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Questions tagged [risk]

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16
votes
2answers
4k views

What is the importance of Epstein-Zin preferences?

I've heard that there is a lot of work being done recently that applies Epstein-Zin preferences. The Wikipedia page doesn't seem to be very full. Why are Epstein-Zin preferences important? How does ...
11
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6answers
676 views

What metrics would indicate a house bubble rather than genuine market values?

There are concerns that Auckland, New Zealand, is currently experiencing a housing bubble. Auckland is one of the top 10 cities in the world on a housing unaffordability index. The question is - ...
9
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2answers
3k views

Intuition behind risk premium

In Lecture 20 of MIT's Microeconomics course, a situation is proposed where a 50/50 bet will either result in losing \$100 or gaining \$125 with a starting wealth of \$100. It is stated that a person ...
8
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5answers
582 views

References for particular definitions of risk and uncertainty

I have some doubts about risk vs. uncertainty. I have read the thread "What is the difference between risk, uncertainty and ambiguity" and have skimmed through Knight's "Risk, Uncertainty, and Profit" ...
8
votes
2answers
1k views

What is the necessity of the FDIC in the US banking system?

A bank's basic function is to "borrow short and lend long". In other words, it borrows money from depositors over the short term, promising to repay it on demand, while it lends most of that money out ...
8
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2answers
250 views

Will high computing power substitute the certainty-equivalence assumption?

Bloom in a recent JEP paper considers that "the increase in computing power has made it possible to include uncertainty shocks directly in a wide range of models, allowing economists to abandon ...
8
votes
2answers
679 views

How is momentum justified as a common risk factor?

Momentum as a common risk factor? This question is partly a follow-up to another question found here. In this other question it was noted in momentum is difficult to explain as a common risk factor ...
7
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3answers
514 views

What is the average economic value of a human life?

What is the economic value of a human life? If there are multiple methods to use in calculating, what are they, which method is preferred, and why? Considerations/sub-questions on methods A. Is the ...
7
votes
6answers
1k views

What are alternative measures of risk?

In finance, the variance of the returns of a security are used as a proxy for the associated risk of the security. I've seen some books include sentences like "if you take variance as a measure of ...
7
votes
2answers
230 views

Do stock markets price in existential risk (i.e. global nuclear war)?

Question Moved from Money StackExchange: https://money.stackexchange.com/questions/74002/do-stock-markets-price-in-existential-risk-i-e-global-nuclear-war Q: Do stock markets price in existential ...
6
votes
2answers
327 views

Definition of Absolute Risk Aversion

In its Wikipedia article, absolute risk aversion is defined as $ARA = -\frac{u''(c)}{u'(c)}$. However, I have alternatively seen absolute risk aversion defined as half the decrease in consumption ...
5
votes
5answers
258 views

Why is everyone suggested to specialize their education?

Why is so common to suggest university students to specialize in order to get a better paid job? This goes completely against the principle of diversification of investments, in order to decrease ...
5
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1answer
438 views

Independence axiom of lottery when $\alpha \ge 1$

When studying preference over lotteries we learned the independence axiom which goes like this: The preference relation $\succsim$ on the space of simple lotteries $\mathscr{L}$ satisfies the ...
5
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1answer
154 views

Portfolio choice of a risk lover

Take the standard portfolio choice problem as presented in MWG (p.188-189), but with a risk loving decision maker: with initial wealth $w$ invests an amount $\alpha$ in a risky asset with a random ...
4
votes
1answer
412 views

Does dollar cost averaging actually have any advantage over one time investment?

Some banks promote savings plans by stating that investing a fixed amount of money in regular time intervals minimizes the average buying price or the downside risk (dollar cost averaging). Since the ...
4
votes
3answers
77 views

Can I recreate an experiment on Allais paradox using student grades as payoffs?

