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

scientific ambiguity and climate policy economic evaluation of climate policy traditionally treats uncertainty by appealing to expected utility theory yet our knowledge of the impacts of climate policy may not be of sufficient quality to be described by unique probabilistic beliefs in such circumstances it has been argued that the axioms of expected utility theory may not be the correct standard of rationality by contrast several axiomatic frameworks have recently been proposed that account for ambiguous knowledge in this paper we apply static and dynamic versions of a smooth ambiguity model to climate mitigation policy we obtain a general result on the comparative statics of optimal abatement and ambiguity aversion and then extend our analysis to a more realistic dynamic setting where we introduce scientific ambiguity into the well known dice model of the climate economy system for policy relevant exogenous mitigation policies we show that the value of emissions abatement increases as ambiguity aversion increases and that this ambiguity premium can in some plausible cases be very large in these cases the effect of ambiguity aversion on welfare is comparable to that of other much studied welfare parameters thus ambiguity aversion may be an important neglected aspect of climate change economics and seems likely to provide another argument for strong abatement policy

environmental protection rare disasters and discount rates the stern review s evaluation of environmental protection stresses low discount rates and uncertainty about environmental effects an appropriate model for analysing this uncertainty and the associated discount rates requires sufficient risk aversion and fat tailed uncertainty to account for the observed equity premium calibrations based on epstein zin preferences and existing analyses of rare macroeconomic disasters suggest that optimal environmental investment can be a significant share of gdp even with reasonable rates of time preference optimal environmental investment increases with risk aversion and the probability and typical size of environmental disasters but decreases with uncertainty about policy effectiveness

focusing and framing of risky alternatives abstract this paper develops a theory of focusing and framing in an intertemporal context with risky choices we provide a selection criterion between existing theories of focusing by allowing a decision maker to choose her frame such that her attention is either drawn to salient events associated with an option or to the expected utilities an option yields in different time periods our key assumption is that a decision maker can choose her frame in a self serving manner we predict that the selected frame induces overoptimistic actions in the sense that subjects underrate downside risk but overrate upside risk and accordingly reveal overoptimistic choices hence our theory can explain phenomena such as excessive harmful consumption smoking unhealthy diet and risky investments entrepreneurship lotteries gambling in one coherent framework notably overoptimistic actions are not universal but have plausible limits we characterize under which situations overoptimistic actions are most likely to occur and under which circumstances choices should be rational or even pessimistic

precautionary saving and the notion of ambiguity prudence this letter develops a set of simple conditions under which an individual is willing to save an extra amount of money due to the presence of ambiguity concerning his second period wealth this extra precautionary saving motive is naturally associated with the notion of ambiguity prudence

entrepreneurs perceived chances for success abstract entrepreneurs involved in planning or starting firms must engage in a continuing process of appraising prospects for success these assessments presumably bear upon the preparations they make as well as at some later point whether they decide to make major changes or even to discontinue the business in this study data from 2994 entrepreneurs who had recently become business owners were analyzed to determine their perceived changes of success although previous evidence on business survival led to the hypothesis that the entrepreneurs would only be cautiously optimistic this was not the case they perceived their prospects as very favorable with 81 seeing odds of 7 out of 10 or better and a remarkable 33 seeing odds of success of 10 out of 10 in considering the prospects for other businesses like their own they perceived odds which were significantly lower but still moderately favorable based upon previous research on factors associated with new business success it was hypothesized that those who were more likely to succeed based upon their personal backgrounds and the nature of their new firms would be more optimistic however this was not the case those who were poorly prepared were just as optimistic as those who were well prepared at this point shortly after having become business owners the assessment by entrepreneurs of their own likelihood of success was dramatically detached from past macro statistics from perceived prospects for peer businesses and from characteristics typically associated with higher performing new firms the psychological literature on post decisional bolstering suggests that decision makers in many settings tend to bolster or exaggerate the attractiveness of an option after it has been chosen this coupled with the tendency of entrepreneurs to believe that they can control their own destinies implies that the extreme optimism observed here is probably a typical occurrence for entrepreneurs the findings suggest that it is probably natural to experience feelings of entrepreneurial euphoria when first becoming a business owner with the available evidence it is difficult to judge whether this leads to inadequate preparations or an inability to diagnose problems and make adjustments after the business is started this extreme optimism probably does contribute to the heavy personal commitments observed here in which the median entrepreneur devoted more than 60 hours per week to the business the entrepreneur would seem well advised to form relationships with outsiders such as board members and professional advisors who can be objective and detached in diagnosing problems and assessing objectively the prospects for the business in its current form

