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on Utility Models and Prospect Theories |
| By: | Pavlo Blavatskyy; Ganna Pogrebna |
| Abstract: | In the television show Affari Tuoi a contestant is endowed with a sealed box containing a monetary prize between one cent and half a million euros. In the course of the show the contestant is offered to exchange her box for another sealed box with the same distribution of possible monetary prizes inside. This offers a unique natural laboratory for testing the predictions of expected utility theory versus prospect theory using lotteries with large stakes. While expected utility theory predicts that an individual is exactly indifferent between accepting and rejecting the exchange offer, prospect theory predicts that an individual should always reject the exchange offer due to the assumption of loss aversion. We find that the assumption of loss aversion is violated by 46 percent of all contestants in our recorded sample. Thus, contestants do not appear to be predominantly loss averse when dealing with lotteries involving large stakes. |
| Keywords: | loss aversion, expected utility theory, prospect theory, natural experiment |
| JEL: | C93 D81 |
| Date: | 2006–02 |
| URL: | http://d.repec.org/n?u=RePEc:zur:iewwpx:274&r=upt |
| By: | Robert G. Chambers (Dept of Agricultural and Resource Economics, University of Maryland, College Park); John Quiggin (Department of Economics, University of Queensland) |
| Abstract: | The idea that preferences may be state-dependent fits naturally with an analysis of uncertainty based on explicit representation of random variables as state-contingent consumption or production bundles. In this paper we show how these concepts of risk-aversion may be extended to the case of state-dependent preferences, whether or not these preferences are autocomparable in the sense of Karni. We characterize autocomparability as a special case. We show how standard comparative static results, originally derived for the state-independent expected utility model, may be extended to general state-dependent preferences, without the requirement for additive separability. |
| Date: | 2005–06 |
| URL: | http://d.repec.org/n?u=RePEc:rsm:riskun:r05_5&r=upt |
| By: | Monica Paiella (Bank of Italy, Research Department) |
| Abstract: | This paper estimates a lower bound to the foregone gains of incomplete portfolios, which are in turn a lower bound to the (unobserved) entry costs that could rationalize non-participation to financial markets. My estimates provide a heuristic test for the cost-based explanation of limited financial market participation: high estimates would imply implausibly high participation costs. Using the CEX and assuming isoelastic utility and a relative risk aversion of 3 or less, for the stock market I estimate an average lower bound ranging between 0.7 and 3.3 percent of consumption. Since annual total (observable plus unobservable) participation costs are likely to exceed these bounds, the cost-based explanation is not rejected by this test. |
| Keywords: | intertemporal consumption model, financial market participation, household portfolio allocation, non-proportional cost of participation, near-rationality |
| JEL: | G11 D12 E21 |
| Date: | 2006–02–01 |
| URL: | http://d.repec.org/n?u=RePEc:sef:csefwp:156&r=upt |
| By: | Olivier ROUSSE; Benoît SEVI |
| Abstract: | The aim of this paper is to examine portfolio management of emission allowances in the US Sulfur Dioxide Emissions Allowance Trading Program, to determine whether utilities have a real motive to bank when risk increases. We test a theoretical model linking the motivation of the firm to accumulate permits in order to prepare itself to face a risky situation in the future. Empirical estimation using data for years 2001 to 2004 provides evidence of a relationship between banking behavior and uncertainty the utility is facing with. |
| Keywords: | Emissions Trading, Permits Banking, Acid Rain Program Uncertainty, Risk Aversion, Prudence. |
| JEL: | D81 G11 Q28 |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:mop:credwp:06.63&r=upt |
| By: | Mette Gørtz (Department of Economics, University of Copenhagen) |
| Abstract: | This paper discusses the determinants of the retirement decision and the implications of retirement on economic well-being. The main contribution of the paper is to formulate the role of individual heterogeneity explicitly. We argue that individual heterogeneity in 1) productivity of market work versus housework, 2) preferences for leisure compared to consumption, and 3) marginal utility of wealth, is correlated with the retirement decision. Based on US consumption and time use data for 2001 and 2003 from the Consumptions and Activities Mail Survey (CAMS), we study the patterns of individual choices of expenditure, household production and leisure for people in and around retirement. The unobserved individual heterogeneity factor is isolated by comparing cross-sectional evidence and panel data estimates of the effects of retirement on consumption and time allocation. Based on cross-section data, we can identify a difference in consumption due to retirement status, but when the panel nature of the data is exploited, the effect of retirement on consumption is small and insignificant. Moreover, the analyses point at a large positive effect of retirement on household production. Our results therefore contribute to the discussion of the so-called retirement-consumption puzzle. Many analyses of the retirement-consumption drop assume that the retirement decision is exogenous. However, the individual decision on when to retire may depend on expected changes in consumption and time allocation. This suggests that the retirement decision is endogenous. To test this, we apply an instrumental variables method in the treatment effects tradition. |
| Keywords: | retirement; consumption; household production; heterogeneity |
| JEL: | C23 D91 J14 |
| Date: | 2006–01 |
| URL: | http://d.repec.org/n?u=RePEc:kud:kuieca:2006_01&r=upt |
| By: | Francesco Menoncin |
| Abstract: | In a simple framework where we have: (i) a stochastic domestic interest rate, (ii) a stochastic exchange rate, (iii) both a domestic and a foreign riskless asset, and (iv) both a domestic and a foreign risky asset, we explicitly compute the optimal asset allocation for an investor who wants to maximize the expected (CRRA) utility of his final wealth. This explicit solution allows us the widely investigate the behaviour of the optimal portfolio hedging component with respect to all the parameters in the model. In particular, we show a numerical simulation for investigating the hedging strategy against the exchange rate risk. |
| URL: | http://d.repec.org/n?u=RePEc:ubs:wpaper:ubs0404&r=upt |