
Contents
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6.1 Introduction 6.1 Introduction
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6.2 Irregular Swings in Asset Prices and Risk 6.2 Irregular Swings in Asset Prices and Risk
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6.3 Endogenous Prospect Theory of Risk 6.3 Endogenous Prospect Theory of Risk
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6.3.1 Individual Preferences 6.3.1 Individual Preferences
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6.3.1.1 Original Utility Function 6.3.1.1 Original Utility Function
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6.3.1.2 From Prospective to Expected Values 6.3.1.2 From Prospective to Expected Values
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6.3.1.3 Limits to Speculation and an Individual Uncertainty Premium 6.3.1.3 Limits to Speculation and an Individual Uncertainty Premium
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6.3.2 Momentary Equilibrium Price and the Uncertainty Premium 6.3.2 Momentary Equilibrium Price and the Uncertainty Premium
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6.3.3 Imperfect Knowledge and Expected Values 6.3.3 Imperfect Knowledge and Expected Values
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6.4 An IKE Gap Model of the Market Risk Premium 6.4 An IKE Gap Model of the Market Risk Premium
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6.4.1 The Gap Effect 6.4.1 The Gap Effect
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6.4.2 Contingent Predictions of the Market Premium 6.4.2 Contingent Predictions of the Market Premium
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6.4.3 The Gap Model and Momentary Equilibrium 6.4.3 The Gap Model and Momentary Equilibrium
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6.5 Bubbles and Lost Fundamentals: Artifacts of the Contemporary Approach 6.5 Bubbles and Lost Fundamentals: Artifacts of the Contemporary Approach
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6.5.1 Technical Trading and Psychology’s Inability to Sustain Swings 6.5.1 Technical Trading and Psychology’s Inability to Sustain Swings
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6.5.1.1 The Fundamental Underpinnings of Psychological and Other Nonfundamental Considerations 6.5.1.1 The Fundamental Underpinnings of Psychological and Other Nonfundamental Considerations
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6.5.2 Fundamentals Matter, But in Nonroutine Ways 6.5.2 Fundamentals Matter, But in Nonroutine Ways
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6.6 An IKE Account of Asset Price Swings 6.6 An IKE Account of Asset Price Swings
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6.6.1 An Individual’s Price Forecast 6.6.1 An Individual’s Price Forecast
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6.6.2 Movements of Fundamentals 6.6.2 Movements of Fundamentals
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6.6.3 Nonroutine Revisions of Forecasting Strategies 6.6.3 Nonroutine Revisions of Forecasting Strategies
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6.6.3.1 Formalization of Guardedly Moderate Revisions 6.6.3.1 Formalization of Guardedly Moderate Revisions
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6.6.3.2 Psychological Motivation for Guardedly Moderate Revisions? 6.6.3.2 Psychological Motivation for Guardedly Moderate Revisions?
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6.6.4 Irregular Swings in an Individual’s Price Forecast 6.6.4 Irregular Swings in an Individual’s Price Forecast
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6.6.5 Bulls, Bears, and Irregular Swings in the Aggregate Forecast 6.6.5 Bulls, Bears, and Irregular Swings in the Aggregate Forecast
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6.6.5.1 Moving to the Aggregate Level 6.6.5.1 Moving to the Aggregate Level
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6.6.6 Irregular Price Swings 6.6.6 Irregular Price Swings
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6.6.6.1 Risk and Bounded Instability 6.6.6.1 Risk and Bounded Instability
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6.7 Contingent Predictions of Long Swings and Their Compatibility with Rationality 6.7 Contingent Predictions of Long Swings and Their Compatibility with Rationality
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6.8 An Intermediate View of Markets and the Role of the State 6.8 An Intermediate View of Markets and the Role of the State
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References References
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Six Opening Models of Asset Prices and Risk to Nonroutine Change
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Published:January 2013
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Abstract
This chapter considers an alternative approach to economic analysis, Imperfect Knowledge Economics (IKE), and introduces a model of asset prices and risk that has explicit mathematical microfoundations and yet remains open to nonroutine change. The IKE model consists of representations of individuals' preferences, forecasting behavior, constraints, and decision rules in terms of a set of causal (often called “informational”) variables, which portray the influence of economic policy, institutions, and other features of the social context. It also entails an aggregation rule and processes for the informational variables. The chapter examines irregular swings in asset prices and their relationship to financial risk. It also presents an IKE account of asset price swings before concluding with an analysis of contingent predictions of long swings and their compatibility with rationality.
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