Peter Woehrmann, Willi Semmler, Martin Lettau, Nonparametric Estimation of the Time-varying Sharpe Ratio in Dynamic Asset Pricing Models, In: Working paper series / Institute for Empirical Research in Economics, No. No. 225, 2005. (Working Paper)
Economic research of the last decade linking macroeconomic fundamentals to asset prices has revealed evidence that standard intertemporal asset pricing theory is not successful in explaining (unconditional) first moments of asset market characteristics such as the risk-free interest rate, equity premium and the Sharpe-ratio. Subsequent empirical research has pursued the question whether those characteristics of asset markets are time varying and, in particular, varying over the business cycle. Recently intertemporal asset pricing models have been employed to replicate those time varying characteristics. The aim of our contribution is (1) to relax some of the assumptions that previous work has imposed on underlying economic and financial variables, (2) to extend the solution technique of Marcet and Den Haan (1990) for those models by nonparametric expectations and (3) to propose a new estimation procedure based on the above solution technique. To allow fornnonparametric expectations in the expectations approach for numerically solving the intertemporal economic model we employ the Local Linear Mapsn(LLMs) of Ritter, Martinetz and Schulten (1992) to approximate conditional expectations in the Euler equation. In our estimation approach based on non-parametric expectations we are able to use full structural information and,nconsequently, Monte Carlo simulations show that our estimations are less biased than the widely applied GMM procedure. Based on quarterly U.S. data we also empirically estimate structural parameters of the model and explore its time varying asset price characteristics for two types of preferences, power utility and habit persistence. We in particular focus on the Sharpe-ratio and find indication that the model is able to capture the time variation of thenSharpe-ratio. |
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Stefan Buehler, Armin Schmutzler, On The Role of Access Charges Under Network Competition, In: Working paper series / Socioeconomic Institute, No. No. 501, 2005. (Working Paper)
We aim to clarify the role of access charges under two-way network competition, employing a reduced-form approach. Retaining the key features of specific network competition models but imposing less structure, we analyze the impact of changes in access charges on linear and non-linear retail prices. We derive su.cient conditions for usage fees to be increasing (and subscriber charges to be decreasing) in access charges. These conditions are shown to be satisfied only under rather restrictive assumptions on the demand for calls, suggesting that implementing collusion by inflating access charges is likely to be nonfeasible. |
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Enrico De Giorgi, Thierry Post, Second Order Stochastic Dominance, Reward-Risk Portfolio Selection and the CAPM, In: Working paper series / Institute for Empirical Research in Economics, No. No. 213, 2005. (Working Paper)
"Starting from the reward-risk model for portfolio selection introduced in De Giorgi (2004), we derive the reward-risk Capital Asset Pricing Model (CAPM) analogously to the classical mean-variance CAPM. The reward-risk portfolio selection arises from an axiomatic definition of reward and risk measures based on few basic principles, including consistency with second order stochastic dominance. With complete markets,nwe show that at any financial market equilibrium, investors optimal allocations arencomonotonic and therefore the capital market equilibrium model can be reduced to a representative investor model. Moreover, the pricing kernel is an explicitly given,nmonotone function of the market portfolio return, corresponding to the increments of the distortion function characterizing the representative investors risk perceptions.nFinally, an empirical application shows that the reward-risk CAPM better captures the cross-section of US stock returns than the mean-variance CAPM does." |
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Margit Osterloh, Bruno Frey, Shareholders Should Welcome Employees as Directors, In: Working paper series / Institute for Empirical Research in Economics, No. No. 228, 2005. (Working Paper)
"The most influential theory of corporate governance, principal agency theory, does not take intonconsideration that the key task of modern corporations is to generate and transfer firm-specific knowledge. It proposes that, in order to overcome the widespread corporate scandals, the interests of top management and directors should be increasingly aligned to shareholder interests by making the board more responsible to shareholders, and strengthening the monitoring of top management by independent outside directors. Corporate governance reform needs to go in another direction altogether. Firm-specific knowledge investments are, like financial investments, not ex ante contractible, leaving investors open to exploitation by shareholders. Employees therefore refuse to make firm-specific investments. To gain a sustainable competitive advantage, there must be an incentive to undertake such firm-specific investments. Three proposals are advanced to deal with this conflict: (1) The board should rely more on insiders. (2) The insidersnshould be elected by those employees of the firm making firm-specific knowledge investments.(3) The board should be chaired by a neutral person. These proposals have major advantages: they provide incentives for knowledge investors; they countervail the dominance of executives; they encourage intrinsic work motivation and loyalty to the firm by strengthening distributive andnprocedural justice, and they ensure diversity on the board while lowering transaction costs. These proposals for reforming the board may help to overcome the crisis corporate governance is in. At the same time, they connect agency theory with the knowledge-based theory of the firm." |