climate change policy what do the models tell us very little a plethora of integrated assessment models iams have been constructed and used to estimate the social cost of carbon scc and evaluate alternative abatement policies these models have crucial flaws that make them close to useless as tools for policy analysis certain inputs e g the discount rate are arbitrary but have huge effects on the scc estimates the models produce the models descriptions of the impact of climate change are completely ad hoc with no theoretical or empirical foundation and the models can tell us nothing about the most important driver of the scc the possibility of a catastrophic climate outcome iam based analyses of climate policy create a perception of knowledge and precision but that perception is illusory and misleading jel c51 q54 q58

salient compromises in the newsvendor game abstract the newsvendor problem denotes the puzzle that a retailer facing an uncertain demand for some product underreacts to profit margins and hence adjusts the order quantity toward the expected demand due to its range of applications in operations management this problem has drawn much interest in recent years various articles have tried to reconcile the newsvendor problem with loss aversion under ad hoc assumptions on the underlying reference point we instead argue that the newsvendor problem is an application of the well studied compromise effect as the compromise effect is based on violations of the iia axiom we argue that models of context dependent behavior such as salience theory better explain newsvendor like behavior than loss aversion based models we conduct a novel experiment which allows us to clearly distinguish between the role of loss aversion and salience and find strong support for the latter thereby we also add to the agenda of comparing loss aversion based models and salience theory

price competition under limited comparability this paper studies market competition when firms can influence consumers ability to compare market alternatives through their choice of price formats we introduce random graphs as a tool for modelling limited comparability of formats our main results concern the interaction between firms equilibrium price and format decisions and its implications for industry profits and consumer switching rates we show that narrow regulatory interventions that aim to facilitate comparisons may have adverse consequences for consumer welfare finally we argue that our limited comparability approach provides a new perspective into the phenomenon of product differentiation

demand shifts due to salience effects experimental evidence we conduct a laboratory experiment that tests two fundamental predictions unique to salience theory if an agent purchases one of two vertically differentiated products salience theory makes the following two distinct predictions first it hypothesizes that a higher expected price level for both products shifts demand toward the more expensive high quality product second it predicts that demand for the high quality product is larger if the price level is expectedly high than if it is unexpectedly high in our experiment subjects purchased fast or slow internet access at different price levels our results strongly support both predictions of salience theory

affective decision making a theory of optimism bias abstract optimism bias is inconsistent with the independence of decision weights and payoffs found in models of choice under risk and uncertainty such as expected utility theory subjective expected utility and prospect theory we therefore propose an alternative model of risky and uncertain choice where decision weights affective or perceived risk are endogenous affective decision making adm is a strategic model of choice under risk and uncertainty where we posit two cognitive processes the rational and the emotional process the two processes interact in a simultaneous move intrapersonal potential game and observed choice is the result of a pure strategy nash equilibrium in this game we show that regular adm potential games have an odd number of locally unique pure strategy nash equilibria and demonstrate this finding for affective decision making in insurance markets we prove that adm potential games are refutable by axiomatizing the adm potential maximizers