For a project in experimental economics, I thought of doing something related to expected utility theory/prospect theory, but using grades instead of money. Is this reformulation of the Allais ...
4
votes
1answer
82 views

Multiplicative factorization of stochastic growth time series--solving for an eigenfunction/eigenvector

I'm trying to understand the tools used/presented in Lars Hansen's Econometrica paper "Dynamic Valuation Decomposition within Stochastic Economies." In a part in the paper, Hansen introduces a long-...
4
votes
1answer
83 views

Transformation of random variables and second order stochastic dominance

Suppose $X$ and $Y$ are two random variables where $X$ has SOSD (second order stochastic dominance) over $Y$. Let $g(\cdot)$ be a monotonic function and $X' = g(X)$ and $Y' = g(Y)$. Under what ...
3
votes
2answers
2k views

Is DARA utility implying CRRA most of the time?

The Wikipedia page on risk aversion states that a "Constant Relative Risk Aversion implies a Decreasing Absolute Risk Aversion, but the reverse is not always true". Let me decompose this statement in ...
3
votes
2answers
113 views

When does gambling reduce risk?

Suppose that you face risk. It is obvious that taking gambles whose outcomes are negatively correlated with the outcomes of your other gambles can reduce your overall risk ('hedging'). My question, ...
3
votes
2answers
143 views

What are the economic justifications of the size premium?

What are the economic justifications of the size premium? In factor pricing models like the intertemportal capital asset pricing model (I-CAPM) or arbitrage pricing theory (APT), it is assumed that ...
3
votes
2answers
230 views

Sanity of lending out made-up money

Background I've done some research to get an understanding into the issue I want to ask about. Regrettably, I found out general descriptions of the mechanism and/or evidently biased explanations, ...
3
votes
2answers
75 views

VaR and rating for commercial banks

I would like to know if there exist a database where Value at risk of commercial banks are. Beyond that if there is a connection between the rating from agency (as S&P, Fitch etc..) and the VaR ...
3
votes
1answer
4k views

Absolute vs Relative Risk Aversion

Are there results that says the monotonicity of one measure of risk aversion implies the monotonicity of the other measure? For example, Does constant relative risk aversion imply decreasing ...
3
votes
1answer
216 views

Perfect risk sharing in Arrow-Debreu w/ the same subjective beliefs over states

So I'm looking at a 2-agent Arrow-Debreu economy with one good. Consumption and endowments are zero in t=0, and 2 states are possible in t=1 with aggregate endowment in both states equal to 1. We ...
3
votes
1answer
249 views

Relative risk aversion and lotteries exercise

Given a consumer with a utility function, $u(w)$, and a wealth of $w>1000$. Assuming that the consumers relative risk aversion is constant and equal to 1, that is $R_r(w)=1$ for $w>0$, the ...
3
votes
1answer
98 views

Why is there consumption sharing in Arrow-debreu time-zero complete markets trading model?

Specifically, I am looking at this paragraph ...
3
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0answers
47 views

Why don't firms and individuals do much more risk management? Couldn't they all hedge all kinds of risks financially?

There are many risks in the economy that agents could hedge. For example, house prices can go up or down, healthcare costs canchange, gas prices constantly change in fact, food prices,etc. They all ...
2
votes
2answers
441 views

What is the need for a special purpose entity/vehicle in mortgage backed securities

What is the need to create a special purpose entity/vehicle (SPV) for mortgage backed securities? What potential risks are avoided due to the creation of SPV? It is my naive idea that the holder of ...
2
votes
2answers
342 views

Is the loan principal ever delivered in pieces over time?

Not sure if this is the right place for this question but it's more of a theoretical finance question than a personal finance question. So a loan has a principal amount that is given to the borrower ...
2
votes
1answer
109 views

Why do riskier investments pay more?

I'm talking about bonds, stocks, and the sort. I understand that an individual investor that's planning to invest, say, 50% of his savings, may require a higher expected gain to go for a riskier ...
2
votes
1answer
73 views

Risky Assets over Bernoulli Utility

My question is about 6.C.4. of Mas-Colell et.al.'s Microeconomic Theory book. We have N risky assets with returns $z_n, n = (1,...,N)$ per dollar invested which are distributed over $F(z_1,...,z_n).$ ...
2
votes
1answer
65 views

Construct utility function for a risk-averse agent

I am trying to construct utility function for an agent who can be risk-seeking or risk-averse. We have an agent $i$ who has an ideal point $x$ in a policy space $X = [0,1]$. There is a policy (option) ...
2
votes
1answer
97 views

Why does Mascolell define second-order stochastic dominance as such?

