Judged knowledge and ambiguity aversion

Competence has recently been proposed as an explanation for the degree of ambiguity aversion. Using general knowledge questions we presented subjects with simple lotteries in which they could bet on an event and against the same event. We show that the sum of certainty equivalents for both bets depends on the judged knowledge of the class of events. We also elicited the decision weights for events and complementary events. We found a similar effect of knowledge on the sum of decision weights.     

Inferring beliefs as subjectively imprecise probabilities

We propose a method for estimating subjective beliefs, viewed as a subjective probability distribution. The key insight is to characterize beliefs as a parameter to be estimated from observed choices in a well-defined experimental task and to estimate that parameter as a random coefficient. The experimental task consists of a series of standard lottery choices in which the subject is assumed to use conventional risk attitudes to select one lottery or the other and then a series of betting choices in which the subject is presented with a range of bookies offering odds on the outcome of some event that the subject has a belief over. Knowledge of the risk attitudes of subjects conditions the inferences about subjective beliefs. Maximum simulated likelihood methods are used to estimate a structural model in which subjects employ subjective beliefs to make bets. We present evidence that some subjective probabilities are indeed best characterized as probability distributions with non-zero variance.     

The Brazilianisation of Youth Transitions in Australia and the UK?

A central theme of Beck's argument in The Brave New World of Work (2000) is that labour markets in the developed world are taking on some of the core characteristics that have been associated with less developed labour markets such as employment insecurity, informality and precarity. A process he refers to as Brazilianisation. In this paper we consider whether Beck's thesis can help us understand changes in youth transitions in Australia and the UK by developing a comparative analysis of processes of casualisation in the youth labour markets of the two countries. We assess the extent to which precarious labour market biographies have become entrenched and represent modern forms of engagement with the labour market. While evidence is presented to suggest that young people's labour market experiences have been affected by a trend towards greater casualisation, we argue that the changes are having the greatest impact on those in the weakest positions: in both countries women are more likely to be affected than men and casualisation is most evident in the lowest skilled occupations.     

Sequential Parimutuel Betting in the Laboratory

This paper investigates parimutuel betting in the laboratory. Our experimental design relies on a simple sequential betting game where equilibrium strategies are characterized according to objective probabilities, the number of bettors, and publicly observable odds. The empirically well-documented phenomenon referred to as the favorite-longshot bias is observed in two of our three treatments. We offer a theoretical explanation of the subjects' behavior which relies on rank-dependent expected utility and pessimistic expectations about future bets.     

Personal probabilities of probabilities

By definition, the subjective probability distribution of a random event is revealed by the (‘rational’) subject's choice between bets — a view expressed by F. Ramsey, B. De Finetti, L. J. Savage and traceable to E. Borel and, it can be argued, to T. Bayes. Since hypotheses are not observable events, no bet can be made, and paid off, on a hypothesis. The subjective probability distribution of hypotheses (or of a parameter, as in the current ‘Bayesian’ statistical literature) is therefore a figure of speech, an ‘as if’, justifiable in the limit. Given a long sequence of previous observations, the subjective posterior probabilities of events still to be observed are derived by using a mathematical expression that would approximate the subjective probability distribution of hypotheses, if these could be bet on. This position was taken by most, but not all, respondents to a ‘Round Robin’ initiated by J. Marschak after M. H. De-Groot's talk on Stopping Rules presented at the UCLA Interdisciplinary Colloquium on Mathematics in Behavioral Sciences. Other participants: K. Borch, H. Chernoif, R. Dorfman, W. Edwards, T. S. Ferguson, G. Graves, K. Miyasawa, P. Randolph, L. J. Savage, R. Schlaifer, R. L. Winkler. Attention is also drawn to K. Borch's article in this issue.     

Adverse selection and equilibrium in liability insurance markets

Models of asymmetric information in insurance markets typically consider insurance buyers with Bernoulli loss distributions differing in expected loss. This article analyzes markets where buyer loss distributions are characterized by mean-preserving spreads and insurers can classify applicants in terms of expected values but not by risk. Because liability losses are characterized by skewed continuous probability distributions, both discrete and continuous loss distributions are considered. In contrast to the single separating equilibrium in the classic Rothschild-Stiglitz insurance market, multiple separating equilibria are identified in this article: three in the discrete case and four in the continuous case. The possibility of extreme discontinuities in insurer policy offers provides a new explanation for crises in liability insurance markets.The support of the National Association of Insurance Commissioners is gratefully acknowledged.     

Subjective beliefs and confidence when facts are forgotten

Forgetting can be a salient source of uncertainty for subjective beliefs, confidence, and ambiguity attitudes. To investigate this, we run several experiments where people bet on propositions (facts) that they cannot recall with certainty. We use betting preferences to infer subjects’ revealed beliefs and their revealed confidence in these beliefs. Forgetting is induced via interference tasks and time delays (up to one year). We observe a natural memory decay pattern where beliefs become less accurate and confidence is reduced as well. Moreover, we find a form of comparative ignorance where subjects are more ambiguity averse when they cannot recall the truth rather than never having learnt it. In a different vein, we identify an overconfidence pattern: on average, subjects overpay for bets on propositions that they believe in, but underpay for the opposite bets. We formulate a two-signal behavioral model of forgetting that generates all of these patterns. It suggests new testable hypotheses that are confirmed by our data.

