nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2007‒04‒28
twelve papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Mixture Models of Choice Under Risk By Anna Conte; John D Hey; Peter G Moffatt
  2. Mean-Variance Portfolio Selection with Reference Dependent Preferences By Sergiy Gerasymchuk
  3. Can Risk Aversion Explain Schooling Attainments? Evidence From Italy By Christian Belzil; Marco Leonardi
  4. Mean-variance vs. full-scale optimization: broad evidence for the U.K. By Björn Hagströmer; Richard G. Anderson; Jane M. Binner; Thomas Elger; Birger Nilsson
  5. Stochastic Dominance and Mean-Variance Measures of Profit and Loss for Business Planning and Investment By Wing-Keung Wong
  6. Personal Identity in the Dictator Game By Fernando Aguiar; Pablo Branas-Garza; Maria Paz Espinosa; Luis M. Miller
  7. Let Me See You! A Video Experiment on the Social Dimension of Risk Preferences By Werner Güth; M. Vittoria Levati; Matteo Ploner
  8. Community, Comparisons and Subjective Well-being in a Divided Society By Geeta Kingdon; John Knight
  9. One-dimensional bargaining with unanimity rule By Predtetchinski Arkadi
  10. Expected stock returns and variance risk premia By Tim Bollerslev; Hao Zhou
  11. The dynamics of television advertising with boundedly rational consumers By Gomes, Orlando
  12. Dumbing down rational players : Learning and teaching in an experimental game. By Antoine Terracol; Jonathan Vaksmann

  1. By: Anna Conte; John D Hey; Peter G Moffatt
    Abstract: This paper is concerned with estimating preference functionals for choice under risk from the choice behaviour of individuals. We start from the observation that there is heterogeneity in behaviour between individuals and within individuals. By ‘heterogeneity between individuals’ we mean that people are different, not only in terms of which type of preference functional that they have, but also in terms of their parameters for these functionals. By ‘heterogeneity within individuals’ we mean that behaviour may be different even by the same individual for the same choice problem. Given the heterogeneity between individuals, the assumption of a ‘representative agent’ preference functional to represent the preference functional of all individuals may well lead to biased estimates. Given the heterogeneity within individuals, we should think carefully about the source of this heterogeneity and model it appropriately, for otherwise we get biased estimates. We propose solutions to both of these problems, concentrating particularly, but not exclusively, on using a Mixture Model to capture the heterogeneity of preference functionals across individuals.
    Keywords: errors, expected utility theory, experimental economics, maximum simulated likelihood, mixture models, preference functionals, risky choice, rank dependent expected utility theory, unobserved heterogeneity
    JEL: C15 C29 C51 C87 C91 D81
    Date: 2007–04
  2. By: Sergiy Gerasymchuk (Advanced School of Economics, University of Venice)
    Abstract: We study S-shaped utility maximization for the standard portfolio se- lection problem with one risky and one risk-free asset. We derive a ean-variance criterium of choice, which preserves reference dependence and the reflection effect. Subsequently we study diversification possibilities and obtain the demand for the risky asset. We close the paper with an alternative interpretation of the criterium in terms of target-based decision making.
    Keywords: portfolio selection, S-shaped utility, prospect theory, reference point, mean-variance analysis, demand for the risky asset, target-based decisions.
    JEL: D81 G11
    Date: 2007–04
  3. By: Christian Belzil (GATE - Groupe d'analyse et de théorie économique - [CNRS : UMR5824] - [Université Lumière - Lyon II] - [Ecole Normale Supérieure Lettres et Sciences Humaines], IZA - Institute for the study of labor - [IZA][Institute for the study of labor]); Marco Leonardi (IZA - Institute for the study of labor - [IZA][Institute for the study of labor], Università degli studi di Milano - [Università di Milano][Università degli studi di Milano])
    Abstract: Using unique Italian panel data, in which individual differences in behavior toward risk are measured from answers to a lottery question, we investigate if (and to what extent) risk aversion can explain differences in schooling attainments. We formulate the schooling decision process as a reduced-form dynamic discrete choice. The model is estimated with a degree of flexibility virtually compatible with semiparametric likelihood techniques. We analyze how grade transition from one level to the next varies with preference heterogeneity (risk aversion), parental human capital, socioeconomic variables and persistent unobserved (to the econometrician) heterogeneity. We present evidence that schooling attainments decrease with risk aversion, but despite a statistically significant effect, differences in attitudes toward risk account for a modest portion of the probability of entering higher education. Differences in ability(ies) and in parental human capital are much more important. in the most general version of the model, the likelihood function is the joint probability of schooling attainments, and post-schooling wealth and risk aversion.
