This article examines whether rank-dependent theories and the theory of fanning-out indifference curves explain the Allais common consequence effect. A choice pattern consistent with all these theories is the zero effect (aversion to zero outcomes). This pattern entirely accounts for the incremental explanatory power over expected utility of all the theories we test.

We study the design of public information structures that maximize the probability of selecting a Pareto dominant equilibrium in symmetric (2 × 2) coordination games. Because the need to coordi-nate exposes players to strategic risk, we treat the designer as able to implement an equilibrium only if the players believe it is also risk dominant. The designer’s task is therefore to pool the set of states in which the desired equilibrium is risk dominant with the largest possible set in which it is not, while keeping the desired equilibrium risk dominant in expectation. We provide a simple characterization of the optimal signal structure which holds under general conditions. We extend the analysis to related problems, and show that our intu-ition is robust, suggesting that our approach provides a promising way forward for a large class of problems in constrained information design.

We provide a theory of decision under ambiguity that does not require expected utility maximization under risk. Instead, we require only that a decision maker be probabilistically sophisticated in evaluating a subcollection of acts. Three components determine the decision maker's ranking of acts: a prior, a map from ambiguous acts to equivalent risky lotteries, and a generalized notion of certainty equivalent. The prior is Bayesian, defined over the inverse image of acts for which the decision maker is probabilistically sophisticated. Ambiguity preferences are similar to Hurwicz, depending on an act's best- and worst-case interpretations. The generalized certainty equivalent may, but need not, come from a Bernoulli utility. The ability to combine appealing theories of risk and ambiguity at will has been sought after but missing from the literature, and our decomposition provides a promising way forward.

We study decision under uncertainty in an Anscombe–Aumann framework. Two binary relations characterize a decision-maker: one (in general) incomplete relation, reflecting her objective rationality, and a second complete relation, reflecting her subjective rationality. We require the latter to be an extension of the former. Our key axiom is a dominance condition. Our main theorem provides a representation of the two relations. The objectively rational relation has a Bewley-style multiple prior representation. Using this set of priors, we fully characterize the subjectively rational relation in terms of the most optimistic and most pessimistic expected utilities.

We study the design of public information structures that maximize the probability of selecting a Pareto dominant equilibrium in symmetric (2 x 2) coordination games. Because the need to coordinate exposes players to strategic risk, we treat the designer as able to implement an equilibrium only if the players believe it is also risk dominant. The designer's task is therefore to pool the set of states in which the desired equilibrium is risk dominant with the largest possible set in which it is not, while keeping the desired equilibrium risk dominant in expectation. We provide a simple characterization of the optimal signal structure which holds under general conditions. We extend the analysis to related problems, and show that our intuition is robust, suggesting that our approach provides a promising way forward for a large class of problems in constrained information design.

We provide a novel but intuitive explanation for expected utility violations found in the Allais paradox: individuals are commonly averse to receiving nothing. We call this phenomenon the zero effect. Our laboratory experiments show support for the zero effect. By contrast, the evidence for the certainty effect is weak to nonexistent.

A unique feature of the outside director market is that a director usually simultaneously works for several companies. In this paper, based on the linear-exponential-neutral (LEN) framework, I find that the relationship between optimal incentives (pay-performance sensitivity) and the number of directorships is always positive, no matter efforts across directorships are substitutive or complementary.

We provide a theory of decision under ambiguity in which the worst-case and best-case expected utility representations are sufficient statistics for a decision maker’s preferences; we refer to the new utility functions as meta-utilities. Our approach, which generalizes many of the commonly used models, provides an ordinal value of these worst- and best-case expected utilities, mirroring the familiar ordinal utility functions over commodity baskets. Ambiguity attitude is simply the marginal rate of substitution in the meta-utility between worst-and best-case expected utilities.

We study a disclosure decision for a firm's manager with many sources of private information. The presence of multiple numerical signals provides the manager with an opportunity to hide information via aggregation, presenting net amounts in order to show information in its best light. We show that this ability to aggregate fundamentally changes the nature of voluntary disclosure, due to the market's inability to verify that a report is free of strategic aggregation. We find that, in equilibrium, the manager fully discloses if and only if the manager's private information makes the firm look sufficiently weak. By separating bad news from good news, a disaggregate report informs the market of as much offsetting news as possible, revealing how close the news is to a neutral benchmark. The result is, therefore, pooling at the top and separation at the bottom, the opposite of what transpires with a single news source.

This paper studies whether and to what extent transparent disclosure prevents inefficient liquidation arising from rollover risk. We model an illiquid but solvent borrower who can design a public signal about what creditors can recover from forcing liquidation, and what their claims would be worth if the firm survives. We find that the signal structure that minimizes rollover risk never identifies liquidation or continuation values, and that borrowers can commit to this structure. Moreover, if creditors can impose disclosure requirements, they may increase inefficient liquidation, in order to pool states to increase the amount they expect to recover from defaults.

We study the market consequences of reporting with imprecise accounting standards, such as those in model-based nancial reports. In a laboratory experiment, our participants take advantage of imprecision in standards to report aggressively. Two e ects of aggressive reporting are illiquid asset markets and low asset prices, compared with those arising in a regime in which aggressive reporting is prevented and conservative reporting is imposed. Illiquidity occurs because aggressive reports do not provide rms with a credible way to disclose good news about a worst-case scenario, creating a market friction. On the other hand, lower prices occur because aggressive reports convey news about a best-case scenario, protecting investors against paying information rents. We relate our results to empirical studies and to other experiments on reporting with imprecise standards.

This article shows that an apparent puzzle in finance and accounting is resolved by changing from classical to constructive (more specifically, intuitionistic) mathematics. Our position is that it is unproblematic if real-world actors behave inconsistently with nonconstructive mathematical results. Thus the solution to our puzzle lies in a deeper challenge to the standard view of how rational agents reason. The alternative we propose gives refutable predictions that find support in the empirical capital markets literature. Our main tool, intuitionistic mathematics, plays a similar role in the mathematical philosophy literature to that of ambiguity in decision theoretic work.

In this paper, we describe a bankruptcy game played in a pure-exchange, perfectly competitive economy, and establish the existence of competitive equilibria. The game admits of lying by borrowers and costly auditing by lenders. The equilibria are characterized by (endogenously determined) equilibrium probabilities of default, loan quantities, interest rates, and default risk premia, and by equilibria simultaneously determined in risk-free debt markets. We find that the optimal debt contract is the standard debt contract, and that the risk-free debt market may be inactive, as all parties may strictly prefer risky debt contracts to risk-free debt. ∗Many thanks to workshop participants at Carnegie Mellon University and at NHH, and to conference participants at the Western Economic Association International 2009 Pacific Rim Meeting and the European Accounting Association 2009 Annual Meeting. We are especially grateful to Goksel Asan, Nick Baigent, John Dickhaut, Frank Gigler, Jonathan Glover, Chandra Kanodia, Carolyn Levine, Kjell Nyborg, Per Östberg, Ricardo Reis, Remzi Sanver, and Shin Sato. †Carlson School of Management, University of Minnesota. jkareken@umn.edu ‡Tepper School of Business, Carnegie Mellon University jstecher@cmu.edu

I study the design and welfare implications of basket securities issued in markets with limited investor participation. Profit-maximizing intermediaries exploit investors’ inability to trade freely across different markets and choose which market to specialize in. I show that when there is only one intermediary, the equilibrium may not be constrained efficient. Increasing competition among intermediaries increases the variety of baskets issued, but does not always improve investors’ welfare. Although competition increases the variety of baskets issued, many of these baskets are redundant, in the sense that coordination among intermediaries could improve investors’ risk sharing opportunities. The equilibrium basket structure depends on institutional features of a market such as depth and gains from trade.

This article argues that fair-market value accounting could have played a significant role in the recent financial crisis, by causing a drop in demand for the structured finance products that were central to the market collapse. The culprit is the discretion inherent in the use of "mark-to-model" reports, in which firms report fair values that they calculate internally, rather than actual market prices. In equilibrium, discretion in mark-to-model reports leads to aggressive reporting of asset values, compared with a conservative reporting regime. Aggressive reporting weakens demand and increases financial market frictions, resulting in illiquidity. We demonstrate these effects in a laboratory experiment with a matched pairs design, and find that adopting a mark-to-model regime causes drops in prices and reduces the frequency of trade.

This paper studies an economy where agents trade using a shared language, so that they do not need to meet in person with goods physically present. Agents provide vague descriptions of proposed net trades, which we interpret as arising either from inherent limitations in what the agents can describe or from strategic presentations of information. We construct a family of orders over terms in the language, arising from an individual's preferences over consumption as subjectively perceived, illustrate the induced order's properties, and show the constructive existence of competitive equilibrium. Finally, we illustrate the relationship between the existence of a competitive equilibrium obtained in the language and the one that would result from an interaction involving perceived consumption sets.