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You Might as Well be Hung for a Sheep as a Lamb: The Loss Function of an Agent

Listed author(s):
  • Charles Goodhart

    ()

  • Margaret Bray

    ()

Registered author(s):

    Most of those who take macro and monetary policy decisions are agents. The worst penalty which can be applied to these agents is to sack them. Agents thus have loss functions which are bounded above. We work with a bell loss function which has this property. With additive uncertainty the certainty equivalence which holds for a quadratic loss function breaks down with a bell loss function when there are two or more targets. With multiplicative (Brainard) uncertainty policy is more conservative than in the absence of multiplicative uncertainty, but less so with the bell than the quadratic loss function.

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    File URL: http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/fmgdps/DP418.pdf
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    Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp418.

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    Date of creation: Jul 2002
    Handle: RePEc:fmg:fmgdps:dp418
    Contact details of provider: Web page: http://www.lse.ac.uk/fmg/

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    1. Louis K.C. Chan & Jason Karceski & Josef Lakonishok, 1999. "On Portfolio Optimization: Forecasting Covariances and Choosing the Risk Model," NBER Working Papers 7039, National Bureau of Economic Research, Inc.
    2. Chevalier, Judith & Ellison, Glenn, 1997. "Risk Taking by Mutual Funds as a Response to Incentives," Journal of Political Economy, University of Chicago Press, vol. 105(6), pages 1167-1200, December.
    3. Schellekens, Philip, 2002. "Caution and Conservatism in the Making of Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(1), pages 160-177, February.
    4. Grossman, Sanford J & Zhou, Zhongquan, 1996. " Equilibrium Analysis of Portfolio Insurance," Journal of Finance, American Finance Association, vol. 51(4), pages 1379-1403, September.
    5. Chan, Louis K C & Karceski, Jason & Lakonishok, Josef, 1999. "On Portfolio Optimization: Forecasting Covariances and Choosing the Risk Model," Review of Financial Studies, Society for Financial Studies, vol. 12(5), pages 937-974.
    6. Fung, William & Hsieh, David A, 1997. "Empirical Characteristics of Dynamic Trading Strategies: The Case of Hedge Funds," Review of Financial Studies, Society for Financial Studies, vol. 10(2), pages 275-302.
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