Uncertainty, Expectations, and Financial Instability: Reviving Allais’s Lost Theory of Psychological Time

Eric Barthalon

eISBN: 9780231538305

2014 (448 pages 100)

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Front Matter (pages 1-7)

Download Table of Contents
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Table of Contents (pages 8-11)

Download List of Tables
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List of Tables (pages 12-15)

Download List of Figures
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List of Figures (pages 16-19)

Download Preface
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Preface (pages 20-23)

Download Acknowledgments
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Acknowledgments (pages 24-31)

Download Introduction
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Introduction (pages 32-41)

Download Glossary of Mathematical Symbols in Order of Appearance
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Glossary of Mathematical Symbols in Order of Appearance (pages 42-49)

Download Part 1. The Progressive Emergence of Expectations in Economic Theory
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Part 1. The Progressive Emergence of Expectations in Economic Theory (pages 50-51)

Download 1. Expectations Before the Rational Expectations Revolution
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1. Expectations Before the Rational Expectations Revolution (pages 52-65)

Download 2. Rational Expectations Are Endogenous to and Abide by ‘‘the’’ Model
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2. Rational Expectations Are Endogenous to and Abide by ‘‘the’’ Model (pages 66-91)

Download Part 2. Allais's Theory of "Expectations" Under Certainty
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Part 2. Allais's Theory of "Expectations" Under Certainty (pages 92-95)

Download 3. Macrofoundations of Monetary Dynamics
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3. Macrofoundations of Monetary Dynamics (pages 96-115)

Download 4. Microfoundations of Monetary Dynamics: The HRL Formulation of the Demand for Money
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4. Microfoundations of Monetary Dynamics: The HRL Formulation of the Demand for Money (pages 116-143)

Download 5. The Fundamental Equation of Monetary Dynamics
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5. The Fundamental Equation of Monetary Dynamics (pages 144-161)

Download 6. Joint Testing of the HRL Formulation of the Demand for Money and of the Fundamental Equation of Monetary Dynamics
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6. Joint Testing of the HRL Formulation of the Demand for Money and of the Fundamental Equation of Monetary Dynamics (pages 162-177)

Download Part 3. Transposing the HRL Formulation to Financial Markets: Preliminary Steps
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Part 3. Transposing the HRL Formulation to Financial Markets: Preliminary Steps (pages 178-179)

Download 7. Allais’s HRL Formulation: Illustration of Its Dynamic Properties by an Example of Hyperinflation (Zimbabwe 2000-2008)
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7. Allais’s HRL Formulation: Illustration of Its Dynamic Properties by an Example of Hyperinflation (Zimbabwe 2000-2008) (pages 180-201)

Download 8. The HRL Formulation and Nominal Interest Rates
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8. The HRL Formulation and Nominal Interest Rates (pages 202-229)

Download Part 4. The HRL Formulation and Financial Instability
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Part 4. The HRL Formulation and Financial Instability (pages 230-231)

Download 9. Perceived Returns and the Modeling of Financial Behavior
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9. Perceived Returns and the Modeling of Financial Behavior (pages 232-249)

Download 10. Downside Potential Under Risk: The Allais Paradox and Its Conflicting Interpretations
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10. Downside Potential Under Risk: The Allais Paradox and Its Conflicting Interpretations (pages 250-289)

Download 11. Downside Potential Under Uncertainty: The Perceived Risk of Loss
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11. Downside Potential Under Uncertainty: The Perceived Risk of Loss (pages 290-313)

Download 12. Conclusion
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12. Conclusion (pages 314-319)

Download Appendix A: How to Compute Zn and zn
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Appendix A: How to Compute Zn and zn (pages 320-323)

Download Appendix B: Nominal Interest Rates and the Perceived Rate of Nominal Growth
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Appendix B: Nominal Interest Rates and the Perceived Rate of Nominal Growth (pages 324-325)

Download Appendix C: Proofs
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Appendix C: Proofs (pages 326-375)

Download Appendix D: Comparison Between the Kalman Filter and Allais's HRL Algorithm
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Appendix D: Comparison Between the Kalman Filter and Allais's HRL Algorithm (pages 376-379)

Download Appendix E: A Note on the Theory of Intertemporal Choice
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Appendix E: A Note on the Theory of Intertemporal Choice (pages 380-391)

Download Appendix F: Allais’s Cardinal Utility Function
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Appendix F: Allais’s Cardinal Utility Function (pages 392-395)

Download Notes
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Download Bibliography
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Download Index
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Index (pages 424-445)

Uncertainty, Expectations, and Financial Instability: Reviving Allais’s Lost Theory of Psychological Time

Eric Barthalon applies the neglected theory of psychological time and memory decay of Nobel Prize–winning economist Maurice Allais (1911–2010) to model investors’ psychology in the present context of recurrent financial crises. Shaped by the behavior of the demand for money during episodes of hyperinflation, Allais’s theory proves economic agents perceive the flow of clocks’ time and forget the past at a context-dependent pace: rapidly in the presence of persistent and accelerating inflation and slowly in the event of the opposite situation. Barthalon recasts Allais’s work as a general theory of “expectations” under uncertainty, closing the gap between economic theory and investors’ behavior.

Barthalon extends Allais’s theory to the field of financial instability, demonstrating its relevance to nominal interest rates in a variety of empirical scenarios and the positive nonlinear feedback that exists between asset price inflation and the demand for risky assets. Reviewing the works of the leading protagonists in the expectations controversy, Barthalon exposes the limitations of adaptive and rational expectations models and, by means of the perceived risk of loss, calls attention to the speculative bubbles that lacked the positive displacement discussed in Kindleberger’s model of financial crises. He ultimately extrapolates Allaisian theory into a pragmatic approach to investor behavior and the natural instability of financial markets. He concludes with the policy implications for governments and regulators. Balanced and coherent, this book will be invaluable to researchers working in macreconomics, financial economics, behavioral finance, decision theory, and the history of economic thought.

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Uncertainty, Expectations, and Financial Instability: Reviving Allais’s Lost Theory of Psychological Time