Working Papers

Intertemporal Prospect Theory Paper (PDF)
Immanuel Lampe and Matthias Weber. Working Papers on Finance No 2021/09, University of St. Gallen.

Note: We received the Vernon Smith Young Talent Award 2021 for this paper from the Society for Experimental Finance.

Prospect Theory is the most prominent contender of expected utility theory to describe decisions under risk. In atemporal contexts, prospect theory is well understood. In intertemporal contexts, however, it is not clear how prospect theory should be applied (in particular, whether probabilities should be weighted within time periods or whether the probabilities of present values should be weighted). It is also unclear what parametric specifications of probability-weighting and value functions should be used. We find in a pre-registered experiment on a representative sample that an application of prospect theory weighting probabilities of present values predicts decisions best. Estimated probability weighting functions are very similar to those typically estimated in atemporal settings, while value functions are almost linear with a loss aversion coefficient close to one.

IPO Underpricing and Aftermarket Price Accuracy: Auctions vs. Bookbuilding in Japan Paper (PDF)
Timo Lehmann and Matthias Weber. Working Papers on Finance No 2021/02, University of St. Gallen.

We analyse a regulatory change in the Japanese IPO market that created an abrupt shift from hybrid price-discriminatory auctions to bookbuilding. We find that bookbuilding leads to significantly higher underpricing than hybrid price-discriminatory auctions. Further, we find evidence that price accuracy tends to be higher for auctions than for bookbuilding. The results hold under a variety of OLS specifications and with regression discontinuity designs exploiting the abrupt change of the regulation. The results suggest that the interests of issuers and underwriters are not aligned. The popularity of bookbuilding seems puzzling from this perspective.

Credit Default Swap Regulation in Experimental Bond Markets Paper (PDF)
Matthias Weber, John Duffy, and Arthur Schram. Tinbergen Institute Discussion Paper 2019-039/I.

Credit default swaps (CDS) played an important role in the financial crisis of 2008. While CDS can be used to hedge risks, they can also be used for speculative purposes (as occurred during the financial crisis) and regulations have been proposed to limit such speculative use. Here, we provide the first controlled experiment analyzing the pricing of credit default swaps in a bond market subject to default risk. We further use the laboratory as a test bed to analyze CDS regulation. Our results show that the regulation achieves the goal of increasing the use of CDS for hedging purposes while reducing the use of CDS for speculation. This success does not come at the expense of lower bond IPO revenues and does not negatively affect CDS prices or bond prices in the secondary market.

Network-Constrained Covariate Coefficient and Connection Sign Estimation Paper (PDF)
Matthias Weber, Jonas Striaukas, Martin Schumacher, and Harald Binder. Working Papers on Finance No 2020/01, University of St. Gallen.

Often, variables are linked to each other via a network. When such a network structure is known, this knowledge can be incorporated into regularized regression settings via a network penalty term. However, when the type of interaction via the network is unknown (that is, whether connections are of an activating or a repressing type), the connection signs have to be estimated simultaneously with the covariate coefficients. This can be done with an algorithm iterating a connection sign estimation step and a covariate coefficient estimation step. We develop such an algorithm and show detailed simulation results and an application forecasting event times. The algorithm performs well in a variety of settings. We also briefly describe the R-package that we developed for this purpose, which is publicly available.

Subsidies or Tax Breaks Versus Intellectual Property Rights: Dual Markets Link to paper
Egle Skliaustyte and Matthias Weber

Intellectual property rights are monopoly rights, which have undesirable welfare properties. Therefore, several studies suggest to use rewards as incentives for innovation instead. However, these studies have thus far had little effect on actual policy, possibly because such rewards may be difficult to implement in practice. We suggest a way of providing incentives to originators that is easy to implement. This is possible if there is an additional market in which the originator operates, where copying is not easily possible. Taking the music industry as example, copyrights in the records market could be replaced by subsidies or tax breaks in the market for live performances. We provide a modeling framework that can be used to analyze in which cases the replacement of intellectual property rights in one market with subsidies in another market is welfare improving or even pareto efficient.

Behavioral Optimal Taxation: The Case of Aspirations Link to paper
Matthias Weber

I provide a simple two-period model comparing lump-sum taxes with proportional labor taxes. The difference to the classical optimal taxation literature is that I introduce a behavioral twist according to which people’s aspirations change from one period to another as suggested by empirical evidence. It turns out that the policy implication from this model can differ significantly from the one assuming full rationality. In the behavioral model, a lump-sum tax is much less attractive. This paper does not aim at providing a full-fledged quantitative model, it should rather be seen as a cautionary tale about the robustness of classical optimal taxation results when deviating from full rationality.