Behavioral economics 

• Revealed preference
  Revealed preference
  Revealed preference theory, pioneered by American economist Paul Samuelson, is a method by which it is possible to discern the best possible option on the basis of consumer behavior. Essentially, this means that the preferences of consumers can be revealed by their purchasing habits...
  
  : Does Revealed Preference theory truly reveal consumer preference when the consumer is able to afford all of the available options? For example, if a consumer is confronted with three goods and he can afford to purchase all three A, B, and C and he chooses to first purchase A, then C, and then B - does this suggest that the consumer preference for the goods is A > C > B? The debate rests on the fact that since the consumer can afford all three goods and does not need to make a preferential decision, does the order of consumption reflect any preference?
• Tâtonnement: The act of tâtonnement plays a key role in the formulation of the general equilibrium theory. The claim is that if an initial contract does not lead to an equilibrium, they are ended and new contracts are formulated. If the initial contract is not called off, it will likely lead to a different price system, depending on the degree of error in the original process. The question is whether successive re-contracting continues with the parties forgetting the previously planned positions taken or whether the parties engage in a form of tâtonnement to achieve optimality? See Also: Hill climbing
  Hill climbing
  In computer science, hill climbing is a mathematical optimization technique which belongs to the family of local search. It is an iterative algorithm that starts with an arbitrary solution to a problem, then attempts to find a better solution by incrementally changing a single element of the solution...
  
   and Walrasian auction
  Walrasian auction
  A Walrasian auction, introduced by Leon Walras, is a type of simultaneous auction where each agent calculates its demand for the good at every possible price and submits this to an auctioneer. The price is then set so that the total demand across all agents equals the total amount of the good...
  
  
• Unified Models of Human Biases: The majority of economics has concentrated on the development of models that reflect an idealized economic agent, sometimes referred to as Homo economicus
  Homo economicus
  Homo economicus, or Economic human, is the concept in some economic theories of humans as rational and narrowly self-interested actors who have the ability to make judgments toward their subjectively defined ends...
  
  , as a way of studying economics. In the period spanning the 1970s to the 1990s, research began to emerge that suggested that people were subject to cognitive biases such as the framing effect, loss aversion
  Loss aversion
  In economics and decision theory, loss aversion refers to people's tendency to strongly prefer avoiding losses to acquiring gains. Some studies suggest that losses are twice as powerful, psychologically, as gains....
  
  , the gambler's fallacy
  Gambler's fallacy
  The Gambler's fallacy, also known as the Monte Carlo fallacy , and also referred to as the fallacy of the maturity of chances, is the belief that if deviations from expected behaviour are observed in repeated independent trials of some random process, future deviations in the opposite direction are...
  
  , confirmation bias
  Confirmation bias
  Confirmation bias is a tendency for people to favor information that confirms their preconceptions or hypotheses regardless of whether the information is true.David Perkins, a geneticist, coined the term "myside bias" referring to a preference for "my" side of an issue...
  
   and many others. Further, these effects could produce anomalies such as herd behavior
  Herd behavior
  Herd behavior describes how individuals in a group can act together without planned direction. The term pertains to the behavior of animals in herds, flocks and schools, and to human conduct during activities such as stock market bubbles and crashes, street demonstrations, sporting events,...
  
   or momentum investing
  Momentum investing
  Momentum investing, also sometimes known as "Fair Weather Investing", is a system of buying stocks or other securities that have had high returns over the past three to twelve months, and selling those that have had poor returns over the same period...
  
   inconsistent with economic models that did not incorporate human psychological limitations. While some models have begun to include bounded rationality
  Bounded rationality
  Bounded rationality is the idea that in decision making, rationality of individuals is limited by the information they have, the cognitive limitations of their minds, and the finite amount of time they have to make a decision...
  
   and risk aversion
  Risk aversion
  Risk aversion is a concept in psychology, economics, and finance, based on the behavior of humans while exposed to uncertainty....
  
  , such as Prospect Theory
  Prospect theory
  Prospect theory is a theory that describes decisions between alternatives that involve risk i.e. where the probabilities of outcomes are known. The model is descriptive: it tries to model real-life choices, rather than optimal decisions.-Model:...
  
