Robin Pope

Experimental Evidence for Attractions to Chance

Abstract Divide the decision-makers future into: (i) a pre-outcome period (lasting from the decision until the outcome of that decision is known), and (ii) a sequel postoutcome period (beginning when the outcome becomes known). Anticipated emotions in both periods may influence the decision, in particular, with regard to an outcome that matters to the person, the enjoyable tension from not yet knowing what this outcome will be. In the experiments presented, lottery choice can be explained by this attraction to chance, and cannot be explained by either convex von Neumann-Morgenstern utility, or by rank-dependent risk-loving weights: attraction to chance is a separate motivator.

The Riskless Utility Mapping of Expected Utility and All Theories Imposing the Dominance Principle: Its Inability to Include Loans, Commitments Even with Fully Described Decision Trees

Let EU denote the set of axiomatised versions of the expected utility (and game) theory. Let EU+ denote the set of non-EU theories imposing the dominance principle, namely a preference for first order stochastically dominant distributions of outcomes. Let NM utility denote the mapping from outcomes into utilities employed in EU and EU+. Von Neumann and Morgenstern, declared that NM utility has the unappealing and unrealistic feature that it excludes secondary satisfactions (risk attitude) but reported that they had encountered a contradiction in going beyond EU and including them and so left this task to future researchers (1947, pp626-32). But by the early 1950s some dissented and claimed that NM utility is already general enough, or generalisable, to include secondary satisfactions. The paper finds that no matter whether risk attitude involves emotional or financial instances of secondary satisfactions, and no matter how fully the decision situation and associated decision trees are specified with regard to commitment, NM utility excludes secondary satisfactions. The paper thus confirms the von Neumann-Morgenstern interpretation of NM utility as excluding secondary satisfactions and as normatively unappealing. The paper shows how a stages by a degree-of-knowledge-ahead framework overcomes the contradiction that prevented von Neumann and Morgenstern from including secondary satisfactions. It shows how to build models that avoid the implausible dominance principle and consistently incorporate those secondary satisfactions that do and should enter serious personal and corporate decisions.

Local Manufacturing Hurt by Depreciations in a Theoretical Model Reflecting the Australian Experience

The model is motivated by data showing that the Australian production of local manufactures is hurt by depreciations and invigorated by appreciations. The paper briefly presents such evidence and then proceeds to a theoretical analysis. The model aims at capturing short-to-medium run exchange rate effects in an economy with goods and services aggregated into four commodities: Rural goods (agricultural, pastoral, forestry, fishing and mining products), imports, local manufactures and services. The latter three are directly consumed. Rural goods enter consumption only indirectly after processing by the manufacturing sector. Exports are exclusively rural goods. The model has a Keynesian flavour. Production of local manufactures and services is not constrained by the availability of resources and of labour. Variable inputs per unit of output are assumed to be constant. There are also fixed inputs. Variable inputs are imports in the case of the import sector, rural goods and imports in the case of the local manufacturing sector, and labour in the case of the services sector. The prices of imports, local manufactures and services are set by constant mark-up factors on variable costs. This assumption is based on a picture of imperfect competition with constant elasticity of demand at the firm level. The total production of rural goods is an exogenous parameter. The price of rural goods is determined in the export market. It falls with increasing exports. The economy is not assumed to be small in its export market. The domestic consumption demand schedule is modelled as predetermined in the sense that in the time span under consideration the relationship between quantities consumed and nominal prices is not affected by the exchange rate. The nominal wage rate is assumed to be pre-determined in the same sense. No specific functional form is imposed on the consumption demand schedule: the analysis is based on general assumptions, mainly non-inferiority and gross substitutability. In view of gross substitutability, there is a competitive relationship between imports and local manufactures. A depreciation raises the price of imports and ceteris paribus such an increase raises the consumption of manufactures. However the analysis shows that this enhancing influence of a depreciation on manufacturing is weaker than other causal channels which work in the opposite direction. An increase in the price of imports raises variable costs and thereby the price of local manufactures. This leads to a decrease in the output of local manufactures. In the course of the analysis, it is first shown that a uniquely determined equilibrium exists for every exchange rate above a lower bound. Then the effects of a change in the exchange rate are investigated. In most cases the results are unambiguous. In particular this is true for the output and the price of local manufactures. Other conclusions are that a depreciation increases exports and the amount of services provided. In some cases unequivocal results can be obtained only with the help of further assumptions. This concerns the domestic price of rural goods, the balance of trade in domestic prices and import penetration.

Expected utility versus the changes in knowledge ahead

We present a decision theory appropriate for use in serious choices such as insurance. It extends standard decision theories like expected utility or cumulative prospect theory which are atemporal single stage theories. Instead it employs stages of knowledge ahead to track satisfactions and dissatisfactions. In the first stage of the risk, the uninsured face dissatisfactions of worries and planning difficulties (avoided by the insured), also perhaps positive satisfactions of thrills (missed out by the insured). In the second stage when the risk is past, the uninsured may face the dissatisfactions of ridicule and blame if they learn that they were unlucky. From experimental and questionnaire data, 80% of our subjects are influenced by such secondary satisfactions. Only five percent of our participants employ the usage of integrated quantitative aggregation rules for evaluating acts as assumed under expected utility theory.

