Attitudes Of Agents Research Articles

Knightian Uncertainty in Financial Markets: An Assessment

Following the Savage paradigm, the theory of portfolio choice and asset pricing under uncertainty assume that the agent's beliefs about future states of the world are represented by a unique additive probability measure, either objective or Bayesian prior. Given absence of arbitrage, agent optimality and market equilibrium, the price of any security is the discounted state-price weighted sum of its future payoffs. Each asset is valued by the expectation of its random payments with respect to the probability distribution over the state space. However, puzzling behavior such as price booms and crashes, excess volatility of asset prices, violation of call and put parity, bid and ask spreads and portfolio rigidities has been observed, in financial markets. All these phenomena can be explained by introducing transaction costs, asymmetric information, incomplete markets into standard financial market theory. In the last decade, following a reexamination process that has involved expected utility theory, several non-expected utility models have appeared in economic literature. The starting point is the distinction between risk, where the agent's beliefs are represented by a unique additive probability distribution, and Knightian uncertainty, where information is too vague and imprecise to be summarized by a unique additive probability measure. Since Knightian uncertainty is more common than risk in economic decision-making, researchers have introduced the agent's attitude towards ambiguity, proving that it plays a crucial role in asset price determination and portfolio choice. This provided an alternative explanation of financial market failures and enabled puzzles to be solved. In static and dynamic models, it was proved that Knightian uncertainty, summarized by a capacity or multiple priors, is a sufficient condition to induce phenomena such as price indeterminacy, price volatility, bid and ask spreads, portfolio inertia, violation of call and put parity and market breakdowns.

Price skewness and the marketing of finished cattle

Incomplete information about product quality generates risk for market participants. The amount of information and perceived risk varies between marketing channels and an agent's attitude to this risk influences their choice of marketing channel. For risk-averse sellers, expected price and the associated price risk (dispersion) are relevant to their choice of marketing route. This paper examines how the choice of marketing channel by farmers selling finished cattle is influenced by their perceptions of expected market price and price variation. The study uses a unique dataset of “matched” animals, sold first in liveweight auction markets in Northern Ireland and subsequently to a meat packer. The findings indicate that price skewness also influences channel choice. The positive skewness exhibited by auction market prices combined with the negative skewness exhibited by meat packer prices may mean that some risk-averse individuals, faced with incomplete information about product quality, prefer the liveweight auction market to selling directly to meat packers [JEL Codes: Q110]. © 2000 John Wiley & Sons, Inc.

Nondegenerate intervals of no-trade prices for risk averse traders

According to the local risk-neutrality theorem an agent who has the opportunity to invest in an uncertain asset does not buy it or sell it short iff its expected value is equal to its price, independently of the agent's attitude towards risk. Contrary to that it is shown that, in the context of expected utility theory with differentiable vNM utility function, but without the assumption of stochastic constant returns to scale, nondegenerate intervals of no-trade prices may exist. With a quasiconcave expected utility function they do if, and only if, the agent is risk averse of order one.

Compatibilists Could Have Done Otherwise: Responsibility and Negative Agency

One is morally responsible for what one has done only if one could have done otherwise. Those who believe that moral responsibility is incompatible with causal determinism often invoke this principle, known as the Principle of Alternative Possibilities, to show that their position has a foothold in ordinary ways of thinking about the conditions of moral responsibility.' The incompatibilist assumes that whether an agent could have done otherwise in some situation depends on whether that agent could have acted differently in circumstances exactly the same as those that actually existed, and so infers that if determinism is true, this condition of moral responsibility is never satisfied. Interpreted in this way, the Principle of Alternative Possibilities (henceforth PAP) states a metaphysical rather than a psychological condition of responsibility; one cannot ascertain whether it is satisfied by examining the agent's views, attitudes, and assumptions. Nevertheless, incompatibilists often support this principle by arguing that it is presupposed in our ordinary conception of ourselves as deliberators and agents.2 If determinism is true, then an important element in our self-conception as agents is simply a delusion, according to the incompatibilist, and the practice of holding people responsible for their actions that rests upon it is ungrounded-or at least not as well grounded as we ordinarily suppose.