  , there still remains to be seen a unified model that can make useful predictions that incorporates the entirety of cognitive biases and rational limitations in most humans. Further, there even exists debate as to whether it is necessary to incorporate such psychological limitations into economic models. While some economists insist they are necessary to fully appreciate the complexity of the market, others still contend that a model that incorporates human biases is either unrealistic or question its usefulness arguing that a model that doesn't approximate agents as being perfectly rational, with the possibility of minimal exceptions, is unlikely to be successful.

Financial economics

Financial economics

Financial Economics is the branch of economics concerned with "the allocation and deployment of economic resources, both spatially and across time, in an uncertain environment"....

 

• Equity premium puzzle
  Equity premium puzzle
  The equity premium puzzle is a term coined in 1985 by economists Rajnish Mehra and Edward C. Prescott. It is based on the observation that in order to reconcile the much higher returns of stocks compared to government bonds in the United States, individuals must have implausibly high risk aversion...
  
  : The Equity premium puzzle is thought to be one of the most important outstanding questions in the economic field. It is founded on the basis of that over the last one hundred years or so the average real return to stocks in the US has been substantially higher than that of treasury bills. The puzzle lies in the explaining the causes behind this equity premium. While there are a number of different theories regarding the puzzle, there still exists no definitive agreement on its cause.
• Dividend puzzle
  Dividend puzzle
  The dividend puzzle is a concept in finance in which companies that pay dividends are rewarded by investors with higher valuations, even though, according to many economists, it should not matter to investors whether a firm pays dividends or not...
  
  : The Dividend puzzle is the empirically observed phenomena that companies that pay dividend
  Dividend
  Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business , or it can be distributed to...
  
  s tend to be rewarded by investor
  Investor
  An investor is a party that makes an investment into one or more categories of assets --- equity, debt securities, real estate, currency, commodity, derivatives such as put and call options, etc...
  
  s with higher valuations
  Valuation (finance)
  In finance, valuation is the process of estimating what something is worth. Items that are usually valued are a financial asset or liability. Valuations can be done on assets or on liabilities...
  
  . At present, there is no explanation widely accepted by economists. The Modigliani-Miller theorem
  Modigliani-Miller theorem
  The Modigliani–Miller theorem forms the basis for modern thinking on capital structure. The basic theorem states that, under a certain market price process , in the absence of taxes, bankruptcy costs, agency costs, and asymmetric information, and in an efficient market, the value of a firm is...
  
   suggests that the puzzle can (only) be explained by some combination of taxes, bankruptcy costs, market inefficiency (including that due to investor psychology), and asymmetric information
  Information asymmetry
  In economics and contract theory, information asymmetry deals with the study of decisions in transactions where one party has more or better information than the other. This creates an imbalance of power in transactions which can sometimes cause the transactions to go awry, a kind of market failure...
  
  .
• Improved Black–Scholes and Binomial Options Pricing
  Binomial options pricing model
  In finance, the binomial options pricing model provides a generalizable numerical method for the valuation of options. The binomial model was first proposed by Cox, Ross and Rubinstein in 1979. Essentially, the model uses a “discrete-time” model of the varying price over time of the underlying...
  
   models: The Black–Scholes model and the more general binomial options pricing models are a collection of equations that seek to model and price equity
  Private equity
  Private equity, in finance, is an asset class consisting of equity securities in operating companies that are not publicly traded on a stock exchange....
  
   and call option
  Call option
  A call option, often simply labeled a "call", is a financial contract between two parties, the buyer and the seller of this type of option. The buyer of the call option has the right, but not the obligation to buy an agreed quantity of a particular commodity or financial instrument from the seller...
  
  s. While the models are widely used, they have many significant limitations. Chief among them are the model's inability to account for historical market movements and their frequent overpricing of options, with the overpricing increasing with the time to maturity. The development of a model that can properly account for the pricing of call options on an asset with stochastic
  Stochastic
  Stochastic refers to systems whose behaviour is intrinsically non-deterministic. A stochastic process is one whose behavior is non-deterministic, in that a system's subsequent state is determined both by the process's predictable actions and by a random element. However, according to M. Kac and E...
  
   volatility
  Volatility (finance)
  In finance, volatility is a measure for variation of price of a financial instrument over time. Historic volatility is derived from time series of past market prices...
  
   is considered an open problem in financial economics.

International economics

International economics

International economics is concerned with the effects upon economic activity of international differences in productive resources and consumer preferences and the institutions that affect them...

