can self control explain avoiding free money evidence from interest free student loans abstract this paper uses insights from behavioral economics to explain a particularly surprising borrowing phenomenon one in six undergraduate students offered interest free loans turns them down models of impulse control predict that students may optimally reject subsidized loans to avoid excessive consumption during school using the national postsecondary student aid study we investigate students take up decisions and identify a group of students for whom the loans create an especially tempting liquidity increase students who would receive the loan in cash are significantly more likely to turn it down suggesting that consumers choose to limit their liquidity in economically meaningful situations

estimating financial risk measures for options abstract this paper proposes a simulation lattice procedure to estimate financial risk measures for option positions the framework proposed can be applied to many different kinds of options including exotic and vanilla options it can take account of early exercise features heavy tails in underlying processes estimate different risk measures including var expected shortfall and spectral risk measures and in a limited way it can be generalized to accommodate multiple factors it avoids many of the limitations of existing approaches and in particular avoids the problems associated approaches based on delta gamma and similar approximations it also generates some interesting results about the risk measures of some illustrative options positions

temptation and commitment in the laboratory temptation and self control in intertemporal choice environments are receiving increasing attention in the theoretical economics literature nevertheless there remains a scarcity of empirical evidence from controlled environments informing behavior under repeated temptations this is unfortunate in light of the fact that in many natural environments the same temptation must be repeatedly resisted this paper fills that gap by reporting data from a novel laboratory study of economic decisions under repeat temptations subjects are repeatedly offered an option with instantaneous benefit that also entails a substantial reduction to overall earnings we show that this option is tempting in the sense that a substantial fraction of our subjects incur pecuniary costs to eliminate the choice and thus commit to not choosing the tempting alternative we compare the timing and price elasticity of these commitment decisions to predictions from existing theoretical models of decision under temptation our data are broadly consistent with theory with the notable exception that commitment often occurs with delay rather than at the first opportunity moreover the timing of commitment is significantly impacted by the cost of the commitment device the patterns we report have direct implications for economic theory and are a first step toward designing mechanisms that promote prudent economic decisions under temptation

a damped diffusion framework for financial modeling and closed form maximum likelihood estimation abstract asset price bubbles can arise unintentionally when one uses continuous time diffusion processes to model financial quantities we propose a flexible damped diffusion framework that is able to break many types of bubbles and preserve the martingale pricing approach damping can be done on either the diffusion or drift function oftentimes certain solutions to the valuation pde can be ruled out by requiring the solution to be a limit of martingale prices for damped diffusion models monte carlo study shows that with finite time series length maximum likelihood estimation often fails to detect the damped diffusion function while fabricates nonlinear drift function an alternative method based on ait sahalia s specification test on parametric models is proposed

a dynamic programming procedure for pricing american style asian options pricing european style asian options based on the arithmetic average under the black and scholes model involves estimating an integral a mathematical expectation for which no easily computable analytical solution is available pricing their american style counterparts which provide early exercise opportunities poses the additional difficulty of solving a dynamic optimization problem to determine the optimal exercise strategy a procedure for pricing american style asian options of the bermudan flavor based on dynamic programming combined with finite element piecewise polynomial approximation of the value function is developed here a convergence proof is provided numerical experiments illustrate the consistency and efficiency of the procedure theoretical properties of the value function and of the optimal exercise strategy are also established

timing and self control the dual self model of self control with one period lived short run selves is excessively sensitive to the timing of shocks and to the interpolation of additional no action time periods in between the dates when decisions are made we show that when short run selves have a random length of time this excess sensitivity goes away we consider both linear and convex cost of self control models illustrating the theory through a series of examples we examine when opportunities to consume will be avoided or delayed we consider the way in which the marginal interest declines with delay and we examine how preference reversals depend on the timing of information to accommodate the combination of short time periods and convex costs of self control we extend the model to treat willpower as a cognitive resource that is limited in the short run

willpower and the optimal control of visceral urges common intuition and experimental psychology suggest that the ability to self regulate willpower is a depletable resource we investigate the behavior of an agent who optimally consumes a cake or paycheck or workload over time and who recognizes that restraining his consumption too much would exhaust his willpower and leave him unable to manage his consumption unlike prior models of self control a model with willpower depletion can explain the increasing consumption sequences observable in high frequency data and corresponding laboratory findings the apparent links between unrelated self control behaviors and the altered economic behavior following imposition of cognitive loads at the same time willpower depletion provides an alternative explanation for a taste for commitment intertemporal preference reversals and procrastination accounting for willpower depletion thus provides a more unified theory of time preference it also provides an explanation for anomalous intratemporal behaviors such as low correlations between health related activities

