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on Utility Models and Prospect Theories |
| By: | Syngjoo Choi (Department of Economics, University College London); Raymond Fisman (Graduate School of Business, Columbia University); Douglas Gale (Department of Economics, New York University); Shachar Kariv (Department of Economics, University of California, Berkeley) |
| Abstract: | By using graphical representations of budget sets over bundles of state-contingent commodities, we generate a very rich data set well-suited to studying behavior under uncertainty at the level of the individual subject. We test the data for consistency with the maximization hypothesis, and we estimate preferences using a two-parameter utility function based on Faruk Gul (1991). This specification provides a good interpretation to the data at the level of the individual subject and can account for the highly heterogeneous behaviors observed in the laboratory. The parameter estimates jointly describe attitudes toward risk and allow us to characterize the distribution of risk preferences in the population. |
| Keywords: | uncertainty, revealed preference, Expected Utility Theory, loss/disappointment aversion, experiment |
| JEL: | D81 C91 |
| Date: | 2007–01 |
| URL: | http://d.repec.org/n?u=RePEc:ads:wpaper:0076&r=upt |
| By: | William Wild (School of Economics and Finance, Queensland University of Technology) |
| Abstract: | The total market containing all assets is in equilibrium where all investors have the same utility functions and hold the same fully diversifed total market portfolio. This is not an equilibrium, however, where they have different utility functions, even if they are all risk averse. Then investors can all increase their utility by reallocating the market returns among themselves on a non pro-rata basis. Even in a perfect market the utility maximizing investment strategy for risk averse investors with different utility functions requires them to bear idiosyncratic risk, providing a role for asset transformation. The maximum or minimum asset prices at which an investor will transact in pursuance of greater portfolio utility are unique to that investor and the existing market state. |
| URL: | http://d.repec.org/n?u=RePEc:qut:dpaper:206&r=upt |
| By: | Thibault Gajdos (Centre d'Economie de la Sorbonne); Takashi Hayashi (University of Texas); Jean-Marc Tallon (Centre d'Economie de la Sorbonne); Jean-Christophe Vergnaud (Centre d'Economie de la Sorbonne) |
| Abstract: | This paper presents an axiomatic model of decision making which incorporates objective but imprecise information. We axiomatize a decision criterion of the multiple priors (or maxmin expected utility) type. The model achieves two primary objectives. First, it explains how subjective belief varies with information. Second, it identifies an explicit attitude toward imprecision that underlies usual hedging axioms. Information is assumed to take the form of a probability-possibility set, that is, a set P of probability measures on the state space. The decision maker is told that the true probability law lies in P. She is assumed to rank pairs of the form (P,f) where P is a probability-possibility set and f is an act mapping states into outcomes. The representation result delivers multiple-priors utility at each probability-possibility set. There is a mapping that gives for each probability-possibility set the subjective set of priors. This allows both subjective expected utility when the subjective set of priors is reduced to a singleton and the other extreme where the decision maker takes the worst case scenario in the entire probability-possibility set. We show that the relation “more averse to imprecision” is characterized by inclusion of the sets of priors, irrespective of the utility functions that capture risk attitude. We characterize, under extra axioms, a more precise functional form, in which the subjective set of priors is obtained by (i) solving for the “mean value” of the probability-possibility set and (ii) shrinking the probability-possibility set toward the mean value to a degree determined by preference. |
| Keywords: | Imprecise information, imprecision aversion, multiple priors, Steiner point. |
| JEL: | D81 |
| Date: | 2006–07 |
| URL: | http://d.repec.org/n?u=RePEc:mse:wpsorb:v06081&r=upt |
| By: | Hans Keiding (Department of Economics, University of Copenhagen) |