Risk in a simple temporal framework for expected utility theory and for SKAT, the Stages of Knowledge Ahead Theory

The paper re-expresses arguments against the normative validity of expected utility theory in Robin Pope (1983, 1991a, 1991b, 1985, 1995, 2000, 2001, 2005, 2006, 2007). These concern the neglect of the evolving stages of knowledge ahead (stages of what the future will bring). Such evolution is fundamental to an experience of risk, yet not consistently incorporated even in axiomatised temporal versions of expected utility. Its neglect entails a disregard of emotional and financial effects on well-being before a particular risk is resolved. These are arguments are complemented with an analysis of the essential uniqueness property in the context of temporal and atemporal expected utility theory and a proof of the absence of a limit property natural in an axiomatised approach to temporal expected utility theory. Problems of the time structure of risk are investigated in a simple temporal framework restricted to a subclass of temporal lotteries in the sense of David Kreps and Evan Porteus (1978). This subclass is narrow but wide enough to discuss basic issues. It will be shown that there are serious objections against the modification of expected utility theory axiomatised by Kreps and Porteus (1978, 1979). By contrast the umbrella theory proffered by Pope that she has now termed SKAT, the Stages of Knowledge Ahead Theory, offers an epistemically consistent framework within which to construct particular models to deal with particular decision situations. A model by Caplin and Leahy (2001) will also be discussed and contrasted with the modelling within SKAT (Pope, Leopold and Leitner 2006).

Beggar‐Thy‐Neighbour Exchange Rate Regime Misadvice from Misapplications of Mundell (1961) and the Remedy

Economists invoke Mundell (1961) in arguing for the general policy of  a flexible exchange rate regime as a means of restoring equilibria  after shocks. But there is a discrepancy between the intent of the  general policy and attempts at its implementation as identified by  specific changes in exchange rates.  When we assemble the set of  specific changes called for by distinct economists operating as  advocates for individual countries, these are uniformly in the form  of beggar-thy-neighbour advice – ie travesties of objectively  identifying disequilibria and a menace to international cooperation  and peace.  This paper traces the unintended travesties to problems  of complexity and uncertainty, problems that implicitly are assumed  absent in Mundell (1961) rendering the situation so simple that  equilibria are transparent.  The problems remained essentially  unaddressed when economists extended Mundell (1961) via expected  utility theory since this theory also ignores the impossibility of  maximising and the complexities of central bankers, private firms and  others in doing the evaluation stage in reaching decisions.  The  problems can be overcome by modelling within SKAT, the Stages of  Knowledge Ahead Theory.  This paper points to experimental evidence  in support of the view that under all sorts of disequilibrating  shocks, currency unions outperform flexible currencies by eliminating  the inefficiencies generated by exchange rate uncertainty.

Managed Floats to Damp World-Wide Exchange Rate Liquidity Shocks Like 1982-5, 2006-9: Field and Laboratory Evidence for the Benefits of a Single World Currency

This papers field evidence is: (1) in reality a major exchange rate change devastates an economy, i.e. the widespread academic faith that exchange rate changes are either beneficial or harmless is a false faith that contributes to needless world-wide economic havoc; (2) the 1982-85 exchange rate liquidity crisis sent much of the third world into unmanageable debt levels and was so devastating for the first world that in 1985 the G5 instituted managed cooperating floats; (3) nearly all economists in the official sector and in academe rapidly forgot the devastation and reverted to advocating what caused that devastation, namely a closed economy clean floats exchange rate perspective; and (4) the 2006-2008/9 exchange rate liquidity shock would have been far more drastic but for central bank currency swaps yet the role of these swaps in averting unmanageable exchange rate mayhem that would have precluded the September 2008 rescue of the world financial system, has been ignored. The field evidence thus decisively favours stabilizing managed floats, or better a single world currency, and a means of preventing economists in official sectors and in academe forgetting the devastation and dangers of multiple currencies. This field evidence is bolstered by a laboratory experiment. The experiment incorporates more aspects of real world complexity and more different sorts of official and private sector agents than other investigations and employs a new central bank cooperation-conflict model of exchange rate determination. The experiment allows an interpretation within an umbrella theory of Pope, namely SKAT, the Stages of Knowledge Ahead Theory.

Beggar-Thy-Neighbour Exchange Rate Regime Misadvice from Misapplications of ) and the RemedyMundell (1961

Economists invoke Mundell (1961) in arguing for the general policy of  a flexible exchange rate regime as a means of restoring equilibria  after shocks. But there is a discrepancy between the intent of the  general policy and attempts at its implementation as identified by  specific changes in exchange rates.  When we assemble the set of  specific changes called for by distinct economists operating as  advocates for individual countries, these are uniformly in the form  of beggar-thy-neighbour advice – ie travesties of objectively  identifying disequilibria and a menace to international cooperation  and peace.  This paper traces the unintended travesties to problems  of complexity and uncertainty, problems that implicitly are assumed  absent in Mundell (1961) rendering the situation so simple that  equilibria are transparent.  The problems remained essentially  unaddressed when economists extended Mundell (1961) via expected  utility theory since this theory also ignores the impossibility of  maximising and the complexities of central bankers, private firms and  others in doing the evaluation stage in reaching decisions.  The  problems can be overcome by modelling within SKAT, the Stages of  Knowledge Ahead Theory.  This paper points to experimental evidence  in support of the view that under all sorts of disequilibrating  shocks, currency unions outperform flexible currencies by eliminating  the inefficiencies generated by exchange rate uncertainty.