Smooth Preferences Research Articles

Consumption growth, preference for smoothing, changes in expectations and risk premium

Abstract This paper derives a relationship between consumption growth, the consumption–wealth ratio and its first-difference, and asset returns. Using quarterly data for sixteen OECD countries, we find that the three-factor asset pricing model explains a large fraction of the variation in real stock returns. The model captures: (i) the concerns of agents with states of the world in which consumption growth is low; (ii) the preference of investors for a smooth consumption path as implied by the intertemporal budget constraint; and (ii) the role played by shifts in expectations about future returns due to positive or negative news about their wealth.

Ambiguity, ambiguity aversion and stores of value: The case of Argentina

AbstractWe study the household portfolio allocation in an economy with a history of nominal anchor volatility. Applying smooth ambiguity preferences to a static portfolio choice problem, we rationalize two facts about the Argentine experience of the last 20 years: the dollarization of household financial assets and its bias towards investment real estate as a means of preserving the real value of wealth. We find that ambiguity explains portfolio dollarization. In addition, ambiguity aversion reduces the demand for assets denominated in US dollars and increases the demand for investment real estate.

Occam's Razor in sensorimotor learning

A large number of recent studies suggest that the sensorimotor system uses probabilistic models to predict its environment and makes inferences about unobserved variables in line with Bayesian statistics. One of the important features of Bayesian statistics is Occam's Razor--an inbuilt preference for simpler models when comparing competing models that explain some observed data equally well. Here, we test directly for Occam's Razor in sensorimotor control. We designed a sensorimotor task in which participants had to draw lines through clouds of noisy samples of an unobserved curve generated by one of two possible probabilistic models-a simple model with a large length scale, leading to smooth curves, and a complex model with a short length scale, leading to more wiggly curves. In training trials, participants were informed about the model that generated the stimulus so that they could learn the statistics of each model. In probe trials, participants were then exposed to ambiguous stimuli. In probe trials where the ambiguous stimulus could be fitted equally well by both models, we found that participants showed a clear preference for the simpler model. Moreover, we found that participants' choice behaviour was quantitatively consistent with Bayesian Occam's Razor. We also show that participants' drawn trajectories were similar to samples from the Bayesian predictive distribution over trajectories and significantly different from two non-probabilistic heuristics. In two control experiments, we show that the preference of the simpler model cannot be simply explained by a difference in physical effort or by a preference for curve smoothness. Our results suggest that Occam's Razor is a general behavioural principle already present during sensorimotor processing.

Insurance and Prevention with Generalized Two-Period Smooth Ambiguity Preferences

Insurance and Prevention with Generalized Two-Period Smooth Ambiguity Preferences

Mono-Linearity-Based Axiomatic Approach to Non-Linear Expected Utility

In this paper, we study the theory of preference over unbounded random prospects using an axiomatic approach. We first show that Yaari's dual independence axiom can be decomposed into two axioms, the homogeneity axiom and the co-monotonic independence with respect to addition axiom, and we determine the representational form using the first axiom and the two axioms jointly. We then show that the second axiom is equivalent to a mono-linearity axiom, which characterizes a local linearity property of preference. Our work provides an axiomatic approach to the smooth preference model developed by Machina and Chew et al.; this paper may thus be regarded as a bridge between the dual theory of Yaari and the smooth preference model of Machina and Chew et al., and it extends their results to unbounded outcome spaces. Homogeneity and mono-linearity provide additional flexibility in characterizing irregular behavior, and examples are provided to illustrate their applications.

Revealed smooth nontransitive preferences

In the present paper, we are concerned with the behavioural consequences of consumers having nontransitive preference relations. Data sets consist of finitely many observations of price vectors and consumption bundles. A preference relation rationalizes a data set provided that for every observed consumption bundle, all strictly preferred bundles are more expensive than the observed bundle. Our main result is that data sets can be rationalized by a smooth nontransitive preference relation if and only if prices can normalized such that the law of demand is satisfied. Market data sets consist of finitely many observations of price vectors, lists of individual incomes and aggregate demands. We apply our main result to characterize market data sets consistent with equilibrium behaviour of pure-exchange economies with smooth nontransitive consumers.

Semantic Segmentation with Same Topic Constraints

A popular approach to semantic segmentation problems is to construct a pair wise Conditional Markov Random Field (CRF) over image pixels where the pair wise term encodes a preference for smoothness within pixel neighborhoods. Recently, researchers have considered higher-order models that encode local region or soft non-local constraints (e.g., label consistency or co-occurrence statistics). These new models with higher-order terms have significantly pushed the state-of-the-art for semantic segmentation problems. In this study, we consider a novel non- local constraint that enforces consistent pixel labels among those image regions having the same topic. These topics are discovered by Probabilistic Latent Semantic Analysis model (PLSA). We encode this constraint as a robust Pn higher-order potential among all the image regions of the same topic in a unified CRF model. We experimentally demonstrate quantitative and qualitative improvements over a refined baseline unary and pair wise CRF models.

