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on Utility Models and Prospect Theories |
| By: | Fabio Maccheroni; Massimo Marinacci; Aldo Rustichini |
| Abstract: | We introduce and axiomatize dynamic variational preferences, the dynamic version of the variational preferences we axiomatized in [21], which generalize the multiple priors preferences of Gilboa and Schmeidler [9], and include the Multiplier Preferences inspired by robust control and first used in macroeconomics by Hansen and Sargent (see [11]), as well as the classic Mean Variance Preferences of Markovitz and Tobin. We provide a condition that makes dynamic variational preferences time consistent, and their representation recursive. This gives them the analytical tractability needed in macroeconomic and financial applications. A corollary of our results is that Multiplier Preferences are time consistent, but Mean Variance Preferences are not. |
| Keywords: | Ambiguity Aversion; Model Uncertainty; Recursive Utility; Robust Control; Time Consistency |
| JEL: | C61 D81 |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:cca:wpaper:1&r=upt |
| By: | Dhillon, Amrita (Department of Economics, University of Warwick); Herzog-Stein, Alexander (Department of Economics, University of Warwick) |
| Abstract: | Following recent empirical evidence which indicates the importance of rank for the determination of workers’ wellbeing, this paper introduces status seeking preferences in the form of rank-dependent utility functions into a moral hazard framework with one firm and multiple workers, but no correlation in production. Workers’ concern for the rank of their wage in the firm’s wage distribution may induce the firm to offer discriminatory wage contracts when its aim is to induce all workers to expend effort. |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:wrk:warwec:759&r=upt |
| By: | Andrew E. Clark; Paul Frijters; Michael A. Shields |
| Abstract: | There is now a great deal of micro-econometric evidence, both cross-section and panel, showing that income is positively correlated with well-being. Yet the famous Easterlin paradox shows essentially no change in average happiness at the country level, despite spectacular rises in per capita GDP. We argue that survey well-being questions are indeed good proxy measures of utility, and resolve the Easterlin paradox by appealing to income comparisons: these can be to others (social comparisons) or to oneself in the past (habituation). We review a substantial amount of econometric, experimental and neurological literature consistent with comparisons, and then spell out the implications for a wide range of economic issues. |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:pse:psecon:2006-24&r=upt |
| By: | Santiago Budria; Antonia Diaz |
| Abstract: | In this paper we investigate the size of the risk premium and the term premium in an representative agent exchange model economy where households preferences are subject to habit formation. As a novel feature, we develop theoretical measures for risk premium and term premium that can be used even when the consumption growth process is serially autocorrelated. We find that habit formation increases risk aversion significantly but increases much more the aversion to variations of consumption across dates. This induces a substantial increase in the precautionary demand of short term assets and a significant fall in the precautionary demand of long term assets. As a result, the term premium increases substantially with habit formation. Next we calibrate our model economy and examine the quantitative predictions of our theoretical measures of equity premium, risk premium and term premium. In line with previous literature, we show that it is possible to find a reasonable calibration for which the equity premium is that observed in the data. However, we find that around 70 percent of the equity premium is just term premium. That is, a very large fraction of the increase in the equity premium is due to the asymmetric effect that habit formation has on the precautionary demand of an asset depending on its maturity. |
| Date: | 2006–09 |
| URL: | http://d.repec.org/n?u=RePEc:cte:werepe:we065522&r=upt |
| By: | Fabio Maccheroni; Massimo Marinacci; Aldo Rustichini |
| Keywords: | Ambiguity; Robustness, Multiplier Preferences |
| JEL: | D81 |
| Date: | 2004 |
| URL: | http://d.repec.org/n?u=RePEc:cca:wpaper:12&r=upt |
| By: | Olivier Armantier; Nicolas Treich |