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Aleksander Berentsen, Gabriele Camera, Christopher Waller, The Distribution of Money Balances and the Non-Neutrality of Money, In: Working paper series / Institute for Empirical Research in Economics, No. No. 220, 2005. (Working Paper)
"Recent monetary models with explicit microfoundations are made tractable by assumingnthat agents have access to centralized markets after one round of decentralized trade. Given quasi-linear preferences, this makes the distribution of money degenerate which keeps the models simple but precludes discussion of distributional effects of monetary policy. We generalize these models by assuming two rounds of trade before agents can readjust their money holdings to study a range of new distributional effects analytically. We show that unexpected symmetric lump-sum money injections may increase short-run output and welfare,nwhile asymmetric injections may increase long-run output and welfare." |
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Patrick Leoni, Stéphane Luchini, Designing the Financial Tool to Promote Universal Free-Access to AIDS Care, In: Working paper series / Institute for Empirical Research in Economics, No. No. 214, 2004. (Working Paper)
Typical of the AIDS epidemics is that governments in developing countries under-invest in drugs production because of the possible appearance of a curative vaccine. We design a financialntool allowing to hedge against this event. We show that the introduction of this asset increases social welfare, as well as the number of patients treated and the provision of public good. |
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Bruno Frey, Alois Stutzer, Economic Consequences of Mispredicting Utility, In: Working paper series / Institute for Empirical Research in Economics, No. No. 218, 2004. (Working Paper)
Individuals make systematic mistakes in their decisions, because they mispredict utility from choice options. When deciding, extrinsic attributes of choice options are more salient than intrinsic attributes. Adaptation is neglected, recollection of feelings is distorted, decisions are rationalized and wrong intuitive theories of happiness are applied. People overestimate extrinsic attributes and therefore put too much emphasis on acquiring income and gaining status. In contrast, they underestimate intrinsic attributes and devote too littlentime to their family, friends or hobbies, which lowers their utility level. The theoreticalnanalysis is consistent with an econometric study on commuting decisions using reported subjective well-being data. |
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Patrick Leoni, Learning in Repeated Games without Repeating the Game, In: Working paper series / Institute for Empirical Research in Economics, No. No. 215, 2004. (Working Paper)
"This paper extends the convergence result on Bayesian learning in Kalai and Lehrern(1993a, 1993b) to a class of games where players have a payoff function continuous for the product topology. Provided that 1) every player maximizes her expected payoff against her own beliefs, 2) every player updates her beliefs in a Bayesian manner, and 3) prior beliefs other players strategies have a grain of truth, we show that after some finite time the equilibrium outcome of the above game is arbitrarily close to a Nash equilibrium. Those assumptions are shown to be tight." |
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Alois Stutzer, Bruno Frey, Making International Organizations More Democratic, In: Working paper series / Institute for Empirical Research in Economics, No. No. 217, 2004. (Working Paper)
World governance today is characterized by international organizations lacking democratic legitimacy and control by the citizens they claim to represent. They are also criticized for being inefficient. This leads to violent protests and to NGOs having great influence. To address these problems, we propose international governance base on the democratic idea of citizen participation: All citizens of the member countries of international organizations have the potential right to participate in the decision-making of international organizations via initiatives, referendums and recalls. In order to reduce transaction costs, a representative group of citizens is randomly selected who can actually exercise their participation rights. |
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Patrick Leoni, Market Power, Survival and Accuracy of Predictions in Financial Markets, In: Working paper series / Institute for Empirical Research in Economics, No. No. 216, 2004. (Working Paper)