Is not Mascolell's definition in his microeconomic theory of the second-order stochastic dominance narrower? He defines for distribution functions with the same mean only. Although he gives some ...
2
votes
3answers
89 views

Mean vs. variance - which is dominant?

I am currently trying to gain some basic understanding of the mean-variance tradeoff. However, since I do not have an economic education background, I am struggling with some issues. Currently I am ...
2
votes
1answer
72 views

How is project value enhanced by uncertainty in market payoff?

I was reading about the concept of real options valuation. It says that ROV has shown that uncertainty in market pay-off enhances the project value (V). How is that? Will it be possible to explain ...
2
votes
1answer
269 views

Inc Linear Transformation of Bernoulli Utility

According to MWG Proposition 6.B.2, it illustrates that the expected utility form is preserved only by increasing linear transformation. What is the significance of this proposition? The part I ...
2
votes
0answers
528 views

Certainty Equivalents and Risk Premiums in Expected Utility Theory for Asymmetric Distributions

I want to calculte risk-premiums in order to assess how much risk-averse customers would be willing to pay for an insurance against an uncertain loss modeled by a random variable $X$. How would a risk-...
2
votes
0answers
27 views

How do governments deflect risk through greater volatility in the housing market?

Source: p 123 of 296, Understanding Housing Policy, by Brian Lund Although housing immobility limits the impact of globalisation, its influence on financial and labour markets magnifies ...
2
votes
0answers
332 views

Probability of states of nature

I've been given the following question and would really appreciate any help on part a. I've looked over all of my resources for this course and we have always been given the probability of the ...
2
votes
0answers
95 views

What can we conclude from the overdetermined equity premium puzzle?

The equity premium: A puzzle (Mehra and Prescott (1985)) lays out the basic problem with equity returns: Restrictions that a class of general equilibrium models place upon the average returns of ...
2
votes
0answers
45 views

How can I construct a process for cumulative returns that is riskless?

This question is a little more specific than the title. Here I use the same notation that is set forth in this other question about cumulative returns (the sum of return observations). That is, let $...
1
vote
1answer
54 views

How to estimate market risk using only publicly available data?

How can I calculate market risk for the US Stock Market (NYSE or NASDAQ) using only freely accessible data? I'm only interested in the market risk of the whole economy not of different industries, ...
1
vote
2answers
252 views

Are risk-costs a form of external costs?

An example to make to question more clear: With the use of nuclear power plants come several risk-costs (the risk of a nuclear disaster). These costs aren't included in the energy price and there is ...
1
vote
1answer
74 views

Consequentialist View of Risk

In MWG, the authors introduce the consequentialist view of risk by assuming for any risky alternative, only the reduced lottery over final outcome matters to decision maker. From philosophical view, ...
1
vote
1answer
23 views

How is the utility function with constant relative risk-aversion obtained?

In this slide, it says that constant relative risk-Aversion utility function have this form. $u(x) = \frac{1}{1-b} x^{1-b}$ for $b≠1$ $u(x) = In(x)$ for $b=1$ When I tried to derive the utility ...
1
vote
1answer
42 views

Why does it seem like the average cost threshold protocol has a possible gain but no chance of loss?

So, the average cost threshold protocol is a theoretical protocol for crowd funding club goods (it can also be used to crowd fund public goods, but I'll only focus on club goods in this post). It is ...
1
vote
1answer
37 views

How to evaluate if an activity is likely to produce a positive ROI?

I am trying to establish if it would be worth my while to sell a product in a particular online marketplace but am unsure how to evaluate if it would be financially worth my while. The marketplace in ...
1
vote
1answer
43 views

Why charge higher interest rates to poorer customers?

Consumer loans/credit charge different rates depending on the individual's risk. In particular, it charges more to poorer individuals. Whilst this seems to make sense from a risk perspective, there ...
1
vote
0answers
58 views

Assessing risk in a decision problem with repeated toss

The problem starts at time t0. At each time step, the participant can choose to opt out and claim a loser's reward Rl. At each time step, the participant has a probability p to win a winner's reward ...