| Abstract: | The concept of capabilities, introduced originally by Sen, has inspired many researchers but has not found any simple formal representation which might be instrumental in the construction of a comprehensive theory of equality. In a previous paper (Keiding, 2005), we investigated whether preferences over capabilities as sets of functionings can be rationalized by maximization of a suitable utility function over the set of functionings. Such a rationalization turned out to be possible only in cases which must be considered exceptional and which do not allowfor interesting applications of the capability approach to questions of health or equality. In the present paper we extend the notion of rationalizing orderings of capabilities to a dynamical context, in the sense that the utility function is not yet revealed to the individual at the time when the capabilities are ordered. It turns out that orderings which are in accordance with such probabilistic utility assignments can be characterized by a smaller set of the axioms previously considered. |
| Keywords: | Capabilities; characteristics; equality of health |
| JEL: | D63 I10 |
| Date: | 2007–02 |
| URL: | http://d.repec.org/n?u=RePEc:kud:kuiedp:0705&r=upt |
| By: | Jean-Philippe Lefort (Centre d'Economie de la Sorbonne) |
| Abstract: | We adapt the model of comparisons of experts initiated by Lehrer (“Comparison of experts JME 98”) to a context of uncertainty which cannot be modelised by expected utility. We examine the robustness of Lehrer in this new context. Unlike expected utility, there exist several ways to define the strategies allowing to compare the experts, we propose some of them which guarantee a positive value of information. |
| Keywords: | Non-additive preferences, experts. |
| JEL: | D80 D82 |
| Date: | 2006–12 |
| URL: | http://d.repec.org/n?u=RePEc:mse:wpsorb:b06088&r=upt |
| By: | José Olmo (Department of Economics, City University, London) |
| Abstract: | We introduce a family of utility functions that describe the preferences of mean-variance-downside-risk (mvdr) averse investors. The risk premium on a risky asset in an economy with these individuals is given by a weighted sum of CAPM systematic risk and a systematic risk given by the level of comovements between the asset and the market in distress episodes. Hence investors require a higher reward than predicted by CAPM for holding assets correlated with the market in distress episodes, and a lower reward for holding assets with negative correlation in market downturns. The application of this pricing theory to financial sectors in FTSE-100 is illuminating. The empirical failure of standard CAPM is explained by the extra reward required by investors from market downturns. While Chemicals and Mining sectors exhibit positive comovements with FTSE downturns; Banking and Oil and Gas sectors are robust to them and Telecommunications Services exhibit negative comovements serving as refugee of investors fleeing from domestic market distress episodes. |
| Keywords: | Asset Pricing, CAPM, Downside-risk, Mean-variance |
| JEL: | G11 G12 G13 |
| Date: | 2007–01 |
| URL: | http://d.repec.org/n?u=RePEc:cty:dpaper:0701&r=upt |
| By: | Ingmar, SCHUMACHER (UNIVERSITE CATHOLIQUE DE LOUVAIN, Department of Economics) |
| Abstract: | We endogenize the discount rate via a broad measure of wealth and provide empirical evidence that wealth the discount rate negatively. We demonstrate that the Pontryagin conditions require positive felicity for intuitive results, whereas the concavity of the Hamiltonian requires negative felicity for optimality. This dilemna also holds for the endogenizations of Obstfeld (1990) and followers. We solve the model with positive felicity and resolve when optimality is possible. We discuss the impact on technological change, savings and convergence which are more in line with empirics. Finally, we discuss time consistency of a planner who cannot predict his preferences. |
| Keywords: | Endogenous time preference, Stability, Optimal growth, Recursive utility |
| JEL: | D90 C61 O41 |
| Date: | 2006–11–15 |
| URL: | http://d.repec.org/n?u=RePEc:ctl:louvec:2006058&r=upt |
| By: | Bernard M.S. van Praag (SCHOLAR, University of Amsterdam, DIW Berlin, CESifo and IZA) |
| Abstract: | After having been ignored for a long time by economists, happiness is becoming an object of serious research in 21st century economics. In Section 2 we sketch the present status of happiness economics. In Section 3 we consider the practical applicability of happiness economics, retaining the assumption of ordinal individual utilities. In Section 4 we introduce a cardinal utility concept, which seems to us the natural consequence of the happiness economics methodology. In Section 5 we sketch how this approach can lead to a normative approach to policy problems that is admissible from a positivist point of view. Section 6 concludes. |
| Keywords: | happiness economics, subjective well-being, equivalence scales, economic policy |