a sparsity based model of bounded rationality this article defines and analyzes a sparse max operator which is a less than fully attentive and rational version of the traditional max operator the agent builds as economists do a simplified model of the world which is sparse considering only the variables of first order importance his stylized model and his resulting choices both derive from constrained optimization still the sparse max remains tractable to compute moreover the induced outcomes reflect basic psychological forces governing limited attention the sparse max yields a behavioral version of basic chapters of the microeconomics textbook consumer demand and competitive equilibrium i obtain a behavioral version of marshallian and hicksian demand arrow debreu competitive equilibrium the slutsky matrix the edgeworth box roy s identity and so on the slutsky matrix is no longer symmetric nonsalient prices are associated with anomalously small demand elasticities because the consumer exhibits nominal illusion in the edgeworth box the offer curve is a two dimensional surface rather than a one dimensional curve as a result different aggregate price levels correspond to materially distinct competitive equilibria in a similar spirit to a phillips curve the arrow debreu welfare theorems typically do not hold this framework provides a way to assess which parts of basic microeconomics are robust and which are not to the assumption of perfect maximization jel codes d01 d03 d11 d51

theory research design assumptions and causal inferences abstract ferri zheng and zou test fischer and verrecchia s 2000 prediction that a reduction in investors uncertainty about managers financial reporting objectives leads to an increase in the valuation relevance of earnings reports they use mandatory cd a disclosures as an arguably exogenous shock that provided investors with more precise information about managers contractual incentives and find that these enhanced disclosures increased the relation between firms unexpected earnings and stock returns using ferri et al as a backdrop we discuss the implicit assumptions invoked in natural experimental research designs and the fundamental role of theory in drawing causal inferences from empirical evidence

the structure of economic modeling of the potential impacts of climate change grafting gross underestimation of risk onto already narrow science models scientists describe the scale of the risks from unmanaged climate change as potentially immense however the scientific models because they omit key factors that are hard to capture precisely appear to substantially underestimate these risks many economic models add further gross underassessment of risk because the assumptions built into the economic modeling on growth damages and risks come close to assuming directly that the impacts and costs will be modest and close to excluding the possibility of catastrophic outcomes a new generation of models is needed in all three of climate science impact and economics with a still stronger focus on lives and livelihoods including the risks of large scale migration and conflicts

competition for attention we present a model of market competition in which consumers attention is drawn to the products most salient attributes firms compete for consumer attention via their choices of quality and price strategic positioning of a product affects how all other products are perceived with this attention externality depending on the cost of producing quality some markets exhibit commoditized price salient equilibria while others exhibit de commoditized quality salient equilibria when the costs of quality change innovation can lead to radical shifts in markets as in the case of decommoditization of the coffee market by starbucks in the context of financial innovation the model generates the phenomenon of reaching for yield

managing catastrophic climate risks under model uncertainty aversion we propose a robust risk management approach to deal with the problem of catastrophic climate change that incorporates both risk and model uncertainty using an analytical model of abatement we show how aversion to model uncertainty influences the optimal level of mitigation we disentangle the role of preferences from the structure of model uncertainty which we define by means of a simple measure of disagreement across models with data from an expert elicitation about climate change catastrophes we quantify the relative importance of these two effects and calibrate a numerical integrated assessment model of climate change the results indicate that the structure of model uncertainty and specifically how model disagreement varies in abatement is the key driver of optimal abatement and that model uncertainty warrants a higher level of climate change mitigation this paper was accepted by manel baucells decision analysis

are policymakers ambiguity averse we investigate the ambiguity preferences of a unique sample of real life policymakers at the paris un climate conference cop21 we find that policymakers are generally ambiguity averse using a simple design we are moreover able to show that these preferences are not necessarily due to an irrational behaviour but rather to intrinsic preferences over unknown probabilities exploring the heterogeneity within our sample we also show that the country of origin and the degree of quantitative sophistication affect policymakers attitudes towards compound risk but not towards ambiguity robustness results are obtained in a lab experiment with a sample of university students

