inattention in the context of residential water usage where water bills typically account for a small fraction of household expenditures and only attract casual attention we begin by rigorously testing whether or not residential water customers exhibit evidence of rational inattention we then propose a heuristic water demand model to explore the decision making of rationally inattentive consumers and validate the model by comparing the model with the discrete continuous choice model on attentive and fully informed decision makers in out of sample predictions

a linear model for tracking error minimization abstract this article investigates four models for minimizing the tracking error between the returns of a portfolio and a benchmark due to linear performance fees of fund managers we can argue that linear deviations give a more accurate description of the investors risk attitude than squared deviations all models have in common that absolute deviations are minimized instead of squared deviations as is the case for traditional optimization models linear programs are formulated to derive explicit solutions the models are applied to a portfolio containing six national stock market indexes usa japan uk germany france switzerland and the tracking error with respect to the msci morgan stanley capital international index world stock market index is minimized the results are compared to those of a quadratic tracking error optimization technique the portfolio weights of the optimized portfolio and its risk return properties are different across the models which implies that optimization models should be targeted to the specific investment objective finally it is shown that linear tracking error optimization is equivalent to expected utility maximization and lower partial moment minimization