| JEL: | B21 B41 D63 I31 I38 |
| Date: | 2007–01 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp2568&r=upt |
| By: | Fernandez, Pablo (IESE Business School) |
| Abstract: | Equity premium designates four different concepts: Historical Equity Premium (HEP); Expected Equity Premium (EEP);Required Equity Premium (REP); and Implied Equity Premium (IEP). We highlight the confusing message conveyed in the literature regarding equity premium and its evolution. The confusion arises from not distinguishing among the four concepts and from not recognizing that although the HEP is equal for all investors, the REP, the EEP and the IEP differ for different investors. A unique IEP requires assuming homogeneous expectations for expected growth (g), but we show that there are several pairs (IEP, g) that satisfy current prices. We claim that different investors have different REPs and that it is impossible to determine the REP for the market as a whole, because it does not exist. We also investigate the relationship between (IEP - g) and the risk-free rate. There is a kind of schizophrenic approach to valuation: while all authors admit different expectations of equity cash flows, most authors look for a single discount rate. It seems as if the expectations of equity cash flows are formed in a democratic regime, while the discount rate is determined in a dictatorship. |
| Keywords: | equity premium; equity premium puzzle; required market risk premium; historical market risk premium; expected market risk premium; risk premium; market risk premium; market premium; |
| Date: | 2006–12–13 |
| URL: | http://d.repec.org/n?u=RePEc:ebg:iesewp:d-0661&r=upt |
| By: | Roland Bénabou (Princeton University, NBER, CEPR and IZA); Jean Tirole (Université de Toulouse and MIT) |
| Abstract: | We analyze social and economic phenomena involving beliefs which people value and invest in, for affective or functional reasons. Individuals are at times uncertain about their own "deep values" and infer them from their past choices, which then come to define "who they are". Identity investments increase when information is scarce or when a greater endowment of some asset (wealth, career, family, culture) raises the stakes on viewing it as valuable (escalating commitments). Taboos against transactions or the mere contemplation of tradeoffs arise to protect fragile beliefs about the "priceless" value of certain assets (life, freedom, love, faith) or things one "would never do". Whether such behaviors are welfareenhancing or reducing depends on whether beliefs are sought for a functional value (sense of direction, self-discipline) or for "mental consumption" motives (self-esteem, anticipatory feelings). Escalating commitments can thus lead to a "hedonic treadmill", and competing identities cause dysfunctional failures to invest in high-return activities (education, adapting to globalization, assimilation), or even the destruction of productive assets. In social interactions, norm violations elicit a forceful response (exclusion, harassment) when they threaten a strongly held identity, but further erode morale when it was initially weak. Concerns for pride, dignity or wishful thinking lead to the inefficient breakdown of Coasian bargaining even under symmetric information, as partners seek to self-enhance and shift blame by turning down "insultingly low" offers. |
| Keywords: | identity, self-serving beliefs, self-image, memory, wishful thinking, anticipatory utility, self control, hedonic treadmill, bargaining, taboos, religion |
| JEL: | D81 D91 Z13 |
| Date: | 2007–01 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp2583&r=upt |
| By: | Ingmar, SCHUMACHER (UNIVERSITE CATHOLIQUE DE LOUVAIN, Department of Economics) |
| Abstract: | The articles gives new answers to the following questions : One, what can be potential source of the twin-peaks of economi growth ? Two, why were some of the countries that were believed to belong to the group of low steady state countries (like Taiwan, South Korea, Japan, etc) able to reach a convergence path which led them to a high steady state ? We endogenize the time preference rate via a broad measure of wealth and provide empirical evidence that wealth affects the discount rate negatively. We provide sufficient conditions for multiplicity of equilibria and demonstrate how endogenous discounting via wealth leads to the twin-peaks of economic growth. We prove that improvements in technology can help avoid the Twin-peaks. |
| Keywords: | Endogenous time preference, Recursive utility, Twin-peaks of economic growth |
| JEL: | D90 C61 O41 |
| Date: | 2006–11–15 |
| URL: | http://d.repec.org/n?u=RePEc:ctl:louvec:2006059&r=upt |