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on Utility Models and Prospect Theories |
| By: | Morone, Andrea; Schmidt, Ulrich |
| Abstract: | Experimental research on decision making under risk has until now always employed choice data in order to evaluate the empirical performance of expected utility and the alternative nonexpected utility theories. The present paper performs a similar analysis which relies on pricing data instead of choice data. Since pricing data lead in many cases to a different ordering of lotteries than choices (e.g. the preference reversal phenomenon) our analysis may have fundamental different results than preceding investigations. We elicit three different types of pricing data: willingness-to-pay, willingness-to-accept and certainty equivalents under the Becker-DeGroot-Marschak (BDM) incentive mechanism. One of our main result shows that the comparative performance of the single theories differs significantly under these three types of pricing data. |
| Keywords: | expected utility, non-expected utility, experiments, WTP, WTA, BDM |
| JEL: | C91 D81 |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:cauewp:4759&r=upt |
| By: | Daniel Hernandez–Hernandez; Alexander Schied |
| Abstract: | We propose a stochastic control approach to the dynamic maximization of robust utility functionals that are defined in terms of logarithmic utility and a dynamically consistent convex risk measure. The underlying market is modeled by a diffusion process whose coefficients are driven by an external stochastic factor process. In particular, the market model is incomplete. Our main results give conditions on the minimal penalty function of the robust utility functional under which the value function of our problem can be identified with the unique classical solution of a quasilinear PDE within a class of functions satisfying certain growth conditions. The fact that we obtain classical solutions rather than viscosity solutions is important for the use of numerical algorithms, whose applicability is demonstrated in examples. |
| Keywords: | Optimal investment, model uncertainty, incomplete markets, stochastic volatility, coherent risk measure, convex risk measure, optimal control, convex duality |
| JEL: | G11 D81 |
| Date: | 2006–09 |
| URL: | http://d.repec.org/n?u=RePEc:hum:wpaper:sfb649dp2006-061&r=upt |
| By: | Paola Manzini (Queen Mary, University of London and IZA); Marco Mariotti (Queen Mary, University of London) |
| Abstract: | We study two boundedly rational procedures in consumer behavior. We show that these procedures can be detected by conditions on observable demand data of the same type as standard revealed preference axioms. This provides the basis for a non-parametric analysis of boundedly rational consumer behavior mirroring the classical one for utility maximization. |
| Keywords: | Bounded rationality, Revealed preference, Consumer choice |
| JEL: | D1 D11 |
| Date: | 2006–09 |
| URL: | http://d.repec.org/n?u=RePEc:qmw:qmwecw:wp571&r=upt |
| By: | David Schmidt (Federal Trade Commission, Bureau of Economics); Robert Shupp (Ball State University); James M. Walker (Indiana University Bloomington) |
| Abstract: | Across many forms of rent seeking contests, the impact of risk aversion on equilibrium play is indeterminate. We design an experiment to compare individuals’ decisions across three contests which are isomorphic under risk-neutrality, but are typically not isomorphic under other risk preferences. The pattern of individual play across our contests is not consistent with a Bayes-Nash equilibrium for any distribution of risk preferences. We show that replacing the Bayes-Nash equilibrium concept with the quantal response equilibrium, along with heterogeneous risk preferences can produce equilibrium patterns of play that are very similar to the patterns we observe. |
| Keywords: | rent seeking, experiments, risk aversion, game theory |
| JEL: | C72 C92 D72 |
| Date: | 2005–02 |
| URL: | http://d.repec.org/n?u=RePEc:inu:caeprp:2006004&r=upt |
| By: | Schlicht, Ekkehart |
| Abstract: | Many contributions to the economics of religion postulate an "afterlife consumption motive." People are assumed to maximize total utility--including afterlife utility. This essay argues that the approach is unsatifactory for several reasons. First, many regularities in religious participation may be explained by ordinary consumption theory without invoking an afterlife; second, there exist religions that do not postulate an afterlife, and there are religions that suppose an afterlife yet do not allow men to influence their fate in the hereafter by good deeds; and third, if afterlife consumption were the foundation for religious demand, we would observe an inflation of promises about afterlife bliss, brought about by competition among the religions. It is proposed to follow David Hume (1775) and see religious demand as originating from the desire of human beings to understand the world and justify their action. This religious motive ("quest for sense") can explain the emergence of ideas about an afterlife and afterlife consumption in monotheistic religions and permits to understand why an inflation of afterlife promises does not occur. |
