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12 votes

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

The first metric to look at is house-price-to-rent ratios. Rental prices capture the value of the housing (and housing-linked) services provided by a property, including things like how safe a ...
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12 votes

What is the importance of Epstein-Zin preferences?

This is only a quick answer, unfortunately. The key intuitive insight for Epstein-Zin is that they separate two distinct properties of preferences: risk aversion ("I'd prefer less uncertainty to more ...
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  • 1,048
11 votes
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What is the importance of Epstein-Zin preferences?

I think CompEcon covered most of the points that I was going to mention. Just a few last thoughts: 1) Why are Epstein-Zin preferences important? The preferences are important because they allow you ...
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  • 1,553
9 votes
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Intuition behind risk premium

The name for the amount $56.25 is certainty equivalent. The expected utility for the individual from taking the bet is calculated as follows: $$E[U]=\frac12U(100+125)+\frac12U(100-100)=75$$ Suppose ...
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9 votes
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What is the average economic value of a human life?

It depends on the context, of course, but most often in policy analysis "the value of a life" has nothing (directly) to do with output, etc, but instead means the maximum amount that people would want ...
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8 votes
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Independence axiom of lottery when $\alpha \ge 1$

To understand why $\alpha$ must be constrained in $(0,1)$, one has to contemplate the meaning of the expression $$\alpha L$$ when $L$ is a "lottery". How is a lottery denoted mathematically? Authors ...
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8 votes
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Second order stochastic dominance

The answer to 2. is no. One way to see this is from MWG's Property 6.D.2: $F$ SOSD $G$ if and only if \begin{equation} \int_0^xF(t)\mathrm dt \le \int_0^xG(t)\mathrm dt \quad\text{for all }x. \end{...
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7 votes

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

While it is possible to rigorously define a bubble in principle (see for example asset markets where prices violate transversality conditions), in practice it can be difficult or impossible to ...
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  • 15.9k
7 votes

Why is everyone suggested to specialize their education?

Note: I did not vote down on this question, and it is not clear why anyone would do so. Why is so common to suggest university students to specialize in order to get a better paid job? Because ...
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7 votes

Second order stochastic dominance

The answer to 1. Your conjecture is correct. Consider lotteries $A,B$ where $A$ guarantues a payoff of 1 while $B$ yields 0 or 4, each with 50% probability. $B$ does not SOSD $A$, as you can easily ...
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6 votes

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

You provide a generally correct impression of history (i.e., there were lots of runs on banks by depositors in the US until federal deposit insurance was established— a good history is provided by ...
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6 votes
Accepted

Is the loan principal ever delivered in pieces over time?

Handing out the principal amount of debt gradually, in increments, is standard practice in investment loans extended by a bank to a corporation. The rationale is clear : the corporation wants to ...
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6 votes

Most utility functions under risk and uncertainty generalizes expected utility. What is deadly wrong if a model does not include EU as special case?

Many people accept the axiomatizations of expected utility as normatively appealing, especially in contexts of pure risk. For people with this view, rational decision-makers should behave in ...
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5 votes

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

With apologies for the somewhat journalistic answer (as others have noted, even defining a bubble in a rigorous fashion is difficult). Information on housing supply may be of some use. Demand for ...
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  • 16.6k
5 votes

Will high computing power substitute the certainty-equivalence assumption?

This is perhaps a good opportunity to point out that the "certainty equivalence" concept means one thing in microeconomics/choice under uncertainty theory, while it means something different in ...
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5 votes

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

Here are a few reasons that build on @Dismalscience's answer. Capital requirements: Banks don't typically need to hold capital against loans they originated but subsequently moved into an SPV. This ...
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5 votes
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Does dollar cost averaging actually have any advantage over one time investment?

The seminal academic criticism of dollar cost averaging on many specifications of economic conditions is A Note on the Suboptimality of Dollar-Cost Averaging as an Investment Policy (Constantinides (...
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  • 15.9k
5 votes
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Why is the risk premium always positive for risk averse individuals?

Suppose that the vector $W=\left(w_1,w_2,\dots,w_n\right)$ represents wealth in $n$ possible states. In addition, assume the probability of each state occurring is represented by the vector $\pi=\left(...
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4 votes

Definition of Absolute Risk Aversion

@Alecos's answer is great. For pedagogical purposes, I'm just going to rephrase some of the steps. We want to show that $ARA = -u''(c)/u'(c)$ given that ARA is defined such that $u(c - ARA/2) = E[u(c ...
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  • 9,107
4 votes

Definition of Absolute Risk Aversion

Set $y \equiv c+\varepsilon$. So $y$ represents changed consumption around and "close" to a given level $c$. Take a 2nd-order Taylor expansion of the function $E[u(y)\mid c]$ around $c$, which is ...
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4 votes
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Portfolio choice of a risk lover

Since we are suspecting a corner-solution, it is better to write the problem explicitly with its constraint. Even better, use the Fritz John (FJ) conditions rather than the Karush-Kuhn-Tucker (KKT) ...
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4 votes

What are alternative measures of risk?

A variance is an incomplete measure of risk in a sense, that it measures uncertainty in security payoffs, rather than uncertainty in holder's welfare. In the simplest way we can demonstrate this point ...
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4 votes

Intuition behind risk premium

There is a typo in the figure that introduces some confusion in the previous answer, which is basically wrong. Based on the numbers and the figure, the utility is such that $$u=\sqrt{x},$$ so $$E[u]=\...
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  • 6,652
4 votes

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

It's actually quite easy. The key things to know are 1) that the majority of house purchases are made via mortgage lending, and that 2) an excess of bank lending over bank loan repayment causes money ...
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  • 2,690
4 votes
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Sanity of lending out made-up money

There are two ways I can think of interpreting this question. My first thought is that a single bank doesn't lend out more money than it has, but the banking system does. So let's say someone ...
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  • 6,409
4 votes

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

SPVs are typically used in MBS issuance to get the loans off the issuing bank's balance sheet, freeing up that balance sheet space to make more loans and providing bankruptcy-remoteness (i.e., the SPV ...
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4 votes

References for particular definitions of risk and uncertainty

Knight's 1921 essay was not written in formal mathematics (and trying to formulate a direct translation into modern mathematics may be quite problematic). Since Knight's time, a formal decision theory ...
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3 votes

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

A lot has already been written about this topic and there is absolutely no historical evidence that liquidity related problems should occur in a banking system without a deposit insurance (because of ...
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  • 169
3 votes

Risky Assets over Bernoulli Utility

Regarding your first question, the space on which you can apply Lebesgue's theorem is $\mathbb{R}_{+}^{N}$. The relevant $\sigma$-algebra is the Borel $\sigma$-algebra and the integration corresponds ...
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  • 3,202
3 votes

What are alternative measures of risk?

For alternative measurements of risk, consider: 1. Maximum Adverse Excursion [MAE]- the largest historical loss suffered by a system, trade or investment whether real or back-test. 2. Average True ...
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