In this dissertation, I examine the impact of uncertainty and information processing restrictions on standard economic models. Chapter 1 examines a reevaluation of the excess volatility puzzle in asset prices by assessing the impact of a shift in the agent's focus from minimizing average loss to minimizing maximum loss. Chapters 2 and 3 extend and clarify the newly developing arena of economic models in which the agent's capacity for information processing is systematically limited, as in the recent rational inattention literature. Chapter 1, which represents joint work with Charles Whiteman, studies the consequences changing the present value formula for stock prices. In place of the squared-error-loss minimizing expected present value of future dividends, we use a predictor optimal for the min-max preference relationship appropriate in cases of ambiguity. With ``robust" predictions, the well-known variance bound is reversed in that prices are predicted to be far more volatile than what is observed. We also investigate an intermediate ``partially robust'' case in which the degree of ambiguity is limited, and discover that such an intermediate model cannot be rejected in favor of an unrestricted time series model. Chapter 2 demonstrates the properties and solutions for the more general two-period rational inattention model. We show that the problem is convex, can be solved in seconds, and highlights several important features of information-processing-capacity-constrained models. Additionally, we show the importance of deriving, rather than assuming, the form of the final solution in rational inattention models. Chapter 3 extends the work of Chapter 2 to a finite-horizon dynamic setting by creating a structure in which distributional state and control variables interact under information-processing constraints. Limited information processing capacity is used optimally, and agents have the opportunity to trade processing capacity for higher expected future income. The framework is applied to the canonical life-cycle model of consumption and saving, and an analysis of the impact of preference parameters on optimal attention allocation is conducted. The model produces a distinct hump-shaped profile in expected consumption.

In this thesis, we study Bayesian games with two players and two actions (2 by 2 games) in realistic settings where private information is correlated or players have scarcity of attention. The contribution of this thesis is to shed further light on strategic interactions in realistic settings. Chapter 1 gives an introduction of the research and contributions of this thesis. In Chapter 2, we study how the correlation of private information affects rational agents’ choice in a symmetric game of strategic substitutes. The game we study is a static 2 by 2 entry game. Private information is assumed to be jointly normally distributed. The game can, for some parameter values, be solved by a cutoff strategy: that is enter if the private payoff shock is above some cutoff value and do not enter otherwise. Chapter 2 shows that there is a restriction on the value of correlation coefficient such that the game can be solved by the use of cutoff strategies. In this strategic-substitutes game, there are two possibilities. When the game can be solved by cutoff strategies, either, the game exhibits a unique (symmetric) equilibrium for any value of correlation coefficient; or, there is a threshold value for the correlation coefficient such that there is a unique (symmetric) equilibrium if the correlation coefficient is below the threshold, while if the correlation coefficient is above the threshold value, there are three equilibria: a symmetric equilibrium and two asymmetric equilibria. To understand how parameter changes affect players’ equilibrium behaviour, a comparative statics analysis on symmetric equilibrium is conducted. It is found that increasing monopoly profit or duopoly profit encourages players to enter the market, while increasing information correlation or jointly increasing the variances of players’ prior distribution will make players more likely to choose entry if the equilibrium cutoff strategies are below the unconditional mean, and less likely to choose entry if the current equilibrium cutoff strategies are above the unconditional mean. In Chapter 3, we study a 2 by 2 entry game of strategic complements in which players’ private information is correlated. As in Chapter 2, the game is symmetric and private information is modelled by a joint normal distribution. We use a cutoff strategy as defined in Chapter 2 to solve the game. Given other parameters, there exists a critical value of the correlation coefficient. For correlation coefficient below this critical value, cutoff strategies cannot be used to solve the game. We explore the number of equilibria and comparative static properties of the solution with respect to the correlation coefficient and the variance of the prior distribution. As