     

The Personal Costs of Subprime Lending and the Foreclosure Crisis: A Matter of Trust,Insecurity, and Institutional Deception*

Objective. Research on widespread loan failures suggests that many of the mortgage loans that were made since 2000 were of a deceptive or predatory nature. This study explores the experiences and sentiments of those who are at risk of foreclosure within a broader framework of trust, individualization, and ontological security. Methods. Interviews examine families' lending experience and how they have coped with their personal troubles that resulted from their housing crisis. Results. As many of these loans were of a deceptive or predatory nature, individuals are likely to reflect on the psychological consequences of their predicament. Although these findings suggest that these individuals have lost trust in the housing market, many have internalized their situation as a personal failure. In addition, feelings of anxiety, stress, insecurity, and uncertainty have come to characterize their experiences. Conclusions. This research calls for policy recommendations that seek to restore confidence and to ensure greater consumer protection in financial markets.     

Reinsurance and the liability insurance crisis

Insurance-industry accounts of the liability insurance crisis of the mid-1980s often cite disruption of supply in reinsurance markets as an important contributing factor. Economic theories of the crisis have not explored this explanation for the severity of the crisis. This article investigates the extent to which events in reinsurance markets affected liability insurance market outcomes. It documents significant shocks to reinsurance supply in the early 1980s and finds evidence of subsequent disruptions to the price and availability of reinsurance. Regression analysis of liability insurance profitability over the time period supports the hypothesis that problems in reinsurance markets played an important role in the crisis.     

The containment and expulsion of wayward soldiers in the U.S. military

The U.S. Armed forces manage deviant soldiers, sailors, and airmen by either punishment while they remain in uniform, or by expulsion with stigma. This article divides court material rates for the period 1941 to 1979 into two categories with regard to whether or not stigmatized soldiers were punished within the confines of the military system or punished and expelled. It finds that the military does not expel the overwhelming majority of those who have committed serious offenses—in that a court martial is an indicator of seriousness. Soldiers who are expelled from the military are more likely to have a problem with their persona than with their behavior. Patterns of stigmatized expulsion do not follow the war-peace cycle. Social order imposed in a complex institution that is grounded in caste-like distinctions produces a distinctive kind of “outsider.” Labelling theory offers an explanation.     

The Construction of a Simple Book

A book is made for a horse race, and punters place their bets. The problem considered here is how the bookmaker should construct his book. Before this can be solved, it has to be determined how the punters will react to any proposed book. Much of the detailed discussion is confined to a race with two horses, though some results apply in the general case. The punters' problem is solved using a utility function, special attention being paid to the case of constant risk-aversion. Two solutions are provided for the bookmaker's problem, dependent on whether it is desired to maximize expected gain, or achieve the same gain whatever horse wins.     

The economic costs of US stock mispricing

The USAGE model for the United States is used to quantify economic costs due to stock mispricing, made operational by shocking Tobin's q. The simulations quantify a potentially large impact even in the most favorable environment, where export demand holds up, and, the dollar is pro-cyclical. A two-year investment boom in two sectors increases consumption by a Net Present Value (NPV) amount of nearly one per cent, due to a positive investment externality onto the US terms of trade. If the investment is wasted, however, the consumption loss is nearly one-half of a per cent. A 5-year ‘capital strike’ across the whole economy subsequent to the boom - mimicking financial distress from a burst bubble - shaves around 10 per cent off consumption. Given these significant costs associated with “boom” and “bust” equity markets, we consider some, policy options that might result in greater stability in these markets.     

Risk,uncertainty and hidden information

People are less willing to accept bets about an event when they do not know the true probability of that event. Such uncertainty aversion has been used to explain certain economic phenomena. This paper considers how far standard private information explanations (with strategic decisions to accept bets) can go in explaining phenomena attributed to uncertainty aversion. This paper shows that if two individuals have different prior beliefs about some event, and two sided private information, then each individuals willingness to bet will exhibit a bid ask spread property. Each individual is prepared to bet for the event, at sufficiently favorable odds, and against, at sufficiently favorable odds, but there is an intermediate range of odds where each individual is not prepared to bet either way. This is only true if signals are distributed continuously and sufficiently smoothly. It is not true, for example, in a finite signal model.     