The Dual Theory of Choice under Risk

IN THIS ESSAY, a new theory of choice under risk is being proposed. It is a theory which, in a sense that will become clear, is to expected utility theory, hence the title dual Risky prospects are evaluated in this theory by a cardinal numerical scale which resembles an expected utility, except that the roles of payments and probabilities are reversed. This theme-the reversal of the roles of probabilities and payments-will recur throughout the paper. I should emphasize that playing games, with probabilities masquerading as payments and payments masquerading as probabilities, is not my object. Rather, I hope to convince the reader that the theory has intrinsic economic significance and that, in some areas, its predictions are superior to those of expected utility theory (while in other areas the reverse will be the case). Two reasons have prompted me to look for an alternative to expected utility theory. The first reason is methodological: In expected utility theory, the agent's attitude towards risk and the agent's attitude towards wealth are forever bonded together. At the level of fundamental principles, risk aversion and diminishing marginal utility of wealth, which are synonymous under expected utility theory, are horses of different colors. The former expresses an attitute towards risk (increased uncertainty hurts) while the latter expresses an attitude towards wealth (the loss of a sheep hurts more when the agent is poor than when the agent is rich). A question arises, therefore, as to whether these two notions can be kept separate from each other in a full-fledged theory of cardinal utility. The theory will have this property. The second reason that leads me to look for an alternative to expected utility theory is empirical: Behavior patterns which are systematic, yet inconsistent with expected utility theory, have often been observed. (Two prominent references, among many others, are Allais (1953) and Kahneman-Tversky (1979).) So deeply

De Re Belief in Action

B eliefs and other attitudes play a prominent role in the explanation of action. It has thus seemed plausible, even obvious, that actions directed upon concerete objects are explainable in part by attitudes directed upon those objects. My aim is to expose vexing difficulties in the received views that attempt such explanation, to show that the received views cannot simply be patched up to avoid the difficulties, and to suggest a somewhat different approach to the explanation of action in terms of the agent's attitudes. Belief intuitively seems to come in two varieties: belief about an object or person and belief that something is the case. Belief about is belief regarding an object or res and is called de re belief; belief that is belief in a (nonsingular) proposition or dictum and is called de dicto belief. For example, the police, suspecting arson, may believe (de dicto) that someone set the fire without believing (de re) of any particular person that he is the culprit. Or again: there is a primafacie distinction between a de re belief regarding Sims, the most junior member of the faculty, that she is underpaid, and a de dicto belief that the most junior member of the faculty, whoever she may be, is underpaid. A de dicto belief may be thought of as a dyadic relation between a believer and a proposition. A de re belief may be thought of as a triadic relation among a believer, an object (or nonnull sequence of objects), and a property that the believer attributes to the object(s).' Since the res itself is one

Recovering Cardinal Utility

Individual choice under uncertainty depends on an agent's attitudes towards risk, typically represented by his von Neumann-Morgenstern cardinal utility function, u. This function is, of course, an unobservable characteristic. What is, at least in principal, observable is the agent's demand for alternative assets. Problems of prediction and welfare often require conclusions to be drawn concerning the unobservable characteristics based on observable behaviour. To predict the response to a change in the stochastic production plan of a firm, or to determine the compensation necessary so as to avoid a loss in welfare due to a change in the capital tax structure, knowledge of an agent's attitude towards risk is required. It is the purpose of the present paper to demonstrate that, as long as the joint distribution of returns of the available assets is known, the cardinal utility function can be recovered without ambiguity from asset demands, provided that the set of available assets contains a riskless asset. The distinguishing characteristic of the recoverability problem as posed here is the possible incompleteness of markets. In a framework of complete markets, if nominal income and prices vary independently, the range of the demand correspondence can be assumed to cover an open subset of the consumption set. The utility function can then be immediately recovered, up to a monotone transformation, over this range, given mild regularity conditions on demand behaviour. Given incomplete markets, however, this argument fails. Since the choice set is a lower dimensional subspace of state space, we learn only about the agent's preferences within this subspace. We show that the existence of a riskless asset (and some risky asset) implies recoverability of von NeumannMorgenstern preferences, even if markets are incomplete. In the presence of a riskless asset, any positive, riskless level, a, of wealth is demanded for some asset prices. Using arguments from Pratt (1964), the ratio u'(a)/u'(a) can be recovered without ambiguity for all positive (resp. non-negative) values of a, and hence, an integration argument can be used to recover the cardinal utility function, u, up to a positive affine transformation. Beyond the argument based on knowledge of the asset demand correspondence, we explore an alternative approach to recoverability. We demonstrate that knowledge of the portfolio indifference surfaces permits recovery of the cardinal utility function, provided there is a riskless asset. The intuition here is that the agent's risk aversion is directly related to the curvature of the indifference curve around the riskless point and the variance of the risky asset(s). That this approach is in general equivalent to the demand correspondence approach is well known-we give a brief proof for twice continuously differentiable and strictly monotone utility functions. We point out two results concerning the informational requirements of the argument for recoverability. Specifically, the argument does not require complete knowledge of the distribution of returns independently of the asset demands. Instead, it suffices to know the mean and variance of the returns to just one asset other than the riskless, and the return of the riskless asset. Furthermore, if the demand for assets is known only on a subset of the