the correlation coefficient changes from the lowest feasible (such that cutoff strategies are applicable) value to one, the sequence of the number of equilibrium will be 3 to 2 to 1, or 3 to 1. Alternatively, under some parameter specifications, the game exhibits a unique equilibrium for all feasible value of the correlation coefficient. The comparative statics of equilibrium strategies depends on the sign of the equilibrium cutoff strategies and the equilibrium’s stability. We provide a necessary and sufficient condition for the existence of a unique equilibrium. This necessary and sufficient condition nests the sufficient condition for uniqueness given by Morris and Shin (2005). Finally, if the correlation coefficient is negative for the strategic-complements games or positive for the strategic-substitutes games, there exists a critical value of variance such that for a variance below this threshold, the game cannot be solved in cutoff strategies. This implies that Harsanyi’s (1973) purification rationale, supposing the perturbed games are solved by cutoff strategies and the uncertainty of perturbed games vanishes as the variances of the perturbation-error distribution converge to zero, cannot be applied for a strategic-substitutes (strategic-complements) game with dependent perturbation errors that follow a joint normal distribution if the correlation coefficient is positive (negative). However, if the correlation coefficient is positive for the strategic-complements games or negative for the strategic-substitutes games, the purification rationale is still applicable even with dependent perturbation errors. There are Bayesian games that converge to the underlying complete information game as the perturbation errors degenerate to zero, and every pure strategy Bayesian Nash equilibrium of the perturbed games will converge to the corresponding Nash equilibrium of the complete information game in the limit. In Chapter 4, we study how scarcity of attention affects strategic choice behaviour in a 2 by 2 incomplete information strategic-substitutes entry game. Scarcity of attention is a common psychological characteristic (Kahneman 1973) and it is modelled by the rational inattention approach introduced by Sims (1998). In our game, players acquire information about their own private payoff shocks (which here follows a high-low binary distribution) at a cost. We find that, given the opponent’s strategy, as the unit cost of information acquisition increases a player’s best response will switch from acquiring information to simply comparing the ex-ante expected payoff of each action (using the player’s prior). By studying symmetric Bayesian games, we find that scarcity of attention can generate multiple equilibria in games that ordinarily have a unique equilibrium. These multiple equilibria are generated by the information cost. In any Bayesian game where there are multiple equilibria, there always exists one pair of asymmetric equilibria in which at least one player plays the game without acquiring information. The number of equilibria differs with the value of the unit information cost. There can be 1, 5 or 3 equilibria. Increasing the unit information cost could encourage or discourage a player from choosing entry. It depends on whether the prior probability of a high payoff shock is greater or less than some threshold value. We compare the rational inattention Bayesian game with a Bayesian quantal response equilibrium game where the observation errors are additive and follow a Type I extreme value distribution. A necessary and sufficient condition is established such that both the rational inattention Bayesian game and quantal response game have a common equilibrium.

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Recent empirical findings suggest that firms might not always engage in economically optimal tax planning. We conduct a series of four laboratory experiments with 223 students and 62 tax professionals to examine whether decision biases offer a behavioral explanation for tax outcomes. We find that individuals overestimate the importance of tax rates relative to the tax base when facing time pressure in tax-planning decisions. This systematic decision bias results in suboptimal choices. In line with the theory of rational inattention, we observe that increasing tax-burden differences between two tax-planning strategies weakly mitigate the decision bias. However, tax-planning behavior is unaffected by the level of experience: students and highly experienced tax professionals are similarly prone to biased decision-making. Overall, our findings suggest that overestimating the implications of salient tax-rate information can cause decision biases and contribute to heterogeneity in tax outcomes. / Series: WU International Taxation Research Paper Series

