...Journal of Health Economics journal homepage: www.elsevier.com/locate/econbase Moral hazard in insurance, value-based cost sharing, and the benefits of blissful ignorance Mark V. Pauly ∗ , Fredric E. Blavin Health Care Systems Department, The Wharton School, University of Pennsylvania, 3641 Locust Walk, Philadelphia, PA 19104-6218, United States a r t i c l e i n f o a b s t r a c t The conventional theory of optimal coinsurance rates for health insurance with moral hazard indicates that coinsurance should vary with the price responsiveness or price-elasticity of demand for different medical services. An alternative theory called “value-based cost sharing” indicates that coinsurance should be lower for services with higher (marginal) benefits relative to costs. This paper reconciles the two views. It shows that, if patient demands are based on correct information, optimal coinsurance is the same under either theory. If patient demands differ from informed demands, optimal coinsurance depends both on information imperfection and price responsiveness. Value-based cost sharing can be superior to providing information (even if the cost of information is minimal) when patient demands fall short of informed demands. An extended numerical example illustrates these points. © 2008 Published by Elsevier B.V. Article history: Received 17 August 2007 Received in revised form 20 June 2008 Accepted 8 July 2008 Available online 18 July 2008 JEL classification: I11 Keywords: Health...
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...list of Frequently Used Symbols and Notation A text such as Intermediate Financial Theory is, by nature, relatively notation intensive. We have adopted a strategy to minimize the notational burden within each individual chapter at the cost of being, at times, inconsistent in our use of symbols across chapters. We list here a set of symbols regularly used with their specific meaning. At times, however, we have found it more practical to use some of the listed symbols to represent a different concept. In other instances, clarity required making the symbolic representation more precise (e.g., by being more specific as to the time dimension of an interest rate). Roman Alphabet a Amount invested in the risky asset; in Chapter 14, fraction of wealth invested in the risky asset or portfolio AT Transpose of the matrix (or vector)A c Consumption; in Chapter 14 only, consumption is represented by C, while c represents ln C ck Consumption of agent k in state of nature θ θ CE Certainty equivalent CA Price of an American call option CE Price of a European call option d Dividend rate or amount ∆ Number of shares in the replicating portfolio (Chapter xx E The expectations operator ek Endowment of agent k in state of nature θ θ f Futures position (Chapter 16); pf Price of a futures contract (Chapter 16) F, G Cumulative distribution functions associated with densities: f, g Probability density functions K The strike or exercise price of an option K(˜) Kurtosis of the random variable x x ˜ L A lottery...
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...Assignment 1-Economics of Risk and Uncertainty Applied Problems BUS640: Managerial Economics John Sellers July 1, 2013 Assignment 1-Economics of Risk and Uncertainty Applied Problems 1a.) Assuming the opportunity interest rate is 6%, what is the present value of the second alternative? using the formula, PV=FVn/(1+r)n for the present value where n represents number of years in the sequence and r represents the rate, which in this case is the opportunity rate of 6%, the present value of the second alternative is $10,070,000. The calculation for this equation is PV($10m) = $5.5m/(1.06) + $5.5m/(1.06)(1.06) = $5.18m + $4.89m = $10,070,000. b.) Which of the two alternatives should be chosen and why? " Cash flows from year 2, 3, 4, 5, and further into the future must be discounted progressively more heavily since even smaller sums held presently would grow to a dollar if allowed to earn interest for more years from the present period out to year 2, 3, 4, or 5 and beyond" (Douglas, 2012). Using the present value method, I would chose the second alternative as it would net an extra $70,000 that could be put to very good use at the University. c.) How would your decision change if the opportunity interest rate was 12%? Since the second alternative would change to $9,290,000 if the opportunity rate was 12% instead of 6%, my decision would indeed change. PV($10m) = $5.5m/(1.12) + $5.5m/(1.12)(1.12) = $4.91m + $4.38m = $9,290,000. 2a.) Apply the coefficient-of-variation...
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...‘ Investment Analysis & Portfolio Management Sharpe’s Single Index Model Practice Sheet -2 | |1. Betas of two stocks are 0.73 and 1.20 respectively. If the standard deviation of the market returns is 15.49%, the covariance between | | | |the two stock’s return is | | | |(a) 175.20(%)2 (b) 210.20(%)2 (c) 288.20(%)2 (d) 328.76(%)2 (e) 345.60(%) | | | | | | | |2. The index model for two stocks A and B is estimated as follows: | | | |RA = 2% + 0.65RM + eA , RB= 4% + 1.10RM + eB | | | |[pic] =25% | | | |(2 A = 0.15 and (2B = 0.30 (in relation to return on the market index) | | | |(The symbols are in standard notation) | | | |The correlation coefficient between the returns on two stocks is ...
