Time consistency

Abstract: We design experiments to jointly elicit risk and time preferences for the adult Danish population. Since subjects are generally risk averse, we find that joint elicitation provides estimates of discount rates that are significantly lower than those found in previous studies and more in line with what would be considered as a priori reasonable rates. The statistical specification relies on a theoretical framework that involves a latent trade-off between long-run optimization and short-run temptation. Estimation of this specification is undertaken using structural, maximum likelihood methods. Our main results based on exponential discounting are robust to alternative specifications such as hyperbolic discounting. These results have direct implications for attempts to elicit time preferences, as well as debates over the appropriate domain of the utility function when characterizing risk aversion and time consistency.

Abstract: In a financially integrated global market, the conditionally expected return on a portfolio of securities from a particular country is determined by the country's world risk exposure. This paper measures the conditional risk of 17 countries. The reward per unit of risk is the world price of covariance risk. Although the tests provide evidence on the conditional mean variance efficiency of the benchmark portfolio, the results show that countries' risk exposures help explain differences in performance. Evidence is also presented which indicates that these risk exposures change through time and that the world price of covariance risk is not constant. IN A WORLD WITH increasingly integrated financial services, why do industrialized countries have much different average stock returns? Why have Japanese stocks done so well compared to all other countries through 1989 and so poorly recently? If we view countries as stock portfolios in a global market, asset pricing theory suggests that cross-sectional differences in countries' risk exposures should explain the cross-sectional variation in expected returns. This paper tests whether conditional versions of the Sharpe (1964) and Lintner (1965) asset pricing model are consistent with behavior of returns in 17 countries. Country risk is defined as the conditional sensitivity (or covariance) of the country return to a world stock return. This risk is allowed to vary through time. The reward per unit of sensitivity is the world price of covariance risk. Conditional covariances are calculated for each country. The differences in the countries' conditional covariances should explain the differences in national performance if there is only one source of risk. The empirical results indicate that the time-varying covariances are able to capture some, but not all, of the dynamic behavior of the country returns. This could be due to incomplete market integration, the existence of more than one source of risk, or some other misspecification. The world price of covariance risk is also calculated. This measure exhibits significant time

Abstract: We use Koszegi and Rabin's (2006) model of reference-dependent utility, and an extension of it that applies to decisions with delayed consequences, to study preferences over monetary risk. Because our theory equates the reference point with recent probabilistic beliefs about outcomes, it predicts specific ways in which the environment influences attitudes toward modest-scale risk. It replicates "classical" prospect theory-including the prediction of distaste for insuring losses-when exposure to risk is a surprise, but implies first-order risk aversion when a risk, and the possibility of insuring it, are anticipated. A prior expectation to take on risk decreases aversion to both the anticipated and additional risk. For large-scale risk, the model allows for standard "consumption utility" to dominate reference-dependent "gain-loss utility," generating nearly identical risk aversion across situations.