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Uncertainty, Expectations, and Financial InstabilityReviving Allais's Lost Theory of Psychological Time$
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Eric Barthalon

Print publication date: 2014

Print ISBN-13: 9780231166287

Published to Columbia Scholarship Online: November 2015

DOI: 10.7312/columbia/9780231166287.001.0001

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Downside Potential Under Uncertainty

Downside Potential Under Uncertainty

The Perceived Risk of Loss

(p.241) Chapter Eleven Downside Potential Under Uncertainty
Uncertainty, Expectations, and Financial Instability

Eric Barthalon

Columbia University Press

This chapter examines how time can be introduced in the assessment of downside risk, that is, how Maurice Allais's paradox and his theory of psychological time can be combined into the perceived risk of loss. It illustrates the relevance of the perceived risk of loss by analyzing the pricing of some financial instruments. It considers whether the perceived risk of loss can explain the pricing of some financial assets and plays a role in the inception of financial bubbles. It also asks whether institutional or demographic factors might justify the claim made by the HRL formulation that collective human psychology is on average constant through time and space. It suggests that major bubbles tend to be heralded by a fall in the perceived risk of loss to unprecedented levels. The chapter concludes by discussing potential connections between the perceived risk of loss and moral hazard.

Keywords:   downside risk, Maurice Allais, psychological time, perceived risk of loss, financial instruments, financial assets, financial bubbles, HRL formulation, human psychology, moral hazard

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