pollution control with uncertain stock dynamics when and how to be precautious abstract the precautionary principle pp applied to environmental policy stipulates that in the presence of uncertainty society must take robust preventive action to guard against worst case outcomes it follows that the higher the degree of uncertainty the more aggressive this preventive action should be this normative maxim is explored in the case of a stylized dynamic model of pollution control with uncertain in the knightian sense stock dynamics using the robust control framework of hansen and sargent 12 optimal investment in damage control is found to be increasing in the degree of uncertainty thus confirming the conventional pp wisdom optimal mitigation decisions however need not always comport with the pp in particular when damage control investment is both sufficiently cheap and sensitive to changes in uncertainty damage control investment and mitigation may act as substitutes and a pp with respect to the latter can be unambiguously irrational the theoretical results are applied to a calibrated linear quadratic model of climate change the analysis suggests that a reversal of the pp with respect to mitigation while theoretically possible is very unlikely

reverse bayesianism a choice based theory of growing awareness this article introduces a new approach to modeling the expanding universe of decision makers in the wake of growing awareness and invokes the axiomatic approach to model the evolution of decision makers beliefs as awareness grows the expanding universe is accompanied by extension of the set of acts the preference relations over which are linked by a new axiom invariant risk preferences asserting that the ranking of lotteries is independent of the set of acts under consideration the main results are representation theorems and rules for updating beliefs over expanding state spaces and events that have the flavor of reverse bayesianism jel d81 d83 according to the bayesian paradigm as new discoveries are made and new infor mation becomes available the universe shrinks with the arrival of new information events replace the prior universal state space to become the posterior state space or universe of discourse this process of destruction reflects the impossibility in the bayesian framework of expanding the state space and of updating the probabilities of null events coupled with the fact that conditioning on new information renders null events that a priori were nonnull yet experience and intuition alike contradict this view of the world becoming accustomed to possibilities that were once inconceivable is part of history and our own life experience there is a sense therefore in which our universe expands as we become aware of new opportunities in this paper we take a step toward modeling the process of growing awareness and expansion of the universe or state space in its wake 1 to model the evolution of beliefs in response to growing awareness we invoke the theory of choice under uncertainty borrowing its language and structure while modifying it to fit our pur pose in particular we allow for new consequences and feasible acts to be discovered and for new evidence to establish in the mind of decision makers new links between acts and consequences the interpretation of the updating is somewhat dif ferent for the discovery of new feasible acts and consequences on the one hand

model uncertainty in climate change economics a review and proposed framework for future research we review recent models of choices under uncertainty that have been proposed in the economic literature in particular we show how different concepts and methods of economic decision theory can be directly useful for problems in environmental economics the framework we propose is general and can be applied in many different fields of environmental economics to illustrate we provide a simple application in the context of an optimal mitigation policy under climate change

faraway so close coupled climate and economic dynamics in an agent based integrated assessment model abstract in this work we develop an agent based model that offers an alternative to standard computable general equilibrium integrated assessment models iams the dystopian schumpeter meeting keynes dsk model is composed of heterogeneous firms belonging to capital good consumption good and energy sectors production and energy generation lead to greenhouse gas emissions which affect temperature dynamics climate damages are modelled at the individual level as stochastic shocks hitting workers labour productivity energy efficiency capital stock and inventories of firms in that aggregate damages emerge from the aggregation of losses suffered by heterogeneous interacting and boundedly rational agents the model is run focusing on a business as usual carbon intensive scenario consistent with a representative concentration pathway 8 5 we find that the dsk model is able to account for a wide ensemble of micro and macro empirical regularities concerning both economic and climate dynamics simulation experiments show a substantial lack of isomorphism between the effects of micro and macro level shocks as it is typical in complex system models in particular different types of shocks have heterogeneous impact on output growth unemployment rate and the likelihood of economic crises pointing to the importance of the different economic channel affected by the shock overall we report much larger climate damages than those projected by standard iams under comparable scenarios suggesting possible shifts in the growth dynamics from a self sustained pattern to stagnation and high volatility and the need of urgent policy interventions