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...Risk aversion is a concept in psychology, economics, and finance, based on the behavior of humans (especially consumers and investors) while exposed to uncertainty to attempt to reduce that uncertainty. Risk aversion is the reluctance of a person to accept a bargain with an uncertain payoff rather than another bargain with a more certain, but possibly lower, expected payoff. For example, a risk-averse investor might choose to put his or her money into a bank account with a low but guaranteed interest rate, rather than into a stock that may have high expected returns, but also involves a chance of losing value. ------------------------------------------------- Utility of money[edit source | editbeta] In expected utility theory, an agent has a utility function u(x) where x represents the value that he might receive in money or goods (in the above example x could be 0 or 100). Time does not come into this calculation, so inflation does not appear. (The utility function u(x) is defined only up to positive linear affine transformation - in other words a constant offset could be added to the value of u(x) for all x, and/or u(x) could be multiplied by a positive constant factor, without affecting the conclusions.) An agent possesses risk aversion if and only if the utility function is concave. For instance u(0) could be 0, u(100) might be 10, u(40) might be 5, and for comparison u(50) might be 6. The expected utility of the above bet (with a 50% chance of receiving 100 and a 50%...
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...ll companies, from major multinationals to start-ups, face a common challenge: how to grow their businesses so they can boost earnings and enhance the value of their shares. Far too often, however, firms find it difficult to sustain growth because they become risk averse and, as a result, opt for incremental product and service improvements instead of major initiatives, according to a study by a Wharton marketing professor. George S. Day, who also serves as co-director of Wharton’s Mack Center for Technological Innovation, says companies can avoid lackluster growth by better understanding the risks inherent in different levels of innovation and achieving a balance between — using two terms he has coined — BIG I innovation and small i innovation. In his study, Day discusses how executives can properly assess risks and then seek creative ways to reduce risk exposure. Day, a consultant to many Fortune 500 companies, says his research is the outgrowth of years of thinking about the problems that companies face in trying to set and achieve growth targets. Growth — particularly “organic” growth that comes from improving a company’s performance from within rather than relying on acquisitions — is so important that it is at the top of the agendas of some 80% of U.S. chief executive officers, according to Day. “These executives know that the expectation of superior organic growth is the most important driver of enterprise value in capital markets,” Day writes in the paper, titled...
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...Concept Academic research results What it means for us Disposition Effect Shefrin and Statman (1985) predicted that because people dislike incurring losses much more than they enjoy making gains (risk aversion), and people are willing to gamble in the domain of losses, investors will hold onto stocks that have lost value (relative to the reference point of their purchase) and will be eager to sell stocks that have risen in value. They called this the disposition effect. People will hold losing positions hoping that they can close them later at break-even or better. This is how support and resistance are born! Representa-tiveness Heuristic People tend to make judgments in uncertain situations by looking for familiar patterns and assuming that future patterns will resemble past ones, often without sufficient consideration of the reasons for the pattern or the probability of the pattern repeating itself. This anomaly of human judgment, called the representative-ness heuristic, was demonstrated in a number of experiments by psychologists Tversky and Kahneman. Related concept: Overconfidence - people place too much confidence in their own judgement (e.g. thinking they know the “truth” from observing one pattern 3 times), although it is not validated. • Key reason why people use Technical Analysis, and through self-fulfulling prophecy, it becomes relevant • People get used to current market behavior, and through their actions support its continuation leads to stable market regimes ...