Submitted by Yara de Almeida Campos Cordeiro (yarinha.a@gmail.com) on 2015-06-03T18:26:36Z No. of bitstreams: 1 Diss_Biblioteca.pdf: 649363 bytes, checksum: 3edcafbc40c828ea9dfa7b5ecbf4892b (MD5) / Approved for entry into archive by BRUNA BARROS (bruna.barros@fgv.br) on 2015-06-12T14:12:17Z (GMT) No. of bitstreams: 1 Diss_Biblioteca.pdf: 649363 bytes, checksum: 3edcafbc40c828ea9dfa7b5ecbf4892b (MD5) / Approved for entry into archive by Marcia Bacha (marcia.bacha@fgv.br) on 2015-06-12T18:08:06Z (GMT) No. of bitstreams: 1 Diss_Biblioteca.pdf: 649363 bytes, checksum: 3edcafbc40c828ea9dfa7b5ecbf4892b (MD5) / Made available in DSpace on 2015-06-12T18:08:24Z (GMT). No. of bitstreams: 1 Diss_Biblioteca.pdf: 649363 bytes, checksum: 3edcafbc40c828ea9dfa7b5ecbf4892b (MD5) Previous issue date: 2015-04 / This paper investigates the expectations formation process of economic agents about inflation rate. Using the Market Expectations System of Central Bank of Brazil, we perceive that agents do not update their forecasts every period and that even agents who update disagree in their predictions. We then focus on the two most popular types of inattention models that have been discussed in the recent literature: sticky-information and noisy-information models. Estimating a hybrid model we find that, although formally fitting the Brazilian data, it happens at the cost of a much higher degree of information rigidity than observed.

A great amount of available information over the internet makes it impossible for anyone to process it all. In this thesis, we use the rational inattention theory to see how the perceived signals about the exogenous variables would change under different levels of information capacity. Those signals are then applied in the New Keynesian model and corresponding impulse responses are compared with the case of unlimited attention. We found that for some autoregressive processes the differences from the perfect attention case are not very profound while for others the results vary considerably.

This dissertation studies asymmetric pricing in the small (APIS), where small price increases outnumber small price decreases, the asymmetry disappearing for larger price changes; and the corresponding reversed phenomenon (APIS-R). Current evidence suggests retailers deploy these pricing practices despite menu costs and potential consumer concerns. There is also evidence that inflation is only a partial contributor to the phenomena. These point to possible strategic intent driving these retail pricing practices. However, there are only a few papers in the domain, and none specifically address the cross-sectional and longitudinal variations. Further, existing results are mostly based on a single retailer, limited products, short time span, and legacy datasets dating back to the 1980s and 1990s, leaving their current relevance unsettled. Recent papers also question if small price changes are measurement artifacts. This dissertation addresses these gaps by analyzing several large contemporary datasets – a scanner dataset with more than 79 billion price observations and a matching consumer panel dataset with more than 50,000 participating panelists. Our key results imply the pricing practices can be retailers’ strategic responses to the cognitive tasks faced by consumers. Chapter 1 is a general introduction to the thesis. Chapter 2 sets up the fundamentals of the phenomena and reports robust evidence of APIS and APIS-R across the retail price spectrum. Chapter 3 examines the cross-sectional variations of the phenomena and finds that APIS and APIS-R are associated with product characteristics such as purchase frequency and category price level, as well as retail format such as HILO or EDLP. Chapter 4 explores the longitudinal variations and finds that business cycles are a major time-varying factor influencing retail practices of APIS and APIS-R. Chapter 5 concludes with reflections on the findings, implications for theory and practice, limitations, and suggestions for future studies. / Dissertation / Candidate in Philosophy / This dissertation studies asymmetric pricing in the small (APIS), where small price increases outnumber small price decreases, the asymmetry disappearing for larger price changes; and the corresponding reversed phenomenon (APIS-R). There are only a few papers in the domain, and none explain their cross-sectional and longitudinal variations. Existing results are mostly based on a single retailer, limited products, short time span, and legacy datasets dating back to the 1980s and 1990s, leaving their current relevance unsettled. Recent papers also question if small price changes are measurement artifacts. This dissertation addresses these gaps by analyzing several large contemporary datasets. The research finds robust evidence of both APIS and APIS-R in the retail price spectrum, and provides explanations for their cross-sectional variation, across products and retailers, as well as longitudinal variations, across business cycles. The results indicate the pricing practices can be retailers’ strategic responses to the cognitive tasks faced by consumers.

