A Note on Wealth Effect under CARA Utility

Makarov, Dmitry; Schornick, Astrid V.

doi:10.2139/ssrn.1350225

Cited by 7 publications

(5 citation statements)

References 20 publications

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“…Makarov and Schornick (2010) follow this approach. This extension makes it possible to ask whether different disclosure regulations might have different impact on investors of different wealth levels.…”

Section: Welfare With Heterogeneous Investors and Wealth Effectsmentioning

confidence: 99%

Should we regulate financial information?

Kurlat¹,

Veldkamp²

2015

Journal of Economic Theory

100

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Regulations that require asset issuers to disclose payoff-relevant information to potential buyers sound like obvious measures to increase investor welfare. But in many cases, such regulations harm investors. In an equilibrium model, asset returns compensate investors for risk. By making payoffs less uncertain, disclosure reduces risk and therefore reduces return. As high-risk, high-return investments disappear, investor welfare falls. Of course, information is still valuable to each individual investor. But acquiring information is like a prisoners' dilemma. Each investor is better off with the information, but collectively investors are better off if they remain uninformed. The two cases in which providing information improves investors' welfare are 1) where there would otherwise be severe asymmetric information, and 2) where the information induces firms to take on riskier investments. Using a model of information markets, the paper explores when such outcomes are likely to arise. When financial markets with information allocate the real capital stock more efficiently, disclosure improves efficiency, but more efficient firms do not offer investors higher returns. Investors only benefit when disclosure induces firms to take on riskier investments. Since the efficiency gains are fully captured by asset issuers, who can choose to disclose without disclosure being mandatory, the efficiency argument is not a logical rationale for regulation.

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Section: Welfare With Heterogeneous Investors and Wealth Effectsmentioning

confidence: 99%

Should we regulate financial information?

Kurlat¹,

Veldkamp²

2015

Journal of Economic Theory

100

View full text Add to dashboard Cite

show abstract

“…We first consider a market where all the participants have exponential utility functions. It is known that the exponential utility has a constant risk aversion coefficient which leads to trading decisions independent of trader's wealth level (Makarov and Schornick, 2010). This feature eliminates the wealth effect in the trading process and allows us to clearly illustrate the impacts of traders' beliefs and risk preferences upon the limiting prices.…”

Section: Limiting Price For Exponential Utility-based Mu Functionmentioning

confidence: 99%

Price Interpretability of Prediction Markets: A Convergence Analysis

Yu¹,

Gao²,

Wu³

et al. 2022

Preprint

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Prediction markets are long known for prediction accuracy. However, there is still a lack of systematic understanding of how prediction markets aggregate information and why they work so well. This work proposes a multivariate utility (MU)-based mechanism that unifies several existing prediction market-making schemes. Based on this mechanism, we derive convergence results for markets with myopic, risk-averse traders who repeatedly interact with the market maker. We show that the resulting limiting wealth distribution lies on the Pareto efficient frontier defined by all market participants' utilities. With the help of this result, we establish both analytical and numerical results for the limiting price for different market models. We show that the limiting price converges to the geometric mean of agents' beliefs for exponential utility-based markets. For risk measure-based markets, we construct a risk measure family that meets the convergence requirements and show that the limiting price can converge to a weighted power mean of agent beliefs. For markets based on hyperbolic absolute risk aversion (HARA) utilities, we show that the limiting price is also a risk-adjusted weighted power mean of agent beliefs, even though the trading order will affect the aggregation weights. We further propose an approximation scheme for the limiting price under the HARA utility family. We show through numerical experiments that our approximation scheme works well in predicting the convergent prices.

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“…However, this assumption has been challenged by a number of empirical works (see, for example, Vissing‐Jorgensen ). To reconcile our theoretical model with this empirical evidence, we adopt the approach suggested by Makarov and Schornick (), which consists in directly making the absolute risk aversion parameter wealth‐dependent and maintaining the CARA utility function, which allows to keep the problem analytically tractable.…”

Section: Decreasing Risk Aversion and Endogenous Financial Literacymentioning

confidence: 99%

Optimal Decisions on Pension Plans in the Presence of Information Costs and Financial Literacy

Corsini

Spataro

2015

J Public Economic Theory

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Pension reforms are on the political agenda of many countries. Such reforms imply an increasing responsibility on individuals’ side in building an efficient portfolio for retirement. In this paper, we provide a model describing workers’ choices on the allocation of retirement savings in presence of (1) mandatory pension contribution; (2) different pension plans; and (3) information costs and financial literacy investment decisions. In particular, we characterize the results from both a positive and normative standpoint, by highlighting the determinants of individuals’ choice, with special focus on information costs, on the role of income and preferences, and by characterizing the optimal contribution rate to mandatory complementary pension plans. We also introduce endogenous financial literacy and analyze how its optimal level is determined and how it affects the decisions on pension plans

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A Note on Wealth Effect under CARA Utility

Cited by 7 publications

References 20 publications

Should we regulate financial information?

Should we regulate financial information?

Price Interpretability of Prediction Markets: A Convergence Analysis

Optimal Decisions on Pension Plans in the Presence of Information Costs and Financial Literacy

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