| Keywords: | religion; afterlife |
| JEL: | Z12 |
| Date: | 2006–09 |
| URL: | http://d.repec.org/n?u=RePEc:lmu:muenec:1186&r=upt |
| By: | Robert S. Shupp (Ball State University); Arlington W. Williams (Indiana University Bloomington) |
| Abstract: | This research compares lottery valuation decisions made by individuals with similar decisions made by small groups. There is an extensive social psychology literature addressing group versus individual decision making, but few studies explore this issue in economic contexts with cash rewards. Willingness-to pay data elicited from independent samples of individuals and three-person groups in a repeated-measures experimental design reveal that: 1) the variance of risk preferences is generally smaller for groups than individuals, and 2) the average group is more risk averse than the average individual in high-risk situations, but groups tend to be less risk averse in low-risk situations. |
| Keywords: | lab experiments, risk preferences, group decisions, certainty equivalents |
| JEL: | C91 C92 D80 |
| Date: | 2006–04 |
| URL: | http://d.repec.org/n?u=RePEc:inu:caeprp:2006-006&r=upt |
| By: | Raghu Suryanarayanan (University of Chicago and CSEF) |
| Abstract: | This paper clarifies and extends the model of anticipated regret and endogenous beliefs based on the Savage (1951) Minmax Regret Criterion developped in Suryanarayanan (2006a). A decision maker chooses an action with state contingent consequences but cannot precisely assess the true probability distribution of the state. She distrusts her prior about the true distribution and surrounds it with a set of alternative but plausible probability distributions. The decision maker minimizes the worst expected regret over all plausible probability distributions and alternative actions, where regret is the loss experienced when the decision maker compares an action to a counterfactual feasible alternative for a given realization of the state. Preliminary theoretical results provide a systematic algorithm to find the solution to the decision problem and show how models of Minmax Regret differs from models of ambiguity aversion and expected utility. In particular, the solution to the decision problem can always be represented as a saddle point solution to an equivalent zerosum game problem. This new problem jointly produces the solution to the Anticipated Regret problem and the endogenous belief. We then use the endogenous belief to define the implicit certainty equivalent and to build an infinite horizon and time consistent problem for a decision maker minimizing her lifetime worst expected regrets. |
| Date: | 2006–09–01 |
| URL: | http://d.repec.org/n?u=RePEc:sef:csefwp:161&r=upt |
| By: | Santiago Budría; Antonia Díaz |
| Abstract: | In this paper we analyze the equity, risk, and 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. |
| URL: | http://d.repec.org/n?u=RePEc:fda:fdaddt:2006-23&r=upt |
| By: | Wiebke Wittmüß |
| Abstract: | We consider the problem of optimal consumption for an investor who is risk and uncertainty avers. We model these preferences of the investor with the help of a convex risk-measure. Apart from consumption the agent has the possibility to invest initial capital and random endowment in a market where stock-prices are semimartingales. We formulate this as a maximin problem that will be solved by duality methods. |
| Keywords: | duality theory, risk measures, optimal consumption, model uncertainty |
| JEL: | D11 D81 |
| Date: | 2006–09 |
| URL: | http://d.repec.org/n?u=RePEc:hum:wpaper:sfb649dp2006-063&r=upt |
| By: | Urs Schweizer (Department of Economics, University of Bonn, Adenauerallee 24, 53113 Bonn, Germany, schweizer@uni-bonn.de) |
| Abstract: | A setting of reliance investments is explored where one of the parties to a contract obtains private information concerning his utility or cost function that remains hidden to the other party and to courts. As a consequence, it will be a difficult task to award expectation damages corrrectly to a party with private information who sufffers from breach of contract. While a revelation mechanism would exist that leads to the first best solution, assessing expectation damages correctly turns out to be at odds with ex post efficiency. I conclude that, under asymmetric information, the performance of expectation damages falls short of what more general mechanisms could achieve. |
| Keywords: | reliance investments, expectation damages, breach of contract, hidden information |
| JEL: | K12 D82 |
| Date: | 2006–09 |
| URL: | http://d.repec.org/n?u=RePEc:trf:wpaper:162&r=upt |
| By: | Jonathan W. Leland |
| Abstract: | Rubinstein (1988, 2003) and Leland (1994, 1998, 2001, 2002) have shown that choices based on similarity judgments will account for the vast majority of observed violations of expected and discounted utility. In this paper, I show that such judgments also explain which equilibria will be selected in single-shot games with multiple equilibria, predict circumstances in which non-equilibria outcomes may predominate in such games, and predict circumstances in which specific pure strategy outcomes will predominate in games with no pure strategy equilibria. |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:trn:utwpce:0604&r=upt |
