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on Utility Models and Prospect Theories |
| By: | Frank Heinemann (Technische Universität Berlin, Sekretariat H 52 Strasse des 17. Juni 135, 10623 Berlin f.heinemann@ww.tu-berlin.de) |
| Abstract: | Measuring risk aversion is sensitive to assumptions about the wealth in subjects’ utility functions. Data from the same subjects in low- and high-stake lottery decisions allow estimating the wealth in a pre-specified one-parameter utility function simultaneously with risk aversion. This paper first shows how wealth estimates can be identified assuming constant relative risk aversion (CRRA). Using the data from a recent experiment by Holt and Laury (2002), it is shown that most subjects’ behavior is consistent with CRRA at some wealth level. However, for realistic wealth levels most subjects’ behavior implies a decreasing relative risk aversion. An alternative explanation is that subjects do not fully integrate their wealth with income from the experiment. Within-subject data do not allow discriminating between the two hypotheses. Using between-subject data, maximum-likelihood estimates of a hybrid utility function indicate that aggregate behavior can be described by expected utility from income rather than expected utility from final wealth and partial relative risk aversion is increasing in the scale of payoffs. |
| Keywords: | lottery choice, risk aversion, myopic risk aversion |
| JEL: | C81 C91 D81 |
| Date: | 2005–09 |
| URL: | http://d.repec.org/n?u=RePEc:trf:wpaper:156&r=upt |
| By: | Wolfram J. Horneff; Raimond Maurer; Olivia S. Mitchell; Ivica Dus |
| Abstract: | Retirees must draw down their accumulated assets in an orderly fashion so as not to exhaust their funds too soon. We derive the optimal retirement portfolio from a menu that includes payout annuities as well as an investment allocation and a withdrawal strategy, assuming risk aversion, stochastic capital markets, and uncertain lifetimes. The resulting portfolio allocation, when fixed as of retirement, is then compared to phased withdrawal strategies such a “self-annuitization” plan or the 401(k) “default” pattern encouraged under US tax law. Surprisingly, the fixed percentage approach proves appealing for retirees across a wide range of risk preferences, supporting financial planning advisors who often recommend this rule. We then permit the retiree to switch to an annuity later, which gives her the chance to invest in the capital market and “bet on death.” As risk aversion rises, annuities first crowd out bonds in retiree portfolios; at higher risk aversion still, annuities replace equities in the portfolio. Making annuitization compulsory can also lead to substantial utility losses for less risk-averse investors. |
| Date: | 2006–07 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:12392&r=upt |
| By: | Nicholas Barberis; Wei Xiong |
| Abstract: | One of the most striking portfolio puzzles is the “disposition effect”: the tendency of individuals to sell stocks in their portfolios that have risen in value since purchase, rather than fallen in value. Perhaps the most prominent explanation for this puzzle is based on prospect theory. Despite its prominence, this explanation has received little formal scrutiny. We take up this task, and analyze the trading behavior of investors with prospect theory preferences. We find that, at least for the simplest implementation of prospect theory, the link between these preferences and the disposition effect is not as obvious as previously thought: in some cases, prospect theory does indeed predict a disposition effect, but in others, it predicts the opposite. We provide intuition for these results, and identify the conditions under which the disposition effect holds or fails. We also discuss the implications of our results for other disposition-type effects that have been documented in settings such as the housing market, futures trading, and executive stock options. |
| JEL: | G11 G12 |
| Date: | 2006–07 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:12397&r=upt |
| By: | Jonathan Gardner (Watson Wyatt Worldwide); Andrew J. Oswald (University of Warwick and IZA Bonn) |
| Abstract: | One of the famous questions in social science is whether money makes people happy. We offer new evidence by using longitudinal data on a random sample of Britons who receive medium-sized lottery wins of between £1000 and £120,000 (that is, up to approximately U.S. $200,000). When compared to two control groups - one with no wins and the other with small wins - these individuals go on eventually to exhibit significantly better psychological health. Two years after a lottery win, the average measured improvement in mental wellbeing is 1.4 GHQ points. |
| Keywords: | psychological health, happiness, GHQ, income |
| JEL: | D1 I3 |
| Date: | 2006–07 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp2233&r=upt |