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on Utility Models and Prospect Theories |
| By: | John K. Dagsvik (Statistics Norway) |
| Abstract: | This paper develops a theory of probabilistic models for risky choices. Part of this theory can be viewed as an extension of the expected utility theory to account for bounded rationality. One probabilistic version of the Archimedean Axiom and two versions of the Independence Axiom are proposed. In addition, additional axioms are proposed of which one is Luce’s Independence from Irrelevant Alternatives. It is demonstrated that different combinations of the axioms yield different characterizations of the probabilities for choosing the respective risky prospects. An interesting feature of the models developed is that they allow for violations of the expected utility theory known as the common consequence effect and the common ratio effect. |
| Keywords: | Random tastes; bounded rationality; independence from irrelevant alternatives; probabilistic choice among lotteries; Allais paradox. |
| JEL: | C25 D11 D81 |
| Date: | 2006–07 |
| URL: | http://d.repec.org/n?u=RePEc:ssb:dispap:465&r=upt |
| By: | Ronald Bosman; Frans van Winden |
| Abstract: | We investigate a novel dynamic choice problem in an experiment where emotions are measured through self-reports. The choice problem concerns the investment of an amount of money in a safe option and a risky option when there is a “global risk” of losing all earnings, from both options, including any return from the risky option. Our key finding is that global risk can reduce the amount invested in the risky option. This result cannot be explained by classical Expected Utility or by its main contenders Rank-Dependent Utility and Cumulative Prospect Theory. Anexplanation is offered by taking account of emotions, using the emotion data from the experiment and recent psychological findings. We also find that people invest less if own earnings are at stake, compared to money obtained as an endowment. |
| Keywords: | investment; global risk; real effort; emotions; dynamic choice. |
| JEL: | A12 C91 D80 G11 |
| Date: | 2006–09 |
| URL: | http://d.repec.org/n?u=RePEc:dnb:dnbwpp:112&r=upt |
| By: | Peter Bossaerts; Serena Guarnaschelli; Paolo Ghirardato; William Zame |
| Abstract: | Most of the economics and finance literature assumes that individual agents obey the Savage axioms; that is, they maximize expected utility according to subjective priors. However, Knight, Ellsberg and others argue that individual agents distinguish between risk (known probabilities) and uncertainty, or ambiguity (unknown probabilities), and that individual agents may display aversion to ambiguity, just as they display aversion to risk. This paper studies the impact of ambiguity aversion on equilibrium asset prices and portfolio holdings in competitive financial markets. It argues that attitude toward ambiguity is heterogeneous in the population, just as attitude toward risk is heterogeneous in the population, but that heterogeneity in attitude toward ambiguity has di erent implications than heterogeneity in attitude toward risk: agents who are su ciently ambiguity averse find open sets of prices for which they refuse to hold an ambiguous portfolio. This leads to a wider range of state price densities and to potential reversals of ranking of state price densities. Experiments confirm the theoretical predictions. The experiments also suggest a positive correlation between risk aversion and ambiguity aversion, which in turn suggests an explanation of the "value effect." |
| Keywords: | ambiguity, risk aversion, asset prices, portfolio holdings, experimental economics. |
| JEL: | C9 D81 G11 G12 |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:cca:wpaper:27&r=upt |
| By: | Andersson, Fredrik W. (Department of Economics, School of Business, Economics and Law, Göteborg University) |
| Abstract: | This paper presents a closed form consumption function for an individual when he derives utility from both his current and previous consumption and from the consumption of his relevant others. I show that the traditional definition of an individual's marginal propensity to consume (MPC) is too narrow. With existing knowledge we would call for a broader definition of the MPC that I coin as the individual's total MPC, which also takes into account the consumption change of the relevant others, and this affects that total MPC is smaller than the traditional MPC. <p> |
| Keywords: | Consumption decision; consumption of relevant others; habit- formation behavior; marginal propensity to consume; excess smoothness |
| JEL: | D91 E21 |
| Date: | 2006–09–22 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:gunwpe:0226&r=upt |
| By: | Peter Klibanoff; Massimo Marinacci; Sujoy Mukerji |