| By: | Jean-Pascal Bénassy |
| Abstract: | This article studies a new class of models which synthesize the two traditions of general equilibrium with nonclearing markets and imperfect competition on the one hand, and dynamic stochastic general equilibrium (DSGE) models on the other hand. This line of models has become a central paradigm of modern macroeconomics for at least three reasons: (a) it displays solid microeconomic foundations, (b) it is a highly synthetic theory, which combines in a unified framework general equilibrium, nonclearing markets, imperfect competition, growth theory and rational expectations, (c) it is also an empirical success, leading to substantial progress towards matching real world statistics. |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:pse:psecon:2006-26&r=upt |
| By: | Suzanne Grazier (WELMERC, University of Wales at Swansea); Peter J. Sloane (WELMERC, University of Wales at Swansea and IZA Bonn) |
| Abstract: | Many studies show that women are more risk averse than men. In this paper, following DeLeire and Levy (2004) for the US, we use family structure as a proxy for the degree of risk aversion to test the proposition that those with strong aversion to risk will make occupational choices biased towards safer jobs. In line with DeLeire and Levy we find that women are more risk averse than men and those married with children are more risk averse than those without. However, the effect on the degree of gender segregation is much smaller than for the US. |
| Keywords: | accident risk, gender segregation, family status, occupational choice |
| JEL: | J0 J2 K2 |
| Date: | 2006–09 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp2302&r=upt |
| By: | Alejandro Balbás (Universidad Carlos III); Raquel Balbás (Universidad Autónoma de Madrid); Silvia Mayoral (Universidad de Navarra) |
| Abstract: | The minimization of general risk or dispersion measures is becoming more and more important in Portfolio Choice Theory. There are two major reasons. Firstly, the lack of symmetry in the returns of many assets provokes that the classical optimization of the standard deviation may lead to dominated strategies, from the point of view of the second order stochastic dominance. Secondly, but not less important, many institutional investors must respect legal capital requirements, which may be more easily studied if one deals with a risk measure related to capital losses. This paper proposes a new method to simultaneously minimize several risk or dispersion measures. The representation theorems of risk measures are applied to transform the general risk minimization problem in a minimax problem, and later in a linear programming problem between infinite-dimensional Banach spaces. Then, new necessary and sufficient optimality conditions are stated and a simplex-like algorithm is developed. The algorithm solves the dual (and therefore the primal) problem and provides both optimal portfolios and their sensitivities. The approach is general enough and does not depend on any particular risk measure, but some of the most important cases are specially analyzed. |
| Keywords: | Risk Measure. Deviation Measure. Portfolio Selection. Infinite-Dimensional Linear Programming. Simpl |
| JEL: | G11 |
| URL: | http://d.repec.org/n?u=RePEc:una:unccee:wp1106&r=upt |
| By: | Schmidt, Ulrich; Traub, Stefan |
| Abstract: | In this paper we experimentally investigate the disparity between willingness-toaccept (WTA) and willingness-to-pay (WTP) for risky lotteries. The direction of the income effect is reversed by endowing subjects with the highest price of a lottery when asking the WTP question. Our results show that the income effect is too small to be the only source of the disparity. Since the disparity concentrates on a subsample of subjects, parametric and nonparametric tests of the WTA-WTP ratio may lead to contradictory results. The disparity is significantly reduced when background risk is introduced. That is, putting subjects always into a risky position could improve the contingent valuation method which is often concerned with the assessment of risky situations such as health risks, automobile safety, etc. |
| Keywords: | WTA-WTP disparity, lotteries, background risk, contingent valuation |
| JEL: | C91 D81 |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:cauewp:4760&r=upt |
| By: | Alexius, Annika (Department of Economics); Welz, Peter (Riksbanken) |
