andrew_gelman_stats andrew_gelman_stats-2011 andrew_gelman_stats-2011-819 knowledge-graph by maker-knowledge-mining
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Introduction: Richard Thaler writes (click here and search on Thaler): Both risk and risk aversion are concepts that were once well defined, but are now in danger of becoming Aetherized [this is Thaler's term for adding free parameters to a model to make it work, thus destroying the purity and much of the value of the original model]. Stocks that earn surprisingly high returns are labeled as risky, because in the theory, excess returns must be accompanied by higher risk. If, inconveniently, the traditional measures of risk such as variance or covariance with the market are not high, then the Aetherists tell us there must be some other risk; we just don’t know what it is. Similarly, traditionally the concept of risk aversion was taken to be a primitive; each person had a parameter, gamma, that measured her degree of risk aversion. Now risk aversion is allowed to be time varying, and Aetherists can say with a straight face that the market crashes of 2001 and 2008 were caused by sudden increases
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1 Stocks that earn surprisingly high returns are labeled as risky, because in the theory, excess returns must be accompanied by higher risk. [sent-2, score-0.224]
2 If, inconveniently, the traditional measures of risk such as variance or covariance with the market are not high, then the Aetherists tell us there must be some other risk; we just don’t know what it is. [sent-3, score-0.566]
3 Similarly, traditionally the concept of risk aversion was taken to be a primitive; each person had a parameter, gamma, that measured her degree of risk aversion. [sent-4, score-1.498]
4 Now risk aversion is allowed to be time varying, and Aetherists can say with a straight face that the market crashes of 2001 and 2008 were caused by sudden increases in risk aversion. [sent-5, score-1.48]
5 Stocks fell because risk aversion spiked, not vice versa. [sent-7, score-0.919]
6 ) I don’t know anything about the stock market (except that I lost a lot of money when it crashed a couple years ago) so I pass on that . [sent-8, score-0.288]
7 But I am bothered by Thaler’s implication that all was good in the good old days when “he concept of risk aversion was taken to be a primitive; each person had a parameter, gamma, that measured her degree of risk aversion. [sent-9, score-1.538]
8 ” First off, why shouldn’t risk aversion vary over time? [sent-10, score-0.88]
9 Young people are different from old people, life circumstances change, and cultural norms change as well. [sent-11, score-0.079]
10 (In fact, Thaler in his parenthetical above seems to have no problem with risk aversion “spiking” as the result of a stock market crash. [sent-12, score-1.114]
11 ) My second problem is with that single parameter gamma. [sent-13, score-0.092]
12 As we’ve discussed endlessly on this blog (and as Yitzhak has demonstrated mathematically), people generally exhibit a level of uncertainty-aversion that is not consistent with any parameter gamma in a curving utility function. [sent-14, score-0.39]
13 ) In short, the classical risk aversion model does not capture actual aversion to risk. [sent-17, score-1.446]
14 To back to Thaler’s analogy to astronomy, the traditional risk aversion and utility model is like the old-fashioned geocentric model of the universe–without the epicicyles. [sent-18, score-1.231]
15 Thaler is annoyed at people adding epicycles (“aether”) to make the model work. [sent-19, score-0.256]
16 If you really need need need to have a utility model for risk aversion–I argue that you don’t–then you better add some epicycles or your model will be completely useless. [sent-21, score-0.974]
17 I understand the appeal of a lost world of simplicity, but you can’t get that back. [sent-22, score-0.057]
18 There’s no returning to the world of Neumann and Morgenstern or even Luce and Raiffa. [sent-23, score-0.041]
19 Thaler recognizes this in his own research–huge contributions on the border of psychology and economics, going well beyond naive utility theory–so I think this thing he wrote is an atypical descent into nostalgia. [sent-25, score-0.312]
20 Thaler also writes, “there is no need for a term that refers to something that does not exist. [sent-28, score-0.1]
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