Seminar MORE@DIAG - Performance Thresholds and Optimal Risk Taking
In many economic decisional problems, agents confront the choice of how much uncertainty to face, solving a trade-off between (average) profitability and risk, like in a portfolio problem. For example, a government choosing between two economic policies in order to attain some given economic goal (e.g., reduction of national public debt) may consider policies characterised by low risk and low performance (e.g. high tax levels and lower growth), alongside with policies characterised by high risk and high performance (e.g. lower taxes and high, but uncertain, growth rates). In such instances, the final outcome for the decision-maker may be subject to thresholds – defined in terms of quality or performance – that apply to the ex-post realisation of the portfolio choice. For example, governments may be subject to international decisions/processes, whereby the achievement of a given economic goal may imply the entry into a virtuous cooperation process, while the failure to do so may imply substantial losses. Performance thresholds may have important consequences on agents’ preferences and lead to strategic behaviours that affect the final outcomes. The paper provides a theoretical framework which allows capturing these effects and discusses a range of potentially interesting applications. These include: understanding the impact of international norms on domestic political preferences, and investigating how research quality standards (e.g. in the form of the REF) may affect individual research behaviour.