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[pt] Propomos uma nova solução para o paradoxo de Grossman Stiglitz [1980]. Trocando sua estrutura informacional por uma restrição de desatenção racional, nós mostramos que os preços podem refletir toda a informação disponível, sem quebrar os incentivos dos participantes do mercado em processar informação. Esse modelo reformula a hipótese dos mercados eficientes e concilia visões opostas: preços são completamente reveladores, mas apenas para aqueles que são suficientemente espertos. Finalmente, nós desenvolvemos um método para postular e resolver modelos de equilíbrio geral Walrasiano que circunscreve hipóteses simplificadoras anteriores. / [en] We propose a new solution for the Grossman and Stiglitz [1980] paradox. By substituting a rational inattention restriction for their information structure, we show that prices can reflect all the information available without breaking the incentives of market participants to gather information. This model reframes the efficient market hypothesis and reconciles opposing views: prices are fully revealing but only for those who are sufficiently smart. Finally, we develop a method for postulating and solving Walrasian general equilibrium models with rationally inattentive agents circumventing previous tractability assumptions.

Submitted by Rodrigo dos Santos Barbosa (rdsbar@gmail.com) on 2016-06-13T19:54:58Z No. of bitstreams: 1 Tese.pdf: 895418 bytes, checksum: 64d50c7a9b78e9d3f89b6737e052eb58 (MD5) / Approved for entry into archive by Letícia Monteiro de Souza (leticia.dsouza@fgv.br) on 2016-06-13T21:06:35Z (GMT) No. of bitstreams: 1 Tese.pdf: 895418 bytes, checksum: 64d50c7a9b78e9d3f89b6737e052eb58 (MD5) / Made available in DSpace on 2016-06-13T22:04:05Z (GMT). No. of bitstreams: 1 Tese.pdf: 895418 bytes, checksum: 64d50c7a9b78e9d3f89b6737e052eb58 (MD5) Previous issue date: 2016-05-17 / My dissertation focuses on dynamic aspects of coordination processes such as reversibility of early actions, option to delay decisions, and learning of the environment from the observation of other people’s actions. This study proposes the use of tractable dynamic global games where players privately and passively learn about their actions’ true payoffs and are able to adjust early investment decisions to the arrival of new information to investigate the consequences of the presence of liquidity shocks to the performance of a Tobin tax as a policy intended to foster coordination success (chapter 1), and the adequacy of the use of a Tobin tax in order to reduce an economy’s vulnerability to sudden stops (chapter 2). Then, it analyzes players’ incentive to acquire costly information in a sequential decision setting (chapter 3). In chapter 1, a continuum of foreign agents decide whether to enter or not in an investment project. A fraction λ of them are hit by liquidity restrictions in a second period and are forced to withdraw early investment or precluded from investing in the interim period, depending on the actions they chose in the first period. Players not affected by the liquidity shock are able to revise early decisions. Coordination success is increasing in the aggregate investment and decreasing in the aggregate volume of capital exit. Without liquidity shocks, aggregate investment is (in a pivotal contingency) invariant to frictions like a tax on short term capitals. In this case, a Tobin tax always increases success incidence. In the presence of liquidity shocks, this invariance result no longer holds in equilibrium. A Tobin tax becomes harmful to aggregate investment, which may reduces success incidence if the economy does not benefit enough from avoiding capital reversals. It is shown that the Tobin tax that maximizes the ex-ante probability of successfully coordinated investment is decreasing in the liquidity shock. Chapter 2 studies the effects of a Tobin tax in the same setting of the global game model proposed in chapter 1, with the exception that the liquidity shock is considered stochastic, i.e, there is also aggregate uncertainty about the extension of the liquidity restrictions. It identifies conditions under which, in the unique equilibrium of the model with low probability of liquidity