multinomial approximating models for options with k state variables contingent claims whose values depend on multiple sources of uncertainty arise in many financial contracts and in the analysis of real projects unfortunately closed form solutions for these options are rare and numerical methods can be computationally expensive this article extends the literature on multinomial approximating models specifically new multinomial models are presented that include as special cases existing models the more general models are shown to be computationally more efficient

uncertainty and hyperbolic discounting we propose an evolutionary explanation for the pattern of intertemporal preference reversals often ascribed to hyperbolic discounting we take the view that preferences manifested for example in urges cravings and inclinations are the outcome of evolutionary forces and so will induce animals or humans to make survival maximizing choices in typical decision problems we show that if the typical problem involves payoffs whose realization times are uncertain then optimal preferences give rise to relatively patient behavior when the time horizon is long but induce a switch to impatience when the horizon grows short such reversals do not entail dynamic inconsistency in typical decision problems behavior there is optimal however if a decision maker is confronted with a choice for which the realization time uncertainty falls outside the evolutionary norm her preferences may well prompt her to behave inconsistently we argue that if such a choice problem recurs her evolutionarily endowed aability to learn will lead her to make self commitments against these urges this abstract was borrowed from another version of this item

an object oriented framework for valuing shout options on high performance computer architectures abstract a shout option is a financial contract which allows the holder to change the payoff during the lifetime of the contract complex versions of these options are embedded in financial products which offer various types of maturity guarantees such as segregated funds marketed by canadian insurance companies the value of these options can be determined by solving a collection of coupled partial differential equations in this work we develop an object oriented framework for valuing these contracts which is capable of exploiting modern high performance computer architectures we use this framework to study practical aspects of valuing and hedging these contracts

static hedging and pricing american knock in put options abstract this paper extends the static hedging portfolio shp approach of derman et al 1995 carr et al 1998 to price and hedge american knock in put options under the black scholes model and the constant elasticity of variance cev model we use standard european calls puts to construct the shps for american up and in down and in puts we also use theta matching condition to improve the performance of the shp approach numerical results indicate that the hedging effectiveness of a bi monthly shp is far less risky than that of a delta hedging portfolio with daily rebalance the numerical accuracy of the proposed method is comparable to the trinomial tree methods of ritchken 1995 boyle and tian 1999 furthermore the recalculation time the term is explained in section 1 of the option prices is much easier and quicker than the tree method when the stock price and or time to maturity are changed

temptation driven preferences my own behaviour baffles me for i find myself not doing what i really want to do but doing what i really loathe saint paulwhat behaviour can be explained using the hypothesis that the agent faces temptation but is otherwise a standard rational agent in earlier work gul and pesendorfer 2001 use a set betweenness axiom to restrict the set of preferences considered by dekel lipman and rustichini 2001 to those explainable via temptation we argue that set betweenness rules out plausible and interesting forms of temptation including some which may be important in applications we propose a pair of alternative axioms called dfc desire for commitment and aic approximate improvements are chosen dfc characterizes temptation as situations in which given any set of alternatives the agent prefers committing herself to some particular item from the set rather than leaving herself the flexibility of choosing later aic is based on the idea that if adding an option to a menu improves the menu it is because that option is chosen under some circumstances from this interpretation the axiom concludes that if an improvement is worse as a commitment than some commitment from the menu then the best commitment from the improved menu is strictly preferred to facing that menu we show that these axioms characterize a natural generalization of the gul pesendorfer representation copyright wiley blackwell

the response of u s natural gas futures and spot prices to storage change surprises fundamental information and the effect of escalating physical gas production abstract we study the behavior of u s natural gas futures and spot prices on and around the weekly announcements by the u s energy information administration of the amount of natural gas in storage we identify an inverse empirical relation between changes in futures prices and surprises in the change in natural gas in storage and that this relation is not driven by the absolute size of the surprise the evidence also indicates prices react first in the futures market for natural gas with that information then flowing to the spot market post 2005 corresponding to a period of significant increases in the production of natural gas in the united states the response of prices to storage surprises was larger in absolute value no evidence is found of economically meaningful reactions to the surprise other than on the date the storage news is released the results demonstrate the importance of fundamental information in the formation of natural gas prices

present bias quasi hyperbolic discounting and fixed costs in this paper we elicit preferences for money time pairs via experimental techniques we estimate a general specification of discounting that nests exponential and hyperbolic discounting as well as various forms of present bias including quasi hyperbolic discounting our experimental data do not appear peculiar in any dimension in particular we find clear evidence for present bias as most of the previous literature however no evidence for quasi hyperbolic discounting is found and the data strongly favor instead a specification with a small present bias in the form of a fixed cost of the order of 4 on average across subjects with such a fixed cost the curvature of discounting is imprecisely estimated and exponential discounting is hardly rejected in this specification the present bias tends to vanish for economically relevant monetary rewards

