Measuring Risk Aversion and the Wealth Effect

Measuring risk aversion is sensitive to assumptions about the wealth in subjects’ utility functions. Data from the same subjects in low- and high-stake lottery decisions allow estimating the wealth in a pre-specified one-parameter utility function simultaneously with risk aversion. This paper first shows how wealth estimates can be identified assuming constant relative risk aversion (CRRA). Using the data from a recent experiment by Holt and Laury (2002), it is shown that most subjects’ behavior is consistent with CRRA at some wealth level. However, for realistic wealth levels most subjects’ behavior implies a decreasing relative risk aversion. An alternative explanation is that subjects do not fully integrate their wealth with income from the experiment. Within-subject data do not allow discriminating between the two hypotheses. Using between-subject data, maximum-likelihood estimates of a hybrid utility function indicate that aggregate behavior can be described by expected utility from income rather than expected utility from final wealth and partial relative risk aversion is increasing in the scale of payoffs

The Inflationary Impact of Wage Indexation

It is an open question whether and how indexed wage contracts reduce welfare or raise average inflation. This paper analyzes the impact of indexed wage contracts on inflation and social welfare in a Barro–Gordon model with discretionary monetary policy by endogenizing social costs of indexation. Main results are: Wage indexation reduces the inflation bias but may raise the variance of inflation rates. In social optimum wages are fully indexed to the price level, but this requires optimal wage adjustments to productivity shocks. If wage adjustments to productivity are suboptimal, the second best solution calls for non–indexed wage contracts and a central banker with balanced aspiration levels of employment and real wages. In case of decentralized wage bargaining, a prohibition of wage indexation may improve welfare.monetary policy, Phillips curve, wage bargaining, wage indexation

Escaping from a Combination of Liquidity Trap and Credit Crunch

This brief exposition suggests that the Federal Reserve System temporarily guarantee a lower bound on stock prices in order to escape the current combination of liquidity trap and credit crunch. It shortly discusses reasons for this measure, consequences, and some alternatives. It is meant as a policy suggestion in case the recapitalization of banks, agreed upon in mid-October 2008, turns out to be insufficient for stabilizing financial markets and the downward spiral in asset prices resumes.financial crisis, monetary policy, liquidity trap, credit crunch, asset markets

Speculative Attacks

Models with multiple equilibria are a popular way to explain currency attacks. Morris and Shin (1998) have shown that, in the context of those models, unique equilibria may prevail once noisy private information is introduced. In this paper, we generalize the results of Morris and Shin to a broader class of probability distributions and show - using the technique of iterated elimination of dominated strategies - that uniqueness will hold, even if we allow for sunspots and individual uncertainty about strategic behavior of other agents. We provide a clear exposition of the logic of this model and we analyse the impact of transparency on the probability of a speculative attack. For the case of uniform distribution of noisy signals, we show that increased transparency of government policy reduces the likelihood of attacks

Optimal Degree of Public Information Dissemination

Financial markets and macroeconomic environments are often characterized by positive externalities. In these environments, transparency may reduce expected welfare from an ex-ante point of view: public announcements serve as a focal point for higher-order beliefs and affect agents’ behaviour more than justified by their informational contents. Some scholars conclude that it might be better to reduce the precision of public signals or entirely withhold information. This paper shows that public information should always be provided with maximum precision, but under certain conditions not to all agents. Restricting the degree of publicity is a better-suited instrument for preventing the negative welfare effects of public announcements than restrictions on their precision are

Competition for order flow as a coordination game

Competition for order flow can be characterized as a coordination game with multiple equilibria. Analyzing competition between dealer markets and a crossing network, we show that the crossing network is more stable for lower traders’ disutilities from unexecuted orders. By introducing private information, we prove existence of a unique equilibrium with market consolidation. Assets with low volatility and large volumes are traded on crossing networks, others on dealer markets. Efficiency requires more assets to be traded on crossing networks. If traders’ disutilities differ sufficiently, a unique equilibrium with market fragmentation exists. Low disutility traders use the crossing network while high disutility traders use the dealer market. The crossing network’s market share is inefficiently small

