When Does Extra Risk Strictly Increase the Value of Options?

It is well known that risk increases the value of options. This paper makes that precise in a new way. The conventional theorem says that the value of an option does not fall if the underlying option becomes riskier in the conventional sense of the mean-preserving spread. This paper uses two new definitions of ``riskier'' to show that the value of an option strictly increases (a) if the underlying asset becomes ``pointwise riskier,'' and (b) only if the underlying asset becomes ``extremum riskier.''options, risk, mean-preserving spread,calls

A Reputation Model of Quality in North-South Trade

Countries have different comparative advantages in quality. These might be due to technological differences, or to reputation differences of the sort described in Klein & Leffler (1981). Reputation differences are particularly interesting, since good reputations are a form of “social capital” that is amenable to modelling. They can explain why firms in these industries like to export even if the foreign price is no higher than the domestic one, and why governments would like to have large “high- value” sectors.

The Objectives of Sexual Harassment Law, with Application to 1998's Ellerth, Oncale, and Faragher Decisions

Imposing liability on a company for sexual harassment by supervisors cannot be justified as promoting equality between the sexes, protection of workers, or protection of the owners of the company. Such liability might be justified to prevent breach of contract or behavior offensive to the general public-- a "civility code". The recent Supreme Court ruling in Oncale that same-sex harassment is illegal can be justified on these grounds. The ruling in Ellerth and Faragher concerning employer liability for sexual harassment by supervisors contrary to the employer's interest is less satisfactory because the Court's rule will encourage litigation and defensive bureaucratic complexity.sexual harassment, Supreme Court, mandated fringe benefits

An Economic Approach to Adultery Law

A long-term relationship such as marriage will not operate efficiently without sanctions for misconduct, of which adultery is one example. Traditional legal sanctions can be seen as different combinations of various features, differing in who initiates punishment, whether punishment is just a transfer or has real costs, who gets the transfer or pays the costs, whether the penalty is determined ex ante or ex post, whether spousal rights are alienable, and who is punished. Three typical sanctions, criminal penalties for adultery, the tort of alienation of affections, and the self-help remedy of justification are formally modelled. The penalties are then discussed in a variety of specific applications to past and present Indiana law . In fact, there is no warranty at all. And if there are blank lines after this, well that is too bad bec as you will see they are not needed nor wanted and if I have been really careful, they will disappear just like the indentations.adultery, crime, marriage, self-help

Getting Carried Away in Auctions as Imperfect Value Discovery

Bidders in auctions must decide whether and when to incur the cost of estimating the most they are willing to pay. This can explain why people seem to get carried away, bidding higher than they had planned before the auction and then finding they had paid more than the object was worth to them. Even when such behavior is rational, ex ante, it may be perceived as irrational if one ignores other situations in which people revise their bid ceilings upwards and are happy when that enables them to win the auction.

When Does Extra Risk Strictly Increase an Option's Value?

It is well known that risk increases the value of options. This paper makes that precise in a new way. The conventional theorem says that the value of an option does not fall if the underlying option becomes riskier in the conventional sense of the mean-preserving spread. This paper uses two new definitions of "riskier" to show that the value of an option strictly increases (a) if the underlying asset becomes "pointwise riskier," and (b) only if the underlying asset becomes "extremum riskier."

Price Discrimination between Retailers with and without Market Power

Some retail markets are more competitive than others. A manufacturer with market power in the wholesale market who sells his product to competing retailers in cities and monopolistic ones in each of various towns must set the wholesale price difference between towns and cities to be smaller than the transportation cost to prevent “grey market” arbitrage. If he uses linear pricing, the town retail price will be even higher than under single-retailer double marginalization. Two-part tariffs do not solve the problem as they would if there were a single retailer, because the wholesale unit price must be higher than marginal cost to prevent arbitrage to the cities. If transportation costs are low, price discrimination is difficult and two- part tariffs come to resemble inefficient linear monopoly pricing. High transportation costs allow greater efficiency in contracting, and this can outweigh the negative direct effect on welfare.price discrimination, double marginalization, retail network, transportation costs, two-part tariffs, vertical restraints

Quality-Ensuring Profits

In the reputation model of Klein and Leffler (1981) firms refrain from cutting quality or price because if they did they would forfeit future profits. Something similar can happen even in a static setting. First, if there exist some discerning consumers who can observe quality, firms wish to retain their purchases. Second, if all consumers can sometimes but not always spot flaws, firms do not want to lose the business of those who would spot them on a given visit. Third, if the law provides a penalty for fraud, but not one so high as to to make fraud unprofitable, firms may prefer selling high quality at high prices to low quality at high prices plus some chance of punishment.reputation, product quality, moral hazard, quality-guaranteeing price

The Uneasy Case for the Flat Tax

There is a secret paradox at the heart of social contract theories. Such theories assume that, because personal security and private property are at risk in a state of nature, subjects will agree to grant Leviathan a monopoly of violence. But what is to prevent Leviathan from turning on his subjects once they have lain down their arms? If Leviathan has the same incentives as his subjects in the Hobbesian state of nature, he will plunder them more thoroughly than ever they plundered themselves in the state of nature. Thus the social contract always leaves subjects worse off, unless Leviathan can fetter himself. And how can Leviathan bind himself, if he can always impose confiscatory taxes or choke off trade through inefficient regulations? This Article suggests that schemes of progressive taxation, in which marginal tax rates increase with taxable income, may be seen as a useful incentive strategy to bribe Leviathan from imposing inefficient regulations. Income taxes give Leviathan an equity claim in his state's economy, and progressive taxes give him a greater residual interest in upside payoffs. Leviathan will then demand a higher side payment from interest groups to impose value- destroying regulations. Of course, progressive taxation imposes its own incentive costs, by reducing the subject's private gains. However, these costs must be balanced against the gains from correcting Leviathan's misincentives, and it may that such gains exceed the costs of progressive taxation.flat tax, Hobbes, political economy, Leviathan, regulation,mandates, constitutions, progressive taxation

Internalities and Paternalism: Applying the Compensation Criterion to Multiple Selves across Time

One reason to call an activity a vice and suppress it is that it reduces a person’s future happiness more than it increases his present happiness. Gruber and Koszegi (2001) show how a vice tax can increase a person’s welfare in a model of multiple selves with hyperbolic preferences across time. The present paper shows that an interself analogy of the Kaldor-Hicks compensation criterion can justify a vice ban whether preferences are hyperbolic or exponential, but subject to the caveat that the person has a binding constraint on borrowing.internalities, sin tax, moral regulation, Kaldor-Hicks criterion, time inconsistency, hyperbolic preferences