| Abstract: | We conduct an experiment to test whether probability misperception may be a possible alternative to risk aversion to explain overbidding in independent first-price private-values auctions. The experimental outcomes indicate that subjects underestimate their probability of winning the auction, and indeed overbid. Yet, when provided with feed-back on the precision of their predictions, subjects learn first to predict their probability of winning correctly, and second to curb-down significantly overbidding. The structural estimation of different behavioral models suggests that i) subjects are heterogenous with respect to risk preferences and probability perceptions, ii) subjects tend to best-respond to their stated beliefs, and iii) although necessary to explain fully behavior, risk aversion appears to play a lesser role than previously believed. Finally, our experimental findings are shown to be consistent with a standard theoretical auction model combining risk aversion and misperception of probabilities. <P>Nous menons une expérience pour évaluer si le fait qu'un sujet évalue mal ses probabilités de gagner peut être une hypothèse alternative à l’aversion au risque pour expliquer les surenchères lors d'enchères indépendantes privées au premier prix. Les résultats expérimentaux montrent, en effet, que les sujets sous-estiment leurs probabilités de gagner l'enchère et ont tendance à surenchérir. Cependant, lorsqu'on leur présente plus de précisions sur leurs prédictions, les sujets apprennent d'abord à prédire correctement leurs probabilités de gagner, puis à limiter considérablement la surenchère. L'estimation de différents modèles du comportement suggère que i) les sujets sont hétérogènes par rapport à leurs préférences du risque et leurs perceptions des probabilités, ii) les sujets choisissent leur meilleure réponse conditionnellement aux croyances qu’ils révèlent, et iii) bien que nécessaire pour expliquer pleinement le comportement des sujets, l'aversion au risque semble jouer un rôle moins important que prévu. Finalement, nos résultats expérimentaux sont consistants avec un modèle théorique d'enchères standard qui combine l'aversion au risque et la mauvaise perception des probabilités. |
| Keywords: | auctions, misperception of probabilities, overbidding, risk-aversion, aversion au risque, enchères, mauvaise perception des probabilités, surenchère |
| JEL: | C70 C92 D44 D81 |
| Date: | 2006–08–01 |
| URL: | http://d.repec.org/n?u=RePEc:cir:cirwor:2006s-15&r=upt |
| By: | Hui Guo; Zijun Wang; Jian Yang |
| Abstract: | Using a semiparametric estimation technique, we show that the risk-return tradeoff and the Sharpe ratio of the stock market increases monotonically with the consumption wealth ratio (CAY) across time. While early studies have commonly interpreted such a finding as evidence of the countercyclical variation in aggregate relative risk aversion (RRA), we argue that it mainly reflects changes in investment opportunities for two reasons. First, we fail to reject the null hypothesis of constant RRA after controlling for CAY as a proxy for the hedge against changes in the investment opportunity set. Second, by contrast with habit formation models but consistent with ICAPM, we find that loadings on the conditional stock market variance scaled by CAY are negatively priced in the cross-sectional regressions. For illustration, we replicate the countercyclical stock market risk-return tradeoff using simulated data from Guo's (2004) limited stock market participation model, in which RRA is constant and CAY is a proxy for shareholders' liquidity conditions. |
| Keywords: | Capital assets pricing model ; Stock market |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2006-047&r=upt |
| By: | Larry G. Epstein; Massimo Marinacci |
| Abstract: | The paper considers an agent who must choose an action today under uncertainty about the consequence of any chosen action but without having in mind a complete list of all the contingencies that could influence outcomes. She conceives of some relevant (subjective) contingencies but she is aware that these contingencies are coarse - they leave out some details that may affect outcomes. Though she may not be able to describe these finer details, she is aware that they exist and this may affect her behavior. |
| Keywords: | Unforeseen Contingencies, Ambiguity, Menu Choices |
| JEL: | D81 |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:cca:wpaper:4&r=upt |
| By: | Svensson, Lars E.O.; Williams, Noah |
| Abstract: | We examine optimal and other monetary policies in a linear-quadratic setup with a relatively general form of model uncertainty, so-called Markov jump-linear-quadratic systems extended to include forward-looking variables. The form of model uncertainty our framework encompasses includes : simple i.i.d. model deviations; serially correlated model deviations; estimable regimeswitching models; more complex structural uncertainty about very different models, for instance, backward- and forward-looking models; time-varying central-bank judgment about the state of model uncertainty; and so forth. We provide an algorithm for finding the optimal policy as well as solutions for arbitrary policy functions. This allows us to compute and plot consistent distribution forecasts–fan charts–of target variables and instruments. Our methods hence extend certainty equivalence and “mean forecast targeting” to more general certainty non-equivalence and “distribution forecast targeting.” |
| Keywords: | Optimal policy, multiplicative uncertainty |
| JEL: | E42 E52 E58 |
| Date: | 2005 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:bubdp1:4229&r=upt |