shocks but large dry-ups, a Tobin tax is welfare improving, helping agents to coordinate on the good outcome. The model provides a rationale for a Tobin tax on economies that are prone to sudden stops. The optimal Tobin tax tends to be larger when capital reversals are more harmful and when the fraction of agents hit by liquidity shocks is smaller. Chapter 3 focuses on information acquisition in a sequential decision game with payoff complementar- ity and information externality. When information is cheap relatively to players’ incentive to coordinate actions, only the first player chooses to process information; the second player learns about the true payoff distribution from the observation of the first player’s decision and follows her action. Miscoordination requires that both players privately precess information, which tends to happen when it is expensive and the prior knowledge about the distribution of the payoffs has a large variance. / A presente tese concentra-se em aspectos dinâmicos de processos que envolvem coordenação entre agentes em ambientes com interação estratégica. Propomos utilizar os chamados global games para estudar a capacidade de uma Tobin tax elevar a probabilidade de sucesso em um ambiente em que investidores internacionais sujeitos a choques de liquidez precisam coordenar suas decisões de investimento (capítulo 1), e reduzir a vulnerabilidade de uma economia aberta a fluxos internacionais de capitais a sudden stops (capítulo 2). Também, investigamos o problema da aquisição de informação em jogos sequenciais com informação incompleta e complementaridade em ações (capítulo 3). No capítulo 1, agentes estrangeiros decidem se entram ou não em um projeto, cujo sucesso depende em parte da capacidade dos mesmos em coordenarem suas escolhas. Uma fração λ desses investidores é afetada por restrições de liquidez no segundo período do modelo e é forçada a se retirar do projeto ou impedida de entrar, dependendo de suas respectivas escolhas no primeiro período. Agentes não afetados pelo choque de liquidez possuem a opção de reavaliar decisões tomadas no primeiro estágio do jogo. É assumido que a probabilidade de sucesso do projeto de investimento é crescente no volume total de capital que a economia recebe, mas decrescente no volume de capitais que deixa a economia no segundo período. Na ausência de choques de liquidez (λ = 0), o volume de capital que é recebido em um estado pivotal para o sucesso do projeto de investimento independe da existência de um imposto sobre capitais de curto prazo. Como tal imposto sempre desestimula saídas de capitais, uma Tobin tax sempre favorece as chances de sucesso em uma economia em que λ = 0. Contudo, na presença de choques de liquidez, o volume total de investimento que a economia recebe torna-se decrescente em um imposto incidente sobre capitais de curto prazo. Neste caso, uma Tobin tax pode prejudicar as chances do processo de coordenação ser bem sucedido, caso o benefício de reduzir o volume de saída de capitais não seja suficientemente grande. O capítulo 2 estuda os efeitos de uma Tobin tax no mesmo cenário do capítulo 1, porém considera que a extensão da restrição de liquidez a que os agentes podem estar sujeitos é aleatória. Neste modelo, identificamos condições sob as quais uma Tobin tax reduz a probabilidade de se observar um sudden stop e eleva o bem estar no único equilíbrio de uma economia onde a probabilidade de ocorrência de um choque de liquidez é pequena, mas a magnitude de tal choque pode ser significativa. O capítulo final investiga o problema de aquisição de informação em um jogo sequencial com 2 agentes, externalidade informacional e complementaridade em ações. Demonstramos que, quando o custo de aquisição de informação é pequeno relativamente ao incentivo que os agentes possuem para coordenarem suas ações, apenas o primeiro jogador escolhe adquirir novas informações a respeito da distribuição dos payoffs, e o jogador 2 sempre segue a ação escolhida pelo jogador 1. Probabilidade positiva de se observar divergência em ações requer que ambos os jogadores processem informação privadamente, o que tende a ocorrer quando o custo de aquisição de informação é baixo e a distribuição a priori dos payoffs possui variância elevada.