    Keywords: dynamic discrete choices ; education ; human capital ; risk aversion
    Date: 2007–04–19
  4. By: Björn Hagströmer; Richard G. Anderson; Jane M. Binner; Thomas Elger; Birger Nilsson
    Abstract: In a portfolio choice setting of three common assets (FTSE 100, FTSE 250 and FTSE Emerging Market Index), we identify several utility functions under which Full-Scale Optimization is a substantially better approach than the mean variance approach is. With the Full-Scale Optimization approach the complete empirical financial return probability distribution is considered, and the utility maximising solution is found through grid search. Earlier studies have shown that this approach is useful for investors following non-linear utility functions (such as bilinear and S-shaped utility) and choosing between highly non-normally distributed assets, such as hedge funds. We expand the area of usage to common indices, and show that the results are robust for a broader range of utility function specifications.
    Date: 2007
  5. By: Wing-Keung Wong (Risk Management Institute and Department of Economics, National University of Singapore)
    Abstract: In this paper, we first extend the stochastic dominance (SD) theory by introducing the first three orders of both ascending SD (ASD) and descending SD (DSD) to decisions in business planning and investment to risk-averse and risk- loving decision makers so that they can compare both return and loss. We provide investors with more tools for empirical analysis, with which they can identify the first order ASD and DSD prospects and discern arbitrage opportunities that could increase his/her utility as well as wealth and set up a zero dollar portfolio to make huge profit. Our tools also enable investors and business planners to identify the third order ASD and DSD prospects and make better choices. To complement the stochastic dominance approach, we also introduce an improved mean-variance criterion to decisions in business planning or investment on both return and loss for risk-averse and risk-loving investors. We then illustrate the superiority of the present approaches with well-known examples in the literature and discuss the relationship between the improved stochastic dominance and mean-variance criteria.
    Keywords: Applied probability, Decision analysis, Risk analysis, Risk management, Uncertainty modelling
  6. By: Fernando Aguiar; Pablo Branas-Garza; Maria Paz Espinosa; Luis M. Miller (Max Planck Institute of Economics Jena, Strategic Interaction Group)
    Abstract: This paper aims to analize the role of personal identity in decision making. To this end, it starts by reviewing critically the growing literature on economics and identity. Considering the ambiguities that the concept of social identity poses, our proposal focuses on the concept of personal identity. A formal model to study how personal identity enters in individuals’ utility function when facing a Dictator Game decision is then presented. Finally, this "identity-based" utility function is studied experimentally. The experiment allows us to study the main parameters of the model, suggesting that we should move with caution when attributing identities to individuals.
    Keywords: personal identity, dictator game, game theory, experiments
    JEL: A13 C72 C91
    Date: 2007–04–20
  7. By: Werner Güth (Max Planck Institute of Economics, Jena, Strategic Interaction Group); M. Vittoria Levati (Max Planck Institute of Economics, Jena, Strategic Interaction Group); Matteo Ploner (Max Planck Institute of Economics, Jena, Strategic Interaction Group)
    Abstract: Previous studies have shown that decision makers are less other-regarding when their own payoff is risky than when it is sure. Empirical observations also indicate that people care more about identifiable than unidentifiable others. In this paper, we report on an experiment designed to explore whether rendering the other identifiable - via a short speechless video - can affect the relation between other-regarding concerns and attitudes toward social risk. For this sake, we elicit risk attitudes under two treatments differing in whether the actor can see the other or not. We find that seeing the other does not affect behavior significantly: regardless of the treatment, individuals are mainly self-oriented as to social allocation of risk, though they are other-regarding with respect to expected payoff levels.
    Keywords: Risk attitudes, other-regarding concerns, identifiability
    JEL: C90 D63 D81
    Date: 2007–04–20
  8. By: Geeta Kingdon; John Knight (Department of Economics, University of Oxford)
    Abstract: Abstract: Using a South African data set, the paper poses six questions about the determinants of subjective well-being. Much of the paper is concerned with the role of relative concepts. We find that comparator income – measured as average income of others in the local residential cluster – enters the household’s utility function positively but that income of more distant others (others in the district or province) enters negatively. The ordered probit equations indicate that, as well as comparator groups based on spatial proximity, race-based comparator groups are important in the racially divided South African society. It is also found that relative income is more important to happiness at higher levels of absolute income. Potential explanations of these results, and their implications, are considered.
    Keywords: South Africa: poverty, well-being, absolute income, household’s utility function
    JEL: A1
    Date: 2005–07
  9. By: Predtetchinski Arkadi (METEOR)
    Abstract: The paper examines bargaining over a one--dimensional set of social states, with a unanimity acceptance rule. We consider a class of delta-equilibria, i.e. subgame perfect equilibria in stationary strategies that are free of coordination failures in the response stage.We show that along any sequence of delta-equilibria, as delta converges to one, the proposal of each player converges to the same limit. The limit, called the bargaining outcome, is uniquely determined by the set of players, the recognition probabilities, and the utility functions, and it is independent of the choice of the sequence. We characterize the bargaining outcome as a unique solution of a characteristic equation.
    Keywords: mathematical economics;
    Date: 2007
  10. By: Tim Bollerslev; Hao Zhou
    Abstract: We find that the difference between implied and realized variances, or the variance risk premium, is able to explain more than fifteