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description= 15 posts published by Lars Syll during January 2014;
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c of statistical inference and the rest is really just a piece of cake we praise thee 30 jan 2014 at 14 36 posted in varia comments off on we praise thee preferences that make economic models explode 30 jan 2014 at 08 45 posted in economics 4 comments commenting on experiments showing time preferences switching framing effects performed by experimental economist david eil noah smith writes now here s the thing it gets worse i ve heard whispers that a number of researchers have done experiments in which choices can be re framed in order to obtain the dreaded negative time preferences where people actually care more about the future than the present negative time preferences would cause most of our economic models to explode and if these preferences can be created with simple re framing then it bodes ill for the entire project of trying to model individuals choices over time this matters a lot for finance research one of the big questions facing finance researchers is why asset prices bounce around so much the two most common answers are a time varying risk premia and b behavioral sentiment but eil s result and other results like it could be bad news for both efficient market theory and behavioral finance because if aggregate preferences themselves are unstable due to a host of different framing effects then time varying risk premia can t be modeled in any intelligible way nor can behavioral sentiment be measured in other words the behavior of asset prices may truly be inexplicable since we can t observe all the multitude of things that might cause framing effects it s a scary thought to contemplate but to dismiss the results of experiments like eil s would be a mistake it may turn out that the whole way modern economics models human behavior is good only in some situations and not in others bad news indeed but hardly new in neoclassical theory preferences are standardly expressed in the form of a utility function but although the expected utility theory has been known for a long time to be both theoretically and descriptively inadequate neoclassical economists all over the world gladly continue to use it as though its deficiencies were unknown or unheard of what most of them try to do in face of the obvious theoretical and behavioural inadequacies of the expected utility theory is to marginally mend it but that cannot be the right attitude when facing scientific anomalies when models are plainly wrong you d better replace them as matthew rabin and richard thaler have it in risk aversion it is time for economists to recognize that expected utility is an ex hypothesis so that we can concentrate our energies on the important task of developing better descriptive models of choice under uncertainty in his modern classic risk aversion and expected utility theory a calibration theorem matthew rabin writes using expected utility theory economists model risk aversion as arising solely because the utility function over wealth is concave this diminishing marginal utility of wealth theory of risk aversion is psychologically intuitive and surely helps explain some of our aversion to large scale risk we dislike vast uncertainty in lifetime wealth because a dollar that helps us avoid poverty is more valuable than a dollar that helps us become very rich yet this theory also implies that people are approximately risk neutral when stakes are small while most economists understand this formal limit result fewer appreciate that the approximate risk neutrality prediction holds not just for negligible stakes but for quite sizable and economically important stakes economists often invoke expected utility theory to explain substantial observed or posited risk aversion over stakes where the theory actually predicts virtual risk neutrality while not broadly appreciated the inability of expected utility theory to provide a plausible account of risk aversion over modest stakes has become oral tradition among some subsets of researchers and has been illustrated in writing in a variety of different contexts using standard utility functions expected utility theory is manifestly not close to the right explanation of risk attitudes over modest stakes moreover when the specific structure of expected utility theory is used to analyze situations involving modest stakes such as in research that assumes that large stake and modest stake risk attitudes derive from the same utility for wealth function it can be very misleading in a similar vein daniel kahneman writes in thinking fast and slow that expected utility theory is seriously flawed since it doesn t take into consideration the basic fact that people s choices are influenced by changes in their wealth where standard microeconomic theory assumes that preferences are stable over time kahneman and other behavioural economists have forcefully again and again shown that preferences aren t fixed but vary with different reference points how can a theory that doesn t allow for people having different reference points from which they consider their options have an almost axiomatic status within economic theory the mystery is how a conception of the utility of outcomes that is vulnerable to such obvious counterexamples survived for so long i can explain it only by a weakness of the scholarly mind i call it theory induced blindness once you have accepted a theory and used it as a tool in your thinking it is extraordinarily difficult to notice its flaws you give the theory the benefit of the doubt trusting the community of experts who have accepted it but they did not pursue the idea to the point of saying this theory is seriously wrong because it ignores the fact that utility depends on the history of one s wealth not only present wealth the works of people like rabin thaler and kahneman show that expected utility theory is indeed transmogrifying truth it s an ex hypthesis or as monty python has it this parrot is no more he has ceased to be e s expired and gone to meet is maker e s a stiff bereft of life e rests in peace if you hadn t nailed im to the perch e d be pushing up the daisies is metabolic processes are now istory e s off the twig e s kicked the bucket e s shuffled off is mortal coil run down the curtain and joined the bleedin choir invisible this is an ex parrot share on facebook opens in new window facebook share on x opens in new window x share on bluesky opens in new window bluesky encounters with r a fisher 29 jan 2014 at 19 46 posted in statistics econometrics comments off on encounters with r a fisher is calibration really a scientific advance i ll be dipped 29 jan 2014 at 12 47 posted in economics comments off on is calibration really a scientific advance i ll be dipped noah smith had a post up yesterday lamenting nobel laureate ed prescott the 2004 prize went partly to ed prescott the inventor of real business cycle theory that theory assumes that monetary policy doesn t have an effect on gdp since rbc theory came out in 1982 a number of different people have added frictions to the model to make it so that monetary policy does have real effects but prescott has stayed true to the absolutist view that no such effects exist in an email to a new york times reporter he very recently wrote the following it is an established scientific fact that monetary policy has had virtually no effect on output and employment in the u s since the formation of the fed professor prescott also on