Andreas Fuster

Bio: Andreas Fuster is an academic researcher from Swiss Finance Institute. The author has contributed to research in topics: Mean reversion & Prepayment of loan. The author has an hindex of 26, co-authored 72 publications receiving 2391 citations. Previous affiliations of Andreas Fuster include Federal Reserve Bank of New York & Harvard University.

Expectations as Endowments: Evidence on Reference-Dependent Preferences from Exchange and Valuation Experiments

Abstract: Evidence on loss aversion and the endowment effect suggests that people evaluate outcomes with respect to a reference point. Yet little is known about what determines reference points. We conduct two experiments that show that reference points are determined by expectations. In the first experiment, we endow subjects with an item and randomize the probability they will be allowed to trade it for an alternative. Subjects that are less likely to be able to trade are more likely to choose to keep their item, as predicted when reference points are expectation-based, but not when reference points are determined by the status quo or when preferences are reference-independent. In the second experiment, we randomly assign subjects a high or low probability of obtaining an item for free and elicit their willingness-to-accept for it. Being in the high probability treatment increases valuation of the item by 20-30%.

Natural Expectations and Macroeconomic Fluctuations.

Abstract: In recent decades, research in economics and finance has largely focused on the rational actor model, in which economic agents process all available information perfectly. In contrast to an older perspective represented by Keynes and Pigou, the rational model rules out unjustified optimism or pessimism as an amplifying force for aggregate fluctuations. Consequently, the rational model struggles to explain some of the most prominent facts we observe in macroeconomics, such as large swings in asset prices, in other words “bubbles”, as well as credit cycles, investment cycles, and other mechanisms that contribute to the length and severity of economic contractions. Relaxing the assumption of perfect rationality is a potential way of explaining aggregate volatility. Unfortunately, economists lack a consensus on how to do this. Economists often point out that psychological concepts like Keynesian “animal spirits” (Keynes, 1936) are vague and potentially even untestable (for instance, Fama, 1998). If a sample of macroeconomists were forced to write down a formal model of animal spirits, most wouldn’t know where to start and the rest would produce models that had little in common. In contrast, the rational actor model is conceptually elegant, disciplined, and parsimonious. However, even the assumption of perfect rationality is not sufficient for modeling discipline. Creative assumptions about technology, preferences, information, and market frictions can offset the parsimony purchased with rational beliefs. If the methodological goal is modeling discipline, formal quasi-rational models with a small number of free parameters should also be serious contenders. The methodological litmus tests should be parsimony, portability, and explanatory power (Gabaix and Laibson, 2008 propose a list of seven properties of good models). Rational models are only one potential means to these ends. In this paper, we make the case that quasi-rational models deserve greater attention. We begin by discussing a large body of empirical evidence which suggests that beliefs systematically deviate from perfect rationality. Much of the evidence implies that economic agents tend to form forecasts that are excessively influenced by recent changes – in other words, some form of “extrapolation bias.” We then present a parsimonious quasi-rational model that we call natural expectations, which falls between rational expectations and (naive) intuitive expectations. Intuitive expectations are formed by running growth regressions with a limited number of right-hand-side variables. As we will see, this leads to excessively extrapolative beliefs in certain classes of environments. Next, we show empirically that many U.S. macroeconomic time series have hump-shaped dynamics -- in other words, they exhibit momentum in the short run and (partial) mean reversion in the long run. Natural expectations turn out to be sophisticated enough to capture the short-run momentum but fail to fully reflect the more subtle long-run mean reversion. Hence, when the true dynamics are hump-shaped, natural expectations overstate the long-run persistence of economic shocks. In other words, agents with natural expectations turn out to form beliefs that don’t sufficiently account for the fact that good times (or bad times) won’t last forever. Finally, we embed natural expectations in a simple dynamic macroeconomic model and compare the simulated properties of the model to the available empirical evidence. The model’s predictions match many patterns observed in macroeconomic and financial time series, such as high volatility of asset prices, predictable up-and-down cycles in equity returns, and a negative relationship between current consumption growth and future equity returns. We also discuss the model’s shortcomings, how these can be alleviated, and other potential directions for research in this area.

Predictably Unequal? The Effects of Machine Learning on Credit Markets

Abstract: Recent innovations in statistical technology, including in evaluating creditworthiness, have sparked concerns about impacts on the fairness of outcomes across categories such as race and gender. We build a simple equilibrium model of credit provision in which to evaluate such impacts. We find that as statistical technology changes, the effects on disparity depend on a combination of the changes in the functional form used to evaluate creditworthiness using underlying borrower characteristics and the cross-category distribution of these characteristics. Employing detailed data on US mortgages and applications, we predict default using a number of popular machine learning techniques, and embed these techniques in our equilibrium model to analyze both extensive margin (exclusion) and intensive margin (rates) impacts on disparity. We propose a basic measure of cross-category disparity, and find that the machine learning models perform worse on this measure than logit models, especially on the intensive margin. We discuss the implications of our findings for mortgage policy.

Expectations as Endowments: Evidence on Reference-Dependent Preferences From Exchange and Valuation Experiments

Abstract: While evidence suggests that people evaluate outcomes with respect to reference points, little is known about what determines them. We conduct two experiments that show that reference points are determined, at least in part, by expectations. In an exchange experiment, we endow subjects with an item and randomize the probability they will be allowed to trade. Subjects that are less likely to be able to trade are more likely to choose to keep their item. In a valuation experiment, we randomly assign subjects a high or low probability of obtaining an item and elicit their willingness-to-accept for it. The high probability treatment increases valuation of the item by 20--30%. Copyright 2011, Oxford University Press.

