Utility Models and Prospect Theory
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Utility Models and Prospect Theory2014-07-21Alexander HarinA Behavioral Definition of States of the World
http://d.repec.org/n?u=RePEc:hal:cesptp:halshs-01021388&r=upt
This paper elaborates an axiomatic treatment of the Subjective Expected Utility (SEU) model that dispenses with the assumption of an exogenous state space. Within a state-free description of uncertainty and alternatives, axioms for preferences are formulated and shown to characterize the existence of a subjective state space, a subjective probability and a utility function. In the representation, the individual appears to behave as if he used the state space to describe uncertainty and maximized SEU to make decisions. Moreover, the state space, probability and utility are unique in some appropriate sense.Vassili Vergopoulos2014-02Expected utility; subjective state space; causality; consequentialismEfficient allocations and Equilibria with short-selling and Incomplete Preferences
http://d.repec.org/n?u=RePEc:hal:cesptp:halshs-01020646&r=upt
This article reconsiders the theory of existence of efficient allocations and equilibria when consumption sets are unbounded below under the assumption that agents have incomplete preferences. It is motivated by an example in the theory of assets with short-selling where there is risk and ambiguity. Agents have Bewley's incomplete preferences. As an inertia principle is assumed in markets, equilibria are individually rational. It is shown that a necessary and sufficient condition for the existence of an individually rational efficient allocation or of an equilibrium is that the relative interiors of the risk adjusted sets of probabilities intersect. The more risk averse, the more ambiguity averse the agents, the more likely is an equilibrium to exist. The paper then turns to incomplete preferences represented by a family of concave utility functions. Several definitions of efficiency and of equilibrium with inertia are considered. Sufficient conditions and necessary and sufficient conditions are given for the existence of efficient allocations and equilibria with inertia.Rose-Anne Dana, Cuong Le Van2014-05Uncertainty; risk; risk adjusted prior; no arbitrage; equilibrium with short-selling; incomplete preferences; equilibrium with inertiaExpected Utility without Parsimony
http://d.repec.org/n?u=RePEc:hal:cesptp:halshs-01021392&r=upt
This paper seeks to interpret observable behavior and departures from Savage's model of Subjective Expected Utility (SEU) in terms of knowledge and belief. It is shown that observable behavior displays sensitivity to ambiguity if and only if knowledge and belief disagree. In addition, such an epistemic interpretation of ambiguity leads to dynamically consistent extensions of non-SEU preferences.Antoine Billot, Vassili Vergopoulos2014-03Ambiguity; state of world; knowledge; dynamic consistencyUtilitarianism with Prior Heterogeneity
http://d.repec.org/n?u=RePEc:hal:cesptp:halshs-01021399&r=upt
Harsanyi's axiomatic justification of utilitarianism is extended to a framework with subjective and heterogenous priors. Contrary to the existing literature on aggregation of preferences under uncertainty, society is here allowed to formulate probability judgements, not on the actual state of the world as individuals do, but rather on the opinion they each have on the actual state. An extended Pareto condition is then proposed that characterizes the social utility function as a convex combination of individual ones and the social prior as the independent product of individual ones.Antoine Billot, Vassili Vergopoulos2014-06Utilitarianism; prior heterogeneity; Pareto conditionPortfolio optimization in the case of an asset with a given liquidation time distribution
http://d.repec.org/n?u=RePEc:arx:papers:1407.3154&r=upt
Management of the portfolios containing low liquidity assets is a tedious problem. The buyer proposes the price that can differ greatly from the paper value estimated by the seller, the seller, on the other hand, can not liquidate his portfolio instantly and waits for a more favorable offer. To minimize losses in this case we need to develop new methods. One of the steps moving the theory towards practical needs is to take into account the time lag of the liquidation of an illiquid asset. This task became especially significant for the practitioners in the time of the global financial crises. Working in the Merton's optimal consumption framework with continuous time we consider an optimization problem for a portfolio with an illiquid, a risky and a risk-free asset. While a standard Black-Scholes market describes the liquid part of the investment the illiquid asset is sold at a random moment with prescribed liquidation time distribution. In the moment of liquidation it generates additional liquid wealth dependent on illiquid assets paper value. The investor has the logarithmic utility function as a limit case of a HARA-type utility. Different distributions of the liquidation time of the illiquid asset are under consideration - a classical exponential distribution and Weibull distribution that is more practically relevant. Under certain conditions we show the existence of the viscosity solution in both cases. Applying numerical methods we compare classical Merton's strategies and the optimal consumption-allocation strategies for portfolios with different liquidation-time distributions of an illiquid asset.Ljudmila A. Bordag, Ivan P. Yamshchikov, Dmitry Zhelezov2014-07Long-run risk is the worst-case scenario: ambiguity aversion and non-parametric estimation of the endowment process
http://d.repec.org/n?u=RePEc:fip:fedfwp:2014-16&r=upt
We study an agent who is unsure of the dynamics of consumption growth. She estimates her consumption process non-parametrically to place minimal restrictions on dynamics. We analytically show that the worst-case model that she uses for pricing, given a penalty on deviations from the point estimate, is a model with long-run risks. This result cannot in general be matched in a fixed model with only parameter uncertainty. With a single parameter determining risk preferences, the model generates high and volatile risk premia and matches R2s from return forecasting regressions, even though risk aversion is equal to 5.3 and the worst-case dynamics are statistically nearly indistinguishable from the true model.Bidder, Rhys, Dew-Becker, Ian2014-05Anchoring or Loss Aversion? Empirical Evidence from Art Auctions
http://d.repec.org/n?u=RePEc:cue:wpaper:awp-04-2014&r=upt
We find evidence for the behavioral biases of anchoring and loss aversion. We find that anchoring is more important for items that are resold quickly, and we find that the effect of loss aversion increases with the time that a painting is held. The evidence in favor of anchoring and loss aversion with this large dataset validates previous results and adds to the empirical evidence a finding of increasing loss aversion with the length a painting is held. We do not find evidence that investors can take advantage of these behavioral biases.Kathryn Graddy, Lara Loewenstein, Jianping Mei, Mike Moses, Rachel A J Pownall2014-06D03, D44, Z11