 

• Home bias in trade puzzle
  Home bias in trade puzzle
  The Home bias in trade puzzle is a widely-discussed problem in macroeconomics and international finance, first documented by John T. McCallum in an article from 1995....
  
  : The home bias in trade puzzle is an empirical observation that even when factors such as economic size of trading partners and the distance between them are considered, trade between regions within a given country is substantially greater than trade between regions in different countries, even when there are no substantial legal barriers. There is currently no framework to explain this observation.
• Equity home bias puzzle
  Equity home bias puzzle
  The Equity home bias puzzle is the term given to describe the fact that individuals and institutions in most countries hold only modest amounts of foreign equity. This is puzzling since observed returns on national equity portfolios suggest substantial benefits from international diversification...
  
  : This puzzle concerns the observation that individuals and institutions in many countries only hold modest amounts of foreign equity, despite the ability for vast diversification of their portfolios in the global economy. While some explanations do exist, such as that local individuals and firms have greater access to information about local firms and economic conditions, these explanations are not accepted by the majority of economists and have been mostly refuted.
• Backus-Kehoe-Kydland puzzle
  Backus-Kehoe-Kydland puzzle
  In economics, the Backus–Kehoe–Kydland consumption correlation puzzle, also known as the BKK puzzle, is the observation that consumption is much less correlated across countries than output.In an Arrow–Debreu economy, i.e...
  
  : The Backus-Kehoe-Kydland consumption correlation puzzle is the empirical observation that consumption is much less correlated across countries than output. Standard economic theory suggests that country-specific output risks should be collective and domestic consumption growth should not depend strongly on country-specific income shocks. Thus, we should not see the observation that consumption is much less correlated across countries than output; and yet we do.
• Feldstein-Horioka puzzle
  Feldstein-Horioka puzzle
  The Feldstein-Horioka puzzle is a widely-discussed problem in macroeconomics and international finance, first documented by Martin Feldstein and Charles Horioka in an 1980 paper. According to economic theory, if we assume that investors that are able to easily invest anywhere in the world, they ...
  
  : The Feldstein-Horioka puzzle originates from an article in the 1980s that found that among OECD countries, averages of long-term national savings rates are highly correlated with similar averages of domestic investment rates. Standard economic theory suggests that in relatively open international financial markets, the savings of any country would flow to countries with the most productive investment opportunities; hence, saving rates and domestic investment rates would be uncorrelated, contrary to the empirical evidence suggested by Feldstein
  Martin Feldstein
  Martin Stuart "Marty" Feldstein is an economist. He is currently the George F. Baker Professor of Economics at Harvard University, and the president emeritus of the National Bureau of Economic Research . He served as President and Chief Executive Officer of the NBER from 1978 through 2008...
  
   and Horioka
  Charles Horioka
  Charles Yuji Horioka is an American economist residing in Japan. Horioka received his B.A. and Ph.D. degrees from Harvard University and is currently professor of economics at the Institute of Social and Economic Research at Osaka University...
  
  . While numerous articles regarding the puzzle have been published, none of the explanations put forth thus far have adequate empirical support.
• PPP Puzzle: The PPP puzzle, considered one of the two real exchange rate puzzles
  Real exchange rate puzzles
  The real exchange-rate puzzles is a common term for two much-discussed anomalies of real exchange rates: that real exchange rates are more volatile and show more persistence than what most models can account for...
  
  , concerns the observation that real exchange rates are both more volatile
  Volatility (finance)
  In finance, volatility is a measure for variation of price of a financial instrument over time. Historic volatility is derived from time series of past market prices...
  
   and more persistent than most models would suggest. The only clear way to understand this volatility would be to assign substantial roles to monetary and financial shocks
  Shock (economics)
  In economics a shock is an unexpected or unpredictable event that affects an economy, either positively or negatively. Technically, it refers to an unpredictable change in exogenous factors—that is, factors unexplained by economics—which may have an impact on endogenous economic variables.The...
  
  . However, if shocks play such a large role the challenge becomes finding what source, if one even exists, of nominal rigidity that could be so persistent to explain the long-term prolonged nature of real exchange rate deviations.
• The Exchange Rate Disconnect Puzzle: The exchange rate disconnect puzzle, also one of the so-called real exchange rate puzzles, concerns the weak short-term feedback link between exchange rates and the rest of the economy. In most economies, the exchange rate is the most important relative price, so it is surprising, and thus far unexplained entirely, that the correlations are not stronger.