Trading equilibrium in a public good economy with smooth preferences and a mixed measure space of consumers

Lindahl and Nash equilibria are often used in the theory of public good. Shitovitz and Spiegel (1998) present an example of 2-person economy with one private good and one pure public good, where the core efficient Lindahl allocation does not Pareto dominate the (inefficient) Nash allocation. In this paper we introduce the new concept of Trading equilibrium for a general public good economy with smooth preferences and a mixed measure space of consumers. We obtain that this economy admits a unique Trading equilibrium. Moreover, the Trading equilibrium induces a core allocation that strictly Pareto dominates the Nash allocation.

High Order Smooth Ambiguity Preferences and Asset Prices

This paper extends the recursive smooth ambiguity decision model developed in Klibanoff, Marinacci, and Mukerji (2005, 2009) by relaxing the uniformity imposed on higher order acts. This generalization permits a separation of intertemporal substitution, risk aversion, and ambiguity aversion towards different sources of uncertainty. Our decision model is suited in situations where subjects may treat several kinds of uncertainty in different manners. We apply our preference specification to a consumption-based asset pricing model with long-run risks and assess the impact of ambiguity on asset prices and predictability patterns. We find that modeling attitudes towards uncertainty through high order smooth ambiguity preferences has important implications for asset prices. Our model significantly improves upon the special cases of Epstein and Zin (1989) utility and standard smooth ambiguity preferences.

High Order Smooth Ambiguity Preferences and Asset Prices

High Order Smooth Ambiguity Preferences and Asset Prices

Geological variation in particle surface-roughness preference in the case-bearing caddisflies

Optimality modeling suggests that the choice of resources often represents the best achievable balance of costs and benefits. However, there is no empirical data describing the effect of resource availability on the development of the material choice behavior during construction of a biological structure. Cylindrical case-bearing caddisfly larvae prefer smooth-surface particles to allow construction of a smooth interior case wall. We evaluated the relationship between case material preference and the local availability of sand particle species in 7 distant populations of 2 odontocerid species, Psilotreta kisoensis and Perissoneura paradoxa. The field survey revealed that all populations selectively used the smooth particles from the surrounding sediment to construct their cases. However, when comparing among populations, the larvae originating from areas with relatively few smooth particles constructed cases using rougher particles. We then forced the larvae to choose from a mixture of equal amounts of 2 artificial particles that had different textures (rough and smooth). The preference for smooth artificial particles was lower in populations that naturally incorporated rougher particles in their cases. Our results are consistent with the predictions of optimal foraging theory as the populations living in areas with abundant smooth particles had a stronger preference for smoothness than those in areas where such particles were rare. The abundance of smooth particles in the sediment depended on its mineralogical/ petrological origin. Thus, we suggest that material preference is influenced by local geology. Our results provide important insight into the mechanisms controlling construction behavior. Key words: construction behavior, decision making, optimality theory, sediment geology, surface roughness, Trichoptera. [Behav Ecol]

Taxation, investment and asset pricing

This paper studies the impact of dividend and corporate income taxes on investment and asset returns in a stochastic general equilibrium model. Under the “new” view of dividend taxation (e.g. Poterba and Summers, 1985), proportional dividend taxes do not distort investment decisions, and thus have no impact on asset returns. By contrast, we find that corporate income taxes introduce additional tax-related risk factors into the economy by distorting investment decisions. We uncover a mechanism through which corporate taxes amplify the responses of consumption and investment to technology shocks, and consequently lead to a lower risk-free interest rate and a higher equity premium. This amplification mechanism is the strongest when there exists a strong preference for consumption smoothing and high costs of adjusting the capital stock.

Spatial Models, Cognitive Metrics, and Majority Rule Equilibria

Long-standing results demonstrate that, if policy choices are defined in spaces with more than one dimension, majority-rule equilibrium fails to exist for a general class of smooth preference profiles. This article shows that if agents perceive political similarity and difference in ‘city block’ terms, then the dimension-by-dimension median can be a majority-rule equilibrium even in spaces with an arbitrarily large number of dimensions and it provides necessary and sufficient conditions for the existence of such an equilibrium. This is important because city block preferences accord more closely with empirical research on human perception than do many smooth preferences. It implies that, if empirical research findings on human perceptions of similarity and difference extend also to perceptions ofpoliticalsimilarity and difference, then the possibility of equilibrium under majority rule re-emerges.

