Essays in Behavioral Economics and Risk Management

Abstract

In the first chapter, I develop a model of prospective memory, defined as thecapacity to recall actions to be carried out in the future. An agent faces sometask with stochastic cost ct , benefit b, and T periods until some exogenouslyimposed deadline. The agent can only execute the task at time t if the task isrecalled in that period. The memory process exhibits the rehearsal propertythat the probability of recall is lower if the task was forgotten in the recentpast. The agent sets a threshold cost each period based on her expectationsof whether she will recall and carry out the task in future periods. If the taskis recalled at time t, and the draw from the cost distribution is below thisthreshold, the task is executed. We then introduce memory overconfidenceinto the model, which we define as either overestimating the base likelihoodof recall in future periods or underestimating the effect of temporary forgettingon subsequent recall. Memory overconfidence leads not only to inefficientlylow rates of task completion, but also to the prediction that the probabilityof task completion may vary inversely with the length of time allocated tocompleting the task. We discuss the interaction of these effects with present-biased preferences, and provide examples of economic scenarios where thisdynamic may be exploited by firms to the detriment of consumers.In the second chapter, I introduce a new copula which simultaneously allowsfully-general correlation structures in the bulk of a multivariate distributionand an arbitrarily high degree of dependence in the left tails. This isideally suited for modeling financial assets which may display moderate correlation in normal times, but which experience simultaneous left tail events,such as during a financial crisis. The new copula is shown to be fully flexiblein the sense that the user can specify a desired structure for a sequence ofincreasingly dire events in the left tail, while still retaining the same correlationstructure in the bulk. Finally, I illustrate the use of this copula with anapplication to hedge fund returns.

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