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...Asset Management Contracts and Equilibrium Prices ANDREA M. BUFFA Boston University DIMITRI VAYANOS London School of Economics, CEPR and NBER PAUL WOOLLEY London School of Economics September 13, 2014∗ Abstract We study the joint determination of fund managers’ contracts and equilibrium asset prices. Because of agency frictions, investors make managers’ fees more sensitive to performance and benchmark performance against a market index. This makes managers unwilling to deviate from the index and exacerbates price distortions. Because trading against overvaluation exposes managers to greater risk of deviating from the index than trading against undervaluation, agency frictions bias the aggregate market upwards. They can also generate a negative relationship between risk and return because they raise the volatility of overvalued assets. Socially optimal contracts provide steeper performance incentives and cause larger pricing distortions than privately optimal contracts. buffa@bu.edu, d.vayanos@lse.ac.uk, p.k.woolley@lse.ac.uk. We thank Sergey Chernenko, Chris Darnell, Peter DeMarzo, Ken French, Jeremy Grantham, Zhiguo He, Ron Kaniel, seminar participants at Bocconi, Boston University, CEU, Cheung Kong, Dartmouth, LSE, Maryland, Stanford, and conference participants at AEA, BIS, CRETE, ESSFM Gerzenzee, FRIC, Jackson Hole, and LSE PWC for helpful comments. ∗ 1 Introduction Asset management is a large and growing industry. For example, individual investors...
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...ADVANCED INVESTMENTS Risk & return A1. Agents prefer more over less (nonsatiation). A2. Agents dislike risk (are risk averse). How should investors, given their preferences, invest their money? (normative) What can we say about how the market and (how its participants) actually operates (and invest)? (descriptive) Both revolve around the risk/return relationship and interact: information about how markets work influences investment decisions, which influences the market in its turn. The amount matters (mean and variance) and the relation with other factors (covariance) matters. , x = return distribution (magnitude), p = price, E = expectation (which captures and combines the probability that different outcomes can/will happen) and m = SDF and captures the relation with other factors and the reward required to bear the risk inherent in x (it indicates how much (marginal) utility the outcome has, which captures the role of when we like the payoff more, the conditions matter; it captures the premium needed for this specific risk). The SDF can be derived from the utility function, this gives: . The problem with this is determining marginal utility. In many cases, the SDF is a linear function of a factor (CAPM): That factor f captures when returns in situation A may be more pleasant than the same returns in situation B. Portfolio theory (Risk & return: theory – empirics) Uses assumption A1 and A2, and more: Investors: A3. Agents maximize utility...
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...Answer no 8: ORACLE (ORCL) Over a period of last 2 years the S&P 500 index has gone down by 40% as compared to its level on 26-June-2009. Oracle on the other has increased by approximately 10%. Since beta measures the volatility of a stock as compared to the market our estimated beta for Oracle will be 1.5. If both stock and market move in the same direction with same volatility the beat is 1. In this case we have added the difference (0.40 + 0.10) to 1 and have estimated the number (Beta) at 1.50. Ki = RF + bi (KM - RF ) Where KF (Risk free rate ) = 4.6% (KM – K F) Equity risk premium = 6.4% Bi (Beta) = 1.5 Ki (Required rate of Return) = 4.6% + (1.5 x 6.4) = 4.6% + 9.6% = 14.2% Answer no 9 (a) : McDonalds (MCD): On the basis as described above the beta for MCD is 1.55. So the required rate of return will be as follows: Ki = RF + bi (KM - RF ) Where KF (Risk free rate ) = 4.6% (KM – K F) Equity risk premium = 6.4% Bi (Beta) = 1.55 Ki (Required rate of Return) = 4.6% + (1.55 x 6.4) = 4.6% + 9.92% = 14.52% Answer no 9 (b) : Bank of America: (BAC): On the basis as described above the beta for BAC is 0.50. So the required rate of return will be as follows: ...
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...After having examined the information you provided on the imminent storm and its potential consequences, I have made significant headway in determining what course(s) of action Freemark Abbey Winery can take confidently. However, more important than what the two page summary explains is the information it disregards. The limited scope of information in regards to harvesting options, brand reputation, competitive analysis, managerial risk tolerance, and consumer preferences contribute to a considerable framing bias. Additionally, we have failed to consider the decision of when/how to harvest the Riesling grapes from the perspectives of the various parties involved, including but not limited to other owners, your families, company shareholders, competitors, employees, retailers, and your own. These perspectives are essential in formulating the appropriate problem from which to solve your dilemma. If short-term profit maximization is your goal, with no regard for any of the considerations listed above (a non-exhaustive list), then your best alternative is not to harvest any of your Riesling grapes before the storm. Your Expected Monetary Value for this option is $3.27/bottle; you could expect revenues of $39,240. The highest expected revenue given the “No Harvest” decision is $67,200 ($8.00/bottle), and the lowest is $24,000 ($2.00/bottle). Given Freemark Abbey’s aspirations to compete with Chateau Lafite-Rothschild products, however, it would be short-sighted to ignore the impact...