Home price expectations and behaviour: Evidence from a randomized information experiment

Abstract: Home price expectations are believed to play an important role in housing dynamics, yet we have limited understanding of how they are formed and how they affect behaviour Using a unique “information experiment” embedded in an online survey, this article investigates how consumers’ home price expectations respond to past home price growth, and how they impact investment decisions After eliciting respondents’ priors about past and future local home price changes, we present a random subset of them with factual information about past (one- or five-year) changes, and then re-elicit expectations This unique “panel” data allows us to identify causal effects of the information, and provides insights on the expectation formation process We find that, on average, year-ahead home price expectations are revised in a way consistent with short-term momentum in home price growth, though respondents tend to underpredict the strength of momentum Revisions of longer-term expectations show that respondents do not expect the empirically-occurring mean reversion in home price growth These patterns are in line with recent behavioural models of housing cycles Finally, we show that home price expectations causally affect investment decisions in a portfolio choice experiment embedded in the survey

Nudge: Improving Decisions about Health, Wealth, and Happiness

Abstract: NUDGE: IMPROVING DECISIONS ABOUT HEALTH, WEALTH, AND HAPPINESS by Richard H. Thaler and Cass R. Sunstein Penguin Books, 2009, 312 pp, ISBN 978-0-14-311526-7This book is best described formally as a general explanation of and advocacy for libertarian paternalism, a term coined by the authors in earlier publications. Informally, it is about how leaders, systems, organizations, and governments can nudge people to do the things the nudgers want and need done for the betterment of the nudgees, or of society. It is paternalism in the sense that "it is legitimate for choice architects to try to influence people's behavior in order to make their lives longer, healthier, and better", (p. 5) It is libertarian in that "people should be free to do what they like - and to opt out of undesirable arrangements if they want to do so", (p. 5) The built-in possibility of opting out or making a different choice preserves freedom of choice even though people's behavior has been influenced by the nature of the presentation of the information or by the structure of the decisionmaking system. I had never heard of libertarian paternalism before reading this book, and I now find it fascinating.Written for a general audience, this book contains mostly social and behavioral science theory and models, but there is considerable discussion of structure and process that has roots in mathematical and quantitative modeling. One of the main applications of this social system is economic choice in investing, selecting and purchasing products and services, systems of taxes, banking (mortgages, borrowing, savings), and retirement systems. Other quantitative social choice systems discussed include environmental effects, health care plans, gambling, and organ donations. Softer issues that are also subject to a nudge-based approach are marriage, education, eating, drinking, smoking, influence, spread of information, and politics. There is something in this book for everyone.The basis for this libertarian paternalism concept is in the social theory called "science of choice", the study of the design and implementation of influence systems on various kinds of people. The terms Econs and Humans, are used to refer to people with either considerable or little rational decision-making talent, respectively. The various libertarian paternalism concepts and systems presented are tested and compared in light of these two types of people. Two foundational issues that this book has in common with another book, Network of Echoes: Imitation, Innovation and Invisible Leaders, that was also reviewed for this issue of the Journal are that 1 ) there are two modes of thinking (or components of the brain) - an automatic (intuitive) process and a reflective (rational) process and 2) the need for conformity and the desire for imitation are powerful forces in human behavior. …

When and Why Incentives (Don't) Work to Modify Behavior

Abstract: First we discuss how extrinsic incentives may come into conflict with other motivations. For example, monetary incentives from principals may change how tasks are perceived by agents, with negative effects on behavior. In other cases, incentives might have the desired effects in the short term, but they still weaken intrinsic motivations. To put it in concrete terms, an incentive for a child to learn to read might achieve that goal in the short term, but then be counterproductive as an incentive for students to enjoy reading and seek it out over their lifetimes. Next we examine the research literature on three important examples in which monetary incentives have been used in a nonemployment context to foster the desired behavior: education; increasing contributions to public goods; and helping people change their lifestyles, particularly with regard to smoking and exercise. The conclusion sums up some lessons on when extrinsic incentives are more or less likely to alter such behaviors in the desired directions.

Doing Good or Doing Well? Image Motivation and Monetary Incentives in Behaving Prosocially

Abstract: Most charitable organizations depend on private contributions, in the form of monetary gifts, volunteer efforts, or other tangible contributions, such as blood donations. The magnitude of private contributions is impressive?in the United States 89 percent of households donate, aver? aging $1,620 per year, and 44 percent of US adults volunteer the equivalent of 9 million full time jobs (Independent Sector 2001). This level of prosocial behavior is striking in light of the economic incentive to free-ride in the provision of public goods. In order to elicit contributions, charitable organizations use many creative efforts to incentivize voluntary giving: wrist bands, thank-you gifts, organized walks, concerts, and advertised donors lists. The government also helps promote charitable giving by offering tax breaks for donations. The various types of charitable contributions and the many real-life ways of soliciting such donations suggest that there may be different motives for individuals to behave prosocially. These motives are roughly divisible into three broad categories: intrinsic, extrinsic, and image motiva? tion. Intrinsic motivation is the value of giving per se, represented by private preferences for others' well-being, such as pure altruism or other forms of prosocial preferences (for surveys, see Ernst Fehr and Klaus Schmidt 2003; Meier 2007). Extrinsic motivation is any material reward or benefit associated with giving, such as thank-you gestures and tax breaks. Image motivation, or signaling motivation, refers to an individual's tendency to be motivated partly by others' percep? tions. Image motivation therefore captures the rule of opinion in utility, i.e., the desire to be liked and respected by others and by one's self. If individuals are looking to gain social approval of their behavior, they should try to signal traits defined as "good" based on the community's norms