Topological Complexity of Manifolds of Preferences

The problem of endowing preferences with manifold structures emerged from discussions with Gerard Debreu in 1975 . Time has shown that such structures can be useful in understanding the behavior of economic systems . In Chichilnisky (1976) spaces of smooth preferences were endowed with a Hilbert manifold structure, and this was used to study the existence and structural stability of competitive equilibria in economies where preferences might be non-monotonic and non-convex . This paper constructs manifolds of preferences and applies this construction to the aggregation of preferences . We examine the topological complexity of manifolds of smooth preferences and use this to determine when appropriate aggregation rules exist and when they do not .

Social Aggregation Rules and Continuity

lt is shown that any continuous social aggregation rule for smooth preferences cannot simultaneously satisfy the properties of anonymity and respect of unanimity. This is true even when all individual preferences are linear. The relationship between the conditions on the social rule studied here and those of Arrow's paradox is discussed. The first result requires that the normalized gradient of the social choice rule be definable in the interior of the choice space, thus indicating a direction of increase of social preference. A second impossibility result extends the first to cases where the gradient of the social preference may vanish in the interior of the choice space.

Saving and Investing Over the Life Cycle and the Role of Collective Pension Funds

This paper surveys the academic literature on optimal saving and investment over an individual’s life cycle. We start out with a simple benchmark model with separable and smooth preferences, one aggregate risk factor and riskless wage income. Within this simple setting, optimal saving and investment behavior are explored from the perspective of individuals. Subsequently, we investigate various constraints to optimal individual decision making. We discuss how collective pension schemes may help to relieve some of the market incompleteness that arises from these constraints while at the same time introducing new types of constraints. Finally, various extensions to the benchmark setting are analyzed: a more elaborate modelling of human capital, additional risk factors, and other types of preferences.

The Fed's Preference for Policy Rate Smoothing: Overestimation Due to Misspecification?

The federal funds rate is featured by frequent, small changes in the same direction and infrequent reversals. How to replicate the observed smooth behavior of the federal funds rate with a small scale macroeconomic model? This paper compares the descriptive performance of an empirical fully backward looking model with that of an empirical new-Keynesian hybrid framework. It turns out that the Feds monetary policy conduct can be very well described with a framework allowing for the presence of a small but positive fraction of forward looking agents in the IS curve. This element remarkably reduces the large interest rate smoothing weight otherwise needed to track the observed macroeconomic series.

Estimating Central Banks’ preferences from a time-varying empirical reaction function

We estimate monetary policy reaction functions for the United States, the United Kingdom, and Germany, using a Markov-switching model that allows for shifts in the coefficients of the central bank's reaction function as well as for independent shifts in the residual variance. The results indicate that central bank policy can be characterized as falling into a low- and a high-inflation regime. Over time all central banks have assigned changing weights to inflation and the output gap. Switching in the residual variance turns out to be important for the fit of the model. As a reaction function is a reduced form, coefficients embody preference parameters as well as parameters characterizing the structure of the economy. To recover the central banks’ preferences, we estimate the preference parameters jointly with a small model of the economy. The results show that the Bundesbank has placed a relatively higher weight on inflation than the Fed. Moreover, for the Bundesbank and the Fed the differences between both regimes seem to originate mainly from a changing preference for interest rate smoothing.

The dynamics of government

We model income redistribution with dynamic distortions as determined by rational voting without commitment among individuals of different types and income realizations. We find that redistribution is too persistent relative to that chosen by a planner with commitment. The difference is larger, the lower is the political influence of young agents, the lower is the altruistic concern for future generations, and the lower is risk-aversion. Furthermore, there tends to be too much redistribution in the political equilibrium. Finally, smooth preference aggregation, as under probabilistic voting, produces less persistence and does not admit multiple equilibria, which occur under majority-voting aggregation.

New‐Keynesian Models and Monetary Policy: A Re‐examination of the Stylized Facts*

AbstractUsing an empirical New‐Keynesian model with optimal discretionary monetary policy, we estimate key parameters—the central bank's preference parameters; the degree of forward‐looking behavior in the determination of inflation and output; and the variances of inflation and output shocks—to match some broad characteristics of U.S. data. The parameterization we obtain implies a small concern for output stability but a large preference for interest rate smoothing, and a small degree of forward‐looking behavior in price‐setting but a large degree of forward‐looking in the determination of output. Our methodology also allows us to carefully examine the consequences of alternative parameterizations and to provide intuition for our results.