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...expectations, authors do not refer to any previous work that have utilized such assumption and resulting implications. 2- It would be better had a scatter been introduced instead of Table 1 to make the inverse relationship between RIR and discount factor more visible. Furthermore, authors have neglected the observations of Venezuela which seem as an outlier 3- Moreover, the authors could expand the discussion by incorporating the probable impact of monetary regime followed by respective central banks (e.g. inflation targeting, taylor rule etc) 4- For coefficient of CRRA, the ADF test (Table 2) doesn’t specify whether the constant or trend has been included or not in ADF test application. 5- While the authors argue that the coefficient of Risk Aversion as well as Discount Factor are significant, the P-Values reported in Table 3 for both variables are insignificant at 5%. The authors however argue that since the magnitude is different from zero to a certain degree, the coefficients are significantly different from zero and neglect the pvalue insignificance in their discussion....
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...Can We Measure Portfolio Performance? by Steen Koekebakker and Valeri Zakamouline Introduction The risky assets available to investors are numerous: mutual funds, hedge funds, structured products, equity-linked notes to name a few. The characteristics of each asset class can be summarized in the different return distributions. Even within a single asset class the return distributions of assets are not alike. We assume that the return distributions of all risky assets are known and would like to choose the best asset to invest to, meaning that the risky assets are mutually exclusive investment alternatives. How to do this? The standard approach in financial theory and practice is to employ some portfolio performance measure to rank the various risky investments. Each portfolio performance measure calculates a score for each asset using its probability distribution of returns. The best asset to invest to is the asset with the highest score. The Sharpe ratio is a commonly used measure of portfolio performance. But because it is based on mean-variance theory, this measure can only be used in some restrictive cases, for example, when return distributions are normal. When return distributions are non-normal, the Sharpe ration can lead to misleading conclusions and unsatisfactory paradoxes, see Bernardo and Ledoit (2000) and Hodges (1998). There have been proposed numerous universal performance measures that, in one way or the other, are alternatives to the Sharpe...
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...Ch26-Basic Tools of Finance 1. The future value of a deposit in a savings account will be larger a. the longer a person waits to withdraw the funds. b. the higher the interest rate is. c. the larger the initial deposit is. d. All of the above are correct. 2. Edgar has four savings accounts. Which one has the most in it? a. $100 deposited 1 year ago at an 8% interest rate. b. $100 deposited 2 years ago at a 4% interest rate. c. $100 deposited 4 years ago at a 2% interest rate. d. $100 deposited 8 years ago at a 1% interest rate. 3. Suppose that the price of a bond is equal to the sum of the present value of its future payments. Suppose further that this bond pays $50 in one year and $1,050 in two years. What is the price of the bond if the interest rate is 5 percent? a. $1,050.00 b. $1,045.35 c. $1,000.00 d. $945.35 4. Prospect theory says that a. people should follow their gut feelings and purchase stocks they think have good prospects. b. people will tend to sell off winning investments too quickly and hold onto losing ones too long. c. people tend to be overly pessimistic about developments in the stock market. d. during a speculative bubble most people are thinking that they won’t be able to get out of the market before the bubble bursts. 5. Al, Ralph, and Stan are all intending to retire. Each currently has $1 million in assets. Al will earn 16% interest and retire in two years...
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...Revere Street Working Paper Series Financial Economics 272-18 Mean-Variance Analysis versus Full-Scale Optimization Out of Sample First Version: November 11, 2005 This Draft: December 13, 2005 Timothy Adler Windham Capital Management, LLC 5 Revere Street Cambridge, MA 02138 617 234-9459 tadler@windhamcapital.com Abstract For three decades, mean-variance analysis has served as the standard procedure for constructing portfolios. Recently, investors have experimented with a new optimization procedure, called full-scale optimization, to address certain limitations of mean-variance optimization. Specifically, mean-variance optimization assumes that returns are normally distributed or that investor preferences are well approximated by mean and variance. Full-scale optimization relies on sophisticated search algorithms to identify the optimal portfolio given any set of return distributions and based on any description of investor preferences. Full-scale optimization yields the truly optimal portfolio in sample, whereas the mean-variance solution is an approximation to the insample truth. Both approaches to portfolio formation, however, suffer from estimation error. Mean-variance analysis requires investors to estimate the means and variances of all assets and the covariances of all asset pairs. To the extent the out-of-sample experience of these parameters departs from the in-sample parameter values, the mean-variance approximation will be even less accurate. Full-scale optimization...
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