"This paper aims to show that the market selection hypothesis in finance is not solely driven by the competitiveness of such markets, as was originally claimed by Alchian [1] and Friedman [4]. Within a standard intertemporal General Equilibrium framework, we allow for an agentnto have enough influence on financial markets to strategically affect prices of assets traded. We then show that, as in Sandroni [15], the agent long-run consumption will vanish if she makes less accurate predictions than the market, and maintain her market power otherwise. We conclude thatnthe Darwinian justification to this market selection is not the only explanation for the eventualndomination of agents making the most accurate predictions. Rather, we claim that the origin of market selection, and in turn of the common prior assumption in asset pricing, is associated withnthe ability to foresee accurately market uncertainty." |
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Stefan Buehler, Armin Schmutzler, Asymmetric Vertical Integration, In: Working paper series / Socioeconomic Institute, No. No. 306, 2004. (Working Paper)
We examine vertical backward integration in a reducedform model of successive oligopolies. Our key findings are: (i) There may be asymmetric equilibria where some firms integrate and others remain separated, even if firms are symmetric initially; (ii) Efficient firms are more likely to integrate vertically. As a result, integrated firms also tend to have a large market share. The driving force behind these findings are demand/mark-up complementarities in the product market. We also identify countervailing forces resulting from strong vertical foreclosure, upstream sales and endogenous acquisition costs. |
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Reto Foellmi, Josef Zweimüller, Income Distribution and Demand-induced Innovations, In: Working paper series / Institute for Empirical Research in Economics, No. No. 212, 2004. (Working Paper)
"We utilize Schmooklers (1966) concept of demand-induced invention to study the rolenof income inequality in an endogenous growth model. As rich consumers can satisfy morenwants than poor consumers, both prices and market sizes for new products, as well as theirnevolution over time, are determined by the income distribution. We show how a change in the distribution of income affects the incentive to innovate and hence long-run growth. In general, less inequality tends to discourage the incentive to innovate, but this depends on the nature of the redistribution." |
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Bruno Frey, 'Just Forget It' - Memory Distortion as Bounded Rationality", In: Working paper series / Institute for Empirical Research in Economics, No. No. 192, 2004. (Working Paper)
Distortions in memory impose important bounds on rationality but have been largely disregarded in economics. While it is possible to learn, it is more difficult, and sometimes impossible, to unlearn. This retention effect lowers individual utility directly or via reduced productivity, andnadds costs to principal-agent relationships. The imprinting effect states that the more one tries to forget a piece of information the more vivid it stays in memory, leading to a paradoxical outcome. The effects are based on, and are supported by, psychological experiments, and it is shown that they are relevant in many economic situations and beyond. |
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Pavlo R Blavatskyy, Contest success function with the possibility of a draw: axiomatization, In: Working paper series / Institute for Empirical Research in Economics, No. No. 208, 2004. (Working Paper)
In imperfectly discriminating contests the contestants contribute effort to win a prize but the highest contributed effort does not necessarily secure a win. The contest success function (CSF) is the technology that translates an individual's effort into his or her probability of winning. This paper provides an axiomatization of CSF when there is the possibility of a draw (the sum of winning probabilities across all contestants is non-additive). |
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Michael Breuer, Deductible or Co-Insurance: Which is the Better Insurance Contract under Adverse Selection?, In: Working paper series / Socioeconomic Institute, No. No. 401, 2004. (Working Paper)
The standard solution to adverse selection is the separating equilibrium introduced by Rothschild and Stiglitz. Usually, the Rothschild-Stiglitz argument is developed in a model that allows for two states of the world only. In this paper adverse selection is dis-cussed for continuous loss distributions. This gives rise to the new problem of finding the proper form of an insurance contract to impose partial insurance of the low risks. This paper contributes to the discussion on optimal insurance. It analyzes two basic forms of insurance contracts: A contract with a deductible and a contract imposing a positive co-insurance rate. Since high risks can always self-reveal themselves as high risks and buy the optimal insurance contract at high risks’ premiums the Pareto-superior insurance contract is the one that leaves the low risks with higher expected utility while deterring high risks from joining the contract that is designed for low risks. The deductible contract turns out to be superior if premiums contain a sufficiently high loading. |
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Alois Stutzer, Lukas Kienast, Demokratische Beteiligung und Staatsausgaben: Die Auswirkungen des Frauenstimmrechts, In: Working paper series / Institute for Empirical Research in Economics, No. No. 210, 2004. (Working Paper)