the faculty of arizona state university wrote in an email bond buying by the fed he wrote is as effective in bringing prosperity as rain dancing is in bringing rain wow prescott definitely falls into the category of people whom miles kimball and i referred to as purist freshwater macroeconomists prescott has made some odd claims in recent years but these recent remarks were totally consistent with his prize winning research odd claims indeed true there are many kinds of useless economics held in high regard within mainstream economics establishment today few if any are less deserved than the macroeconomic theory method mostly connected with nobel laureates finn kydland robert lucas edward prescott and thomas sargent called calibration interviewed by seppo honkapohja and lee evans in macroeconomic dynamics 2005 vol 9 thomas sargent answered the question if calibration was an advance in macroeconomics in many ways yes the unstated case for calibration was that it was a way to continue the process of acquiring experience in matching rational expectations models to data by lowering our standards relative to maximum likelihood and emphasizing those features of the data that our models could capture instead of trumpeting their failures in terms of dismal likelihood ratio statistics celebrate the features that they could capture and focus attention on the next unexplained feature that ought to be explained one can argue that this was a sensible response a sequential plan of attack let s first devote resources to learning how to create a range of compelling equilibrium models to incorporate interesting mechanisms we ll be careful about the estimation in later years when we have mastered the modelling technology but is the lucas kydland prescott sargent calibration really an advance let s see what two eminent econometricians have to say in journal of economic perspective 1996 vol 10 lars peter hansen and james j hickman writes it is only under very special circumstances that a micro parameter such as the inter temporal elasticity of substitution or even a marginal propensity to consume out of income can be plugged into a representative consumer model to produce an empirically concordant aggregate model what credibility should we attach to numbers produced from their computational experiments and why should we use their calibrated models as a basis for serious quantitative policy evaluation there is no filing cabinet full of robust micro estimats ready to use in calibrating dynamic stochastic equilibrium models the justification for what is called calibration is vague and confusing error probabilistic statistician aris spanos in error and inference mayo spanos 2010 p 240 is no less critical given that calibration purposefully foresakes error probabilities and provides no way to assess the reliability of inference how does one assess the adequacy of the calibrated model the idea that it should suffice that a theory is not obscenely at variance with the data sargent 1976 p 233 is to disregard the work that statistical inference can perform in favor of some discretional subjective appraisal it hardly recommends itself as an empirical methodology that lives up to the standards of scientific objectivity and this is the verdict of paul krugman the point is that if you have a conceptual model of some aspect of the world which you know is at best an approximation it s ok to see what that model would say if you tried to make it numerically realistic in some dimensions but doing this gives you very little help in deciding whether you are more or less on the right analytical track i was going to say no help but it is true that a calibration exercise is informative when it fails if there s no way to squeeze the relevant data into your model or the calibrated model makes predictions that you know on other grounds are ludicrous something was gained but no way is calibration a substitute for actual econometrics that tests your view about how the world works in physics it may possibly not be straining credulity too much to model processes as ergodic where time and history do not really matter but in social and historical sciences it is obviously ridiculous if societies and economies were ergodic worlds why do econometricians fervently discuss things such as structural breaks and regime shifts that they do is an indication of the unrealisticness of treating open systems as analyzable with ergodic concepts the future is not reducible to a known set of prospects it is not like sitting at the roulette table and calculating what the future outcomes of spinning the wheel will be reading sargent and other calibrationists one comes to think of robert clower s apt remark that much economics is so far removed from anything that remotely resembles the real world that it s often difficult for economists to take their own subject seriously instead of assuming calibration and rational expectations to be right one ought to confront the hypothesis with the available evidence it is not enough to construct models anyone can construct models to be seriously interesting models have to come with an aim they have to have an intended use if the intention of calibration and rational expectations is to help us explain real economies it has to be evaluated from that perspective a model or hypothesis without a specific applicability is not really deserving our interest to say as edward prescott that one can only test if some theory whether it incorporates rational expectations or for that matter irrational expectations is or is not consistent with observations is not enough without strong evidence all kinds of absurd claims and nonsense may pretend to be science we have to demand more of a justification than this rather watered down version of anything goes when it comes to rationality postulates if one proposes rational expectations one also has to support its underlying assumptions none is given which makes it rather puzzling how rational expectations has become the standard modeling assumption made in much of modern macroeconomics perhaps the reason is as paul krugman has it that economists often mistake beauty clad in impressive looking mathematics for truth but i think prescott s view is also the reason why calibration economists are not particularly interested in empirical examinations of how real choices and decisions are made in real economies in the hands of lucas prescott and sargent rational expectations has been transformed from an in principle testable hypothesis to an irrefutable proposition irrefutable propositions may be comfortable like religious convictions or ideological dogmas but it is not science or as noah smith puts it but ok suppose for a moment just imagine that somewhere on some other planet there was a group of alien macroeconomists who made a bunch of theories that were completely wrong and were not even close to anything that could actually describe the business cycles on that planet and suppose that the hypothetical aliens kept comparing their nonsense theories to data and they kept getting rejected by the data but the aliens still found the nonsense theories very cool and very a priori convincing and they kept at it finding puzzles estimating parameter values making slightly different nonsense models etc in a neverending cycle of brilliant non discovery now tell me in principle how should those aliens tell the difference between their situation and our own that s the question that i think we need to be asking and that a number of people...
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