The influence of extreme events such as Brexit and Covid-19 on equity markets

In this article first, we show that the result that the PIIGS group had the largest negative unadjusted and abnormal returns on the day following the Brexit Referendum is robust to taking into account jointly other extreme events such as the Covid-19. Second, we provide evidence that the impact of the declaration of Covid-19 to be a global pandemic by the WHO – when global markets fell by nearly 15% – had a total different reaction in the financial markets to the one following the Brexit Referendum, impacting more negatively in countries where quarantine lockdowns were announced that day (i.e. Austria, Belgium, Brazil, Canada, Italy and Spain), independently on their debt-to GDP ratio. We also show that the day after Covid-19 was declared as a global pandemic, China and Japan (countries that already implemented lockdowns in the previous months) were the only analyzed countries that did not experience any evidence of abnormal returns in their financial markets. Moreover, during the three following days, the US was the only analyzed country showing no evidence of negative abnormal returns due to the declaration of the national emergency. These results suggest that government policies must take into account and monitor specially health-related news at global level, since they can have enormous impacts on portfolio allocations on stock markets, in order to take more informed decisions.     

Loss aversion leading to advantageous selection

Some insurance markets are characterized by “advantageous selection”, that is, ex-post risk and coverage are negatively correlated. We show that expectation-based loss aversion as in K?szegi and Rabin (Quarterly Journal of Economics, 121(4), 1133–1165, 2006; The American Economic Review, 97(4), 1047–1073, 2007) provides a natural explanation for this phenomenon in environments in which risk aversion models do not, e.g., when agents face modest-scale risks and/or in absence of moral hazard. More exposure to risk has two competing effects on an agent’s willingness to pay for insurance: a positive effect, as in standard expected utility models; and a negative one, due to a reference effect. We determine conditions under which an insurance provider optimally sets a high price at which only low risk agents buy.     

Pricing in Electricity Markets

The technical characteristics of electricity generation and transmission have implications for the way in which economic principles are adapted to evaluate pricing and regulation issues in electricity markets. In particular, there is an externality associated with the way in which electricity flows in networks because of Kirchoff's laws. In this paper, a mathematical programming model is presented that simulates a competitive electricity market, based on the spatial-intertemporal equilibrium models pioneered by Takayama and Judge (1971). The model is used to simulate the operation of a hypothetical electricity market, illustrating some of the issues arising from the network externality.     

Making Low Probabilities Useful

This paper explores how people process information on low probability-high consequence negative events and what it will take to get individuals to be sensitive to the likelihood of these types of accidents or disasters. In a set of experiments, information is presented to individuals on the likelihood of serious accidents from a chemical facility. Comparisons are made with other risks, such as fatalities from automobile accidents, to see whether laypersons can determine the relative safety of different plants. We conclude that fairly rich context information must be available for people to be able to judge differences between low probabilities. In particular, it appears that one needs to present comparison scenarios that are located on the probability scale to evoke people's own feelings of risk. The concept of evaluability recently introduced by Hsee and his colleagues provides a useful explanation of these findings.     

Comparative Ignorance and the Ellsberg Paradox

We investigate the evaluation of known (where probability is known) and unknown (where probability is unknown) bets in comparative and non-comparative contexts. A series of experiments support the finding that ambiguity avoidance persists in both comparative and non-comparative conditions. The price difference between known and unknown bets is, however, larger in a comparative evaluation than in separate evaluation. Our results are consistent with Fox and Tversky's (1995) Comparative Ignorance Hypothesis, but we find that the strong result obtained by Fox and Tversky is more fragile and the complete disappearance of ambiguity aversion in non-comparative condition may not be as robust as Fox and Tversky had supposed.     

The AART of Ethnography: A Critical Realist Explanatory Research Model

Critical realism is a philosophy of science, which has made significant contributions to epistemic debates within sociology. And yet, its contributions to ethnographic explanation have yet to be fully elaborated. Drawing on ethnographic data on the health‐seeking behavior of HIV‐infected South Africans, the paper compares and contrasts critical realism with grounded theory, extended case method and the pragmatist method of abduction. In so doing, it argues that critical realism makes a significant contribution to causal explanation in ethnographic research in three ways: 1) by linking structure to agency; 2) by accounting for the contingent, conjunctural nature of causality; and 3) by using surprising empirical findings to generate new theory. The paper develops the AART (abduction, abstraction, retroduction, testing) research schema and illustrates its strengths by employing a Bourdieusian field analysis as a model for morphogenetic explanation.     

Betting on Machina’s reflection example: an experiment on ambiguity

In a recent article, Machina (Am Econ Rev forthcoming, 2008) suggested choice problems in the spirit of Ellsberg (Q J Econ 75:643–669, 1961), which challenge tail-separability, an implication of Choquet expected utility (CEU), to a similar extent as the Ellsberg paradox challenged the sure-thing principle implied by subjective expected utility (SEU). We have tested choice behavior for bets on one of Machina’s choice problems, the reflection example. Our results indicate that tail-separability is violated by a large majority of subjects (over 70% of the sample). These empirical findings complement the theoretical analysis of Machina (Am Econ Rev forthcoming, 2008) and, together, they confirm the need for new approaches in the analysis of ambiguity for decision making.