Speculative Attacks with Multiple Sources of Public Information

We propose a speculative attack model in which agents receive multiple public signals. It is characterised by its focus on an informational structure which sets free from the strict separation between public information and private information. Diverse pieces of public information can be taken into account differently by players and are likely to lead to different appreciations ex post. This process defines players’ private value. The main result is to show that equilibrium uniqueness depends on two conditions: (i) signals are sufficiently dispersed (ii) private beliefs about the relative precision of these signals sufficiently differ. We derive economic policy implications of such a result

Speculative attacks : unique sunspot equilibrium and transparency

Models with multiple equilibria are a popular way to explain currency attacks. Morris and Shin (1998) have shown that, in the context of those models, unique equilibria may prevail once noisy private information is introduced. In this paper, we generalize the results of Morris and Shin to a broader class of probability distributions and show - using the technique of iterated elimination of dominated strategies - that uniqueness will hold, even if we allow for sunspots and individual uncertainty about strategic behavior of other agents. We provide a clear exposition of the logic of this model and we analyse the impact of transparency on the probability of a speculative attack. For the case of uniform distribution of noisy signals, we show that increased transparency of government policy reduces the likelihood of attacks. JEL Classification F 31, D 82Modelle mit multiplen Gleichgewichten sind ein populärer Ansatz zur Erklärung spekulativer Attacken. Morris und Shin (1998) haben jedoch gezeigt, dass auch im Rahmen dieser Modelle eindeutige Gleichgewichte zu erwarten sind, sobald die Spekulanten verzerrte private Signale über die Fundamentaldaten erhalten. In dieser Arbeit verallgemeinern wir die Ergebnisse von Morris und Shin und zeigen, dass die Gleichgewichte selbst dann eindeutig sind, wenn Sunspot Variablen und individuelle Unsicherheit über Strategien zugelassen werden. Zudem analysieren wir, welchen Einfluss Transparenz auf die Wahrscheinlichkeit erfolgreicher Attacken hat. Für den Fall der Gleichverteilung verzerrter Signale zeigen wir, dass bei transparenter Geldpolitik ein Ausbruch solcher Attacken mit geringerer Wahrscheinlichkeit auftritt

Publicité limitée de l'information et sur-réaction aux annonces lors des épisodes spéculatifs

Le modèle de Morris et Shin [2002] montre que des annonces publiques imprécises peuvent coordonner les spéculateurs loin de la solution fondamentale par un phénomène de sur-réaction aux annonces. Le fort potentiel focal exercé par la connaissance commune est dommageable au bien-être lorsqu'il induit de la sur-réaction à un signal public imprécis. Pourtant, les expériences de laboratoire montrent que les agents sur-réagissent aux annonces, mais pas aussi fortement que ce que prédisent les modèles théoriques existants, fondés sur de l'information publique qui génère de la connaissance commune. Ce papier introduit la notion de publicité limitée de l'information qui semble mieux à même de rendre compte du degré réel de sur-réaction des agents.publicité limitée de l'information ; sur-réaction ; spéculation

Measuring Agents' Reaction to Private and Public Information in Games with Strategic Complementarities

In games with strategic complementarities, public information about the state of the world has a larger impact on equilibrium actions than private information of the same precision, because the former is more informative about the likely behavior of others. This may lead to welfare-reducing ‘overreactions’ to public signals. We present an experiment based on a game of Morris and Shin (2002), in which agents’ optimal actions are a weighted average of the fundamental state and their expectations of other agents’ actions. We measure the responses to public and private signals and find that, on average, subjects put a larger weight on the public signal. However, the weight is smaller than in equilibrium and closer to level-2 reasoning. Stated second order beliefs indicate that subjects underestimate the information contained in public signals about other players’ beliefs, but this can account only for a part of the observed deviation of behavior from equilibrium. In the extreme case of a pure coordination game, subjects still use their private signals, preventing full coordination. Reconsidering the welfare effects of public and private information theoretically, we find for level-2 reasoning that increasing precision of public signals always raises expected welfare, while increasing precision of private signals may reduce expected welfare if coordination is socially desirable.coordination games, strategic uncertainty, private information, public information, higher-order beliefs, levels of reasoning