a theory of rational addiction we develop a theory of rational addiction in which rationality means a consistent plan to maximize utility over time strong addiction to a good requires a big effect of past consumption of the good on current consumption such powerful complementarities cause some steady states to be unstable they are an important part of our analysis because even small deviations from the consumption at an unstable steady state can lead to large cumulative rises over time in addictive consumption or to rapid falls in consumption to abstention our theory also implies that cold turkey is used to end strong addictions that addicts often go on binges that addicts respond more to permanent than to temporary changes in prices of addictive goods and that anxiety and tensions can precipitate an addiction

pricing and hedging path dependent options under the cev process much of the work on path dependent options assumes that the underlying asset price follows geometric brownian motion with constant volatility this paper uses a more general assumption for the asset price process that provides a better fit to the empirical observations we use the so called constant elasticity of variance cev diffusion model where the volatility is a function of the underlying asset price we derive analytical formulae for the prices of important types of path dependent options under this assumption we demonstrate that the prices of options which depend on extrema such as barrier and lookback options can be much more sensitive to the specification of the underlying price process than standard call and put options and show that a financial institution that uses the standard geometric brownian motion assumption is exposed to significant pricing and hedging errors when dealing in path dependent options

a dual self model of impulse control we propose that a simple dual self model gives a unified explanation for several empirical regularities including the apparent time inconsistency that has motivated models of quasi hyperbolic discounting and rabin s paradox of risk aversion in the large and small the model also implies that self control costs imply excess delay as in the o donoghue and rabin models of quasi hyperbolic utility and it explains experimental evidence that increased cognitive load makes temptations harder to resist the base version of our model is consistent with the gul pesendorfer axioms but we argue that these axioms must be relaxed to account for the effect of cognitive load

strotz meets allais diminishing impatience and the certainty effect abstract decision makers tend to exhibit a higher degree of impatience when considering a delay to an immediate reward than when contemplating an identical delay to an equal future reward this work argues that diminishing impatience originates from the distinction between the certain present and the risky future a simple functional representation of preferences exhibiting time inconsistency when the future is uncertain is derived experimental evidence which is inconsistent with other formulations that account for diminishing impatience supports the proposed approach the new theory uncovers a tight relation between diminishing impatience and well known behavioral regularities in choice under risk and uncertainty jel d12 d81

systematic equity based credit risk a cev model with jump to default we use equity as the traded primitive for a detailed analysis of systematic default risk default is parsimoniously represented by equity value hitting the zero barrier so that unlike in reduced form models the explicit linkage to the firm s capital structure is preserved but unlike in structural models restrictive assumptions on the structure are avoided default risk is either jump like or diffusive the equity price can jump to default in line with recent empirical evidence on the jump to default risk price we highlight how reasonable choices of the pricing kernel can imply remarkable differences in the equity price dependent status between the objective default intensity and the risk neutral intensity as equity returns experience negative diffusive shocks their cev type local variance increases and boosts the objective and risk neutral probabilities of diffusive default a parsimonious version of our general model simultaneously enables analytical credit risk management and analytical pricing of credit sensitive instruments easy cross asset hedging ensues

pricing lookback and barrier options under the cev process this paper examines the pricing of lookback and barrier options when the underlying asset follows the constant elasticity of variance cev process we construct a trinomial method to approximate the cev process and use it to price lookback and barrier options for look back options we find that the technique proposed by babbs for the lognormal case can be modified to value lookbacks when the asset price follows the cev process we demon strate the accuracy of our approach for different parameter values of the cev process we find that the prices of barrier and lookback options for the cev process deviate sig nificantly from those for the lognormal process for standard options the corresponding differences between the cev and black scholes models are relatively small our results show that it is much more important to have the correct model specification for options that depend on extrema than for standard options

pde methods for pricing barrier options abstract this paper presents an implicit method for solving pde models of contingent claims prices with general algebraic constraints on the solution examples of constraints include barriers and early exercise features in this unified framework barrier options with or without american style features can be handled in the same way either continuously or discretely monitored barriers can be accommodated as can time varying barriers the underlying asset may pay out either a constant dividend yield or a discrete dollar dividend the use of the implicit method leads to convergence in fewer time steps compared to explicit schemes this paper also discusses extending the basic methodology to the valuation of two asset barrier options and the incorporation of automatic time stepping

