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
727 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 - ...
10
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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 ...
9
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5answers
726 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
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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
332 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
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2answers
756 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
724 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
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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
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2answers
259 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
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2answers
346 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
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5answers
288 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
456 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
474 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 ...
5
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1answer
161 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 ...
5
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1answer
45 views

Could anyone here be able to explain gambling addiction and its debt with Microeconomics theory?

I am a research master student in Cognitive and Clinical Neuroscience, with the specialization/track Neuroeconomics and have to come up with a master thesis subject soon. I was thinking about gambling ...
4
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3answers
87 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
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1answer
85 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-...
3
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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
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2answers
152 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
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2answers
116 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
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2answers
77 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
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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
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3answers
303 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
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1answer
228 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
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1answer
258 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
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1answer
98 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
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1answer
106 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
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2answers
501 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
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2answers
344 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
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2answers
98 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
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1answer
226 views

Why is the risk premium always positive for risk averse individuals?

I think this has to do with the definition of concavity and the fact that a risk averse person has a concave utility function, but I'm not sure how that helps.
2
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1answer
115 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
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1answer
72 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
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1answer
105 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
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1answer
59 views

How to calculate CRRA bounds from Holt and Laury (2002) type lottery?

Lottery is between: Option A: a certain choice of £5 Option B: £10 with probability 0.1 and £1 with probability 0.9 The probability of receiving £10 increases in each subsequent choice. How do I ...
2
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3answers
92 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
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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
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1answer
302 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
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0answers
578 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
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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
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0answers
371 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
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0answers
107 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
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0answers
49 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
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2answers
33 views

How is an interest swap collateralized

I am trying to understand what it means for an interest swap to be collateralized. If for example, I am paying fixed to a bank and receive floating in return. Who is giving collateral to whom? and how ...
1
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1answer
55 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
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2answers
264 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
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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
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1answer
33 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 ...