| Abstract: | This paper axiomatizes an intertemporal version of the Smooth Ambiguity decision model developed in Klibanoff, Marinacci, and Mukerji (2005). A key feature of the model is that it achieves a separation between ambiguity, identified as a characteristic of the decision maker’s subjective beliefs, and ambiguity attitude, a characteristic of the decision maker’s tastes. In applications one may thus specify/vary these two characteristics independent of each other, thereby facilitating richer comparative statics and modeling flexibility than possible under other models which accomodate ambiguity sensitive preferences. Another key feature is that the preferences are dynamically consistent and have a recursive representation. Therefore techniques of dynamic programming can be applied when using this model. |
| Keywords: | Ambiguity, Uncertainty, Knightian Uncertainty, Ambiguity Aversion, Uncertainty Aversion, Ellsberg Paradox, Dynamic Decision Making, Dynamic Programming under Ambiguity, Smooth Ambiguity. |
| JEL: | D80 D81 |
| Date: | 2006 |
| URL: | http://d.repec.org/n?u=RePEc:cca:wpaper:17&r=upt |
| By: | Frederic Koessler (THEMA, Université de Cergy-Pontoise); Francoise Forges (CEREMADE, Paris-Dauphine University) |
| Abstract: | We survey the main results on strategic information transmission, which is often referred to as ``persuasion" when types are verifiable and as ``cheap talk" when they are not. In the simplest ``cheap talk'' model, an informed player sends a single message to a receiver who makes a decision. The players' utilities depend on the sender's information and the receiver's decision, but not on the sender's message. Furthermore, the messages that are available to the sender do not depend on his true information. As is well-known, such a unilateral ``cheap talk" can affect the sender's decision at equilibrium. In a more general model, both players can exchange simultaneous costless messages during several stages before the final decision. The utility functions are unchanged. Multistage conversation allows the players to reach more equilibrium outcomes, which possibly Pareto dominate the original ones. More precisely, the set of equilibrium outcomes of long cheap talk games is fully characterized; it increases with the number of communication stages and can become even larger if no deadline is imposed. Concentrating on cheap talk is not appropriate if the informed player can influence the decision maker by producing unfalsifiable documents. In order to capture this possibility formally, one assumes that the informed player's set of messages depends on his private information. The literature has mostly dealt with unilateral persuasion. But multistage, bilateral communication enables the players to reach more equilibrium outcomes in the case of verifiable types as in the case of unverifiable ones. Equilibria of long persuasion games are fully characterized when information can be certified at any precision level. |
| Keywords: | Cheap talk; certification; incomplete information; information transmission; jointly controlled lotteries; verifiable types |
| JEL: | C72 D82 |
| Date: | 2006–09 |
| URL: | http://d.repec.org/n?u=RePEc:ema:worpap:2006-14&r=upt |
| By: | Winston T.H. Koh (School of Economics and Social Sciences, Singapore Management University) |
| Abstract: | This paper investigates the optimality of intertemporal price discrimination for a durable-good monopoly in a model where infinitely-lived households face an intertemporal budget constraint, and consume both durable goods and non-durable goods. We prove that the optimal price of the durable good is not constant, and may decrease or increase over time. Some households may choose to purchase the durable good at a later date, and pay lower or higher prices, since the gain in discounted utility of consuming more of the non-durable good more than compensates for the loss in utility from delaying the consumption of the durable good. |
| Keywords: | Intertemporal price discrimination, durable good monopoly, optimal pricing strategy, household demand |
| JEL: | D40 D42 D91 |
| Date: | 2005–01 |
| URL: | http://d.repec.org/n?u=RePEc:siu:wpaper:04-2005&r=upt |
| By: | Prasanna Gai; Nicholas Vause |
| Abstract: | This paper proposes a new method for measuring investor 'risk appetite'. Like other indicators in the literature, it is based on a comparison of risk-neutral probabilities of future returns with the corresponding subjective probabilities. The precise nature of the comparison is novel, however, and involves comparing probabilities across the full range of potential returns. Unlike other indicators, our measure of market sentiment distinguishes risk appetite from risk aversion, and is reported in levels rather than changes. Implementation of the approach yields results that respond to crises and other major economic events in a plausible manner. |
| URL: | http://d.repec.org/n?u=RePEc:boe:boeewp:283&r=upt |