| Abstract: | The strong response of long-term interest rates to macroeconomic shocks has typically been explained in terms of informational asymmetries between the central bank and private agents. The standard models assume that the equilibrium real interest rate is constant over time and independent of structural shocks. We incorporate time-variation in the equilibrium real interest rate as function of structural shocks to e.g. productivity and demand. This extended model implies that forward interest rates at long horizons move about 40 basis points as the short-term interest rate increases one percentage point. In terms of regressions of changes in long-term interest rates on changes in the short-term interest rate, including a time-varying equilibrium real interest rate explains about half of the puzzle. |
| Keywords: | Term structure; equilibrium real interest rate; unobserved components model |
| JEL: | C51 E43 E52 |
| Date: | 2006–09–11 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:uunewp:2006_020&r=upt |
| By: | Charles Bellemare; Bruce S. Shearer |
| Abstract: | The, often observed, positive correlation between incentive intensity and risk has been explained in two ways: the presence of transaction costs as determinants of contracts and the sorting of risk-tolerant individuals into firms using high-intensity incentive contracts. The empirical importance of sorting is perhaps best evaluated by directly measuring the risk tolerance of workers who have selected into incentive contracts under risky environments. We use experiments, conducted within a real firm, to measure the risk preferences of a sample of workers who are paid incentive contracts and face substantial daily income risk. Our experimental results indicate the presence of sorting; Workers in our sample are risk-tolerant. Moreover, their level of tolerance is considerably higher than levels observed for samples of individuals representing broader populations. Interestingly, the high level of risk tolerance suggests that both sorting and transaction costs are important determinants of contract choices when workers have heterogeneous preferences. |
| Keywords: | Risk aversion, sorting, incentive contracts, field experiments |
| JEL: | J33 M52 C93 |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:lvl:lacicr:0631&r=upt |
| By: | Victor Matheson (Department of Economics, College of the Holy Cross); Kent Grote (Department of Economics and Business, Lake Forest College) |
| Abstract: | This paper considers the whether offering multiple lotto games within a state by joining a multi-state lottery increases total ticket sales compared to offering a single state game. The question is considered from two different perspectives, which both lead to the conclusion that states do tend to benefit from increased ticket sales overall by joining a multi-state lottery association. There is, however, a noted difference in the magnitude of that effect depending on the size of the average jackpots of the previously existing state games. |
| Keywords: | lotto, lottery, public finance, gambling |
| JEL: | D81 H71 L83 |
| Date: | 2006–09 |
| URL: | http://d.repec.org/n?u=RePEc:hcx:wpaper:0609&r=upt |
| By: | Daniela Del Boca (University of Turin and IZA Bonn); Robert M. Sauer (University of Southampton and IZA Bonn) |
| Abstract: | In this paper, we formulate a dynamic utility maximization model of female labor force participation and fertility choices and estimate approximate decision rules using data on married women in Italy, Spain and France. The pattern of estimated state dependence effects across countries is consistent with aggregate patterns in part-time employment and child care availability, suggesting that labor market rigidities and lack of child care options are important sources of state dependence. Simulations of the model reveal that Italian and Spanish women would substantially increase their participation rates were they to face the French institutional environment. |
| Keywords: | female employment, fertility, child care, institutions, decision rules |
| JEL: | J2 J6 C3 D1 |
| Date: | 2006–09 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp2285&r=upt |
| By: | Cason, Timothy N.; Noussair, Charles |
| Abstract: | We construct a laboratory market with the structure of the theoretical model of Burdett, Shi, and Wright (2001). The model is a simple and natural way to represent a market in which there is a friction in the matching process between buyers and sellers. Sellers first simultaneously post prices at which they are willing to sell their single unit of a good. Buyers then simultaneously choose a seller from whom to attempt to purchase a unit. If more than one buyer chooses the same seller, the good is randomly sold to one of the buyers. If a seller is not chosen by any buyer, his unit is not sold. Our experimental results show a broad consistency with the model of Burdett et al. and less support for an alternative model, which is analogous to the model of Montgomery (1991), and which has different assumptions on the strategic interaction between sellers. The main departures that we observe from the Burdett et al. model are that (a) price dispersion exists and is slow to decay, (b) prices exceed the equilibrium level when there are only two sellers, and (c) buyers’ purchase probabilities are insufficiently responsive to price differences when there are two sellers. |
| Date: | 2005–06 |
| URL: | http://d.repec.org/n?u=RePEc:pur:prukra:1194&r=upt |