a model of focusing in economic choice we present a generally applicable theory of focusing based on the hypothesis that a person focuses more on and hence overweights attributes in which her options dier more our model predicts that the decisionmaker is too prone to choose options with concentrated advantages relative to alternatives but maximizes utility when the advantages and disadvantages of alternatives are equally concentrated in intertemporal choice because the relative concentrations of an option s costs and benets can be dierent from the perspective of a single period and the perspective of the entire choice problem the decisionmaker often exhibits a form of time inconsistency she is present biased when the costs of current misbehavior are distributed over many future dates such as in harmful consumption but future biased when the benet of many

welfare as equity equivalents equity or its counterpart inequity plays a fundamental role in the evaluation of social welfare in different dimensions in this paper we revisit the concept of inequity in the sense of unequal distributions across individuals time and states of the world using a unified framework that generalizes the standard expected discounted utilitarianism approach we propose a general measure of welfare as equity equivalents and a corresponding inequity index we show that allowing for different attitudes toward inequity across different dimensions covers a scope of possible inequity preferences with different interpretations we then prove that the order of aggregation across the different dimensions matters for welfare evaluations finally we show that many of the welfare theoretical approaches recently developed in the literature can be interpreted as special cases of this general framework

salience competition and decoy goods we consider a brand manufacturer who can offer next to its high quality product also a decoy good and faces competition by a competitive fringe that produces low quality we show that the brand manufacturer optimally provides a decoy good to boost the demand for its main product if consumers purchasing decisions are distorted by salient thinking the optimal decoy good is designed such that the superior quality of the brand manufacturer s main product and the unattractive feature of the fringe product are salient

overconfidence and excess entry an experimental approach psychological studies show that most people are overconfident about their own relative abilities and unreasonably optimistic about their futures e g shelly e taylor and j d brown 1988 neil d weinstein 1980 when assessing their position in a distribution of peers on almost any positive trait like driving ability ola svenson 1981 income prospects or longevity a vast majority of people say they are above the average although of course only half can be if the trait is symmetrically distributed this paper explores whether optimistic biases could plausibly and predictably influence economic behavior in one particular setting entry into competitive games or markets many empirical studies show that most new businesses fail within a few years for example using plant level data from the u s census of manufacturers spanning 1963 1982 timothy dunne et al 1988 estimated that 61 5 percent of all entrants exited within five years and 79 6 percent exited within 10 years most of these exits are failures see also dunne et al 1989a 1989b d shapiro and r s khemani 1987

testing for prudence and skewness seeking numerous theoretical predictions such as precautionary saving or preventive behavior have been derived for prudent decision makers further prudence can be characterized as downside risk aversion and plays a key role in preference for skewness we use a simple experimental method to test for prudence and skewness preference in the laboratory and compare the two to this end we introduce a novel graphical representation of compound lotteries that is easily accessible to subjects and test it for robustness using a factorial design prudence is observed on the aggregate and individual level we find that prudence does not boil down to skewness seeking we further provide some theoretical explanations for this result this paper was accepted by peter wakker decision analysis

on modeling and interpreting the economics of catastrophic climate change with climate change as prototype example this paper analyzes the implications of structural uncertainty for the economics of low probability high impact catastrophes even when updated by bayesian learning uncertain structural parameters induce a critical tail fattening of posterior predictive distributions such fattened tails have strong im plications for situations like climate change where a catastrophe is theoretically possible because prior knowledge cannot place sufficiently narrow bounds on overall damages this paper shows that the economic consequences of fat tailed structural uncertainty along with unsureness about high temperature damages can readily outweigh the effects of discounting in climate change policy analysis

precautionary saving in the small and in the large the theory of precautionary saving is shown to be isomorphic to the arrow pratt theory of risk aversion making possible the application of a large body of knowledge about risk aversion to precautionary saving and more generally to the theory of optimal choice under risk in particular a measure of the strength of the precautionary saving motive analogous to the arrow pratt measure of risk aversion is used to establish a number of new propositions about precautionary saving and to give a new interpretation of the dreze modigliani substitution effect copyright 1990 by the econometric society