pricing options on scalar diffusions an eigenfunction expansion approach this paper develops an eigenfunction expansion approach to pricing options on scalar diffusion processes all contingent claims are unbundled into portfolios of primitive securities calledeigensecurities eigensecurities are eigenvectors eigenfunctions of the pricing operator present value operator all computational work is at the stage of finding eigenvalues and eigenfunctions of the pricing operator the pricing is then immediate by the linearity of the pricing operator and the eigenvector property of eigensecurities to illustrate the computational power of the method we develop two applications pricing vanilla single and double barrier options under the constant elasticity of variance cev process and interest rate knock out options in the cox ingersoll ross cir term structure model

commitment and self control abstract the literature on self control problems has typically concentrated on immediate temptations this paper studies a gul and pesendorfer temptation and self control econometrica 69 2001 1403 1435 self control and the theory of consumption econometrica 72 2004 119 158 style model in which decision makers are affected by temptations that lie in the future while temptation is commonly understood to give rise to a demand for commitment it is shown that temptation by future consumption can induce its absence the model also exhibits procrastination provides an alternative to projection bias as an explanation for some experimental results and can simultaneously account for myopic and hyperopic behavior the evidence on preference reversals supports temptation by future consumption and suggests that it may not be restricted to short time horizons

does self control depletion affect risk attitudes abstract a core prediction of recent dual self models is that risk attitudes depend on self control while these models have received a lot of attention empirical evidence regarding their predictions is lacking we derive hypotheses from three prominent models for choices between risky monetary payoffs under regular and reduced self control we test the hypotheses in a lab experiment using a well established ego depletion task to reduce self control and measuring risk attitudes via finely graduated choice lists manipulation checks document the effectiveness of the depletion task we find no systematic evidence in favor of the theoretical predictions in particular depletion does not increase risk aversion

the brain as a hierarchical organization based on recent neuroscience evidence we model the brain as a dual system organization subject to three conflicts asymmetric information temporal hori zon and incentive salience under the first and second conflicts we show that the uninformed system imposes a positive link between consumption and labor at every period furthermore decreasing impatience endogenously emerges as a consequence of these two conflicts under the first and third conflicts it becomes optimal to set a consumption cap finally we discuss the behavioral implications of these rules for choice bracketing and expense tracking and for consumption over the life cycle jel dil d74 d82 d87 d91

self control and the theory of consumption to study the behavior of agents who are susceptible to temptation in infinite horizon consumption problems under uncertainty we define and characterize dynamic self control dsc preferences dsc preferences are recursive and separable in economies with dsc agents equilibria exist but may be inefficient in such equilibria steady state consumption is independent of initial endowments and increases in self control increasing the preference for commitment while keeping self control constant increases the equity premium removing nonbinding constraints changes equilibrium allocations and prices debt contracts can be sustained even if the only feasible punishment for default is the termination of the contract

pricing and static hedging of american style knock in options on defaultable stocks abstract this paper applies the static hedge portfolio approach shp of chung et al 2013 in two new directions first the shp approach is generalized from the constant elasticity of variance cev model of cox 1975 to the jump to default extended cev jdcev framework of carr and linetsky 2006 for this purpose the recovery value of the american style down and in put is hedged through the one attached to a european style plain vanilla contract whereas for an up and in put it is necessary to use the recovery component of the corresponding european style up and in option second the shp methodology is adapted from single to double barrier american style knock in options by matching the value of the hedging portfolio along both lower and upper barriers finally and to benchmark the accuracy of the novel shp pricing solutions the optimal stopping approach of nunes 2009 is also extended to price american style double knock in options under the jdcev framework such extension highlights the relevant credit derivative component embedded in american style knock in equity puts

a lattice framework for option pricing with two state variables a procedure is developed for the valuation of options when there are two underlying state variables the approach involves an extension of the lattice binomial approach developed by cox ross and rubinstein to value options on a single asset details are given on how the jump probabilities and jump amplitudes may be obtained when there are two state variables this procedure can be used to price any contingent claim whose payoff is a piece wise linear function of two underlying state variables provided these two variables have a bivariate lognormal distribution the accuracy of the method is illustrated by valuing options on the maximum and minimum of two assets and comparing the results for cases in which an exact solution has been obtained for european options one advantage of the lattice approach is that it handles the early exercise feature of american options in addition it should be possible to use this approach to value a number of financial instruments that have been created in recent years

pricing american options under the constant elasticity of variance model and subject to bankruptcy this paper proposes an alternative characterization of the early exercise premium that is valid for any markovian and diffusion underlying price process as well as for any parameterization of the exercise boundary this new representation is shown to provide the best pricing alternative available in the literature for medium and long term american option contracts under the constant elasticity of variance model moreover the proposed pricing methodology is also extended easily to the valuation of american options on defaultable equity and possesses appropriate asymptotic properties