In dieser Arbeit werden die Auswirkungen des Frauenstimmrechts auf die Staatsausgaben in den Kantonen der Schweiz untersucht. Anhand dieser institutionell bedingten Veränderung des Elektorats studieren wir den Zusammenhang zwischen repräsentierten Bürgerpräferenzen und dem Ergebnis des politischen Prozesses. Da Frauen imnDurchschnitt einkommensärmer sind als Männer, steigt mit ihrer Beteiligung gemässnTheorien zur Grösse des Staatshaushaltes die Nachfrage nach staatlichen Leistungen.nEntgegen der Hypothese schätzen wir jedoch eine dämpfende Wirkung des Frauenstimmrechts auf die Entwicklung der Gesamtausgaben. Die zeitlich unterschiedliche Einführung des Rechts erlaubt dabei die Berücksichtigung allgemeiner Trends in Wirtschaft und Gesellschaft. Als Erklärungsversuche diskutieren wir die Möglichkeit fiskalischnkonservativer Frauen und einer Wechselwirkung des Frauenstimmrechts mit denndirektdemokratischen Institutionen. |
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Pavlo R Blavatskyy, Efficient elicitation of utility and probability weighting functions, In: Working paper series / Institute for Empirical Research in Economics, No. No. 211, 2004. (Working Paper)
Elicitation methods in decision making under risk allow a researcher to infer thensubjective utilities of outcomes as well as the subjective weights of probabilities from observed preferences of an individual. An optimally efficient elicitation method is proposed, which takes into account the inevitable distortion of preferences by random errors and minimizesnthe effect of such errors on the inferred utility and probability weighting functions. Under mildnassumptions, the optimally efficient method for eliciting utilities (weights) of many outcomes (probabilities) is the following three-stage procedure. First, a probability is elicited whose subjective weight is one half. Second, an individual's utility function is elicited through the midpoint chaining certainty equivalent method employing the probability elicited at the first stagenas an input. Finally, an individual's probability weighting function is elicited through the probability equivalent method. |
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Enrico De Giorgi, Reward-Risk Portfolio Selection and Stochastic Dominance, In: Working paper series / Institute for Empirical Research in Economics, No. No. 121, 2004. (Working Paper)
The portfolio selection problem is traditionally modelled by two different approaches. The first one is based on an axiomatic model of risk-averse preferences, where decision makers are assumed to possess an expected utility function. The second approach, first proposed by Markowitz (1952), reduces the portfolio choice to a set of two criteria, reward and risk. Usually the reward-risk model is not consistent with the first approach, even when the decision is independent from the specific form of the risk-averse expected utility function. In this paper we generalize the reward-risk model for portfolio selection. We define reward measures and risk measures by giving a set of properties these measures should satisfy. One of these properties will be the consistency with second order stochastic dominance, to obtain a link with the expected utility portfolio selection. We characterize reward and risk measures and we discuss the implication for portfolio selection. |
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Max Gruetter, Rafael Lalive, The Importance of Firms in Wage Determination, In: Working paper series / Institute for Empirical Research in Economics, No. No. 207, 2004. (Working Paper)
Firms are central to many theories of the labor market. However, the actual degree to which firms shape the structure of wages is still not well understood. This paper investigates (i) the importance of firms in explaining wage differences across individuals and industries, and (ii) how the nature of interfirm mobility - job-to-job vs. job-unemployment-job - affects the relative importance of firms and workers in wage determination. Results indicate that (i) firms are much more important in explaining the variance of average wages across industries rather than across individuals, and (ii) using job-to-job transitions to identify the firm's contribution to the wage rate reduces the importance of firm wage policies in explaining wage differences by as much as 50%. |
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Bruno Frey, Alois Stutzer, The Role of Direct Democracy and Federalism in Local Power, In: Working paper series / Institute for Empirical Research in Economics, No. No. 209, 2004. (Working Paper)
"Alienation to politics weakens political competition and can undermine the acceptance and legitimacy of democracy as a political system. Governance andnrepresentation problems at the local level cause part of citizens lack of power andnpolitical alienation. Citizens have local power if they can process so that its outcomes are closer to their preferences and if they feel to be effective in the political sphere. In order to increase citizens local power, we emphasize the role of institutions of local governance. Local democratic governance is concerned about the relationship between citizens and local governmentninstitutions, political representatives and officials. This relationship is fundamentally shaped by the federal structure of a nations government and by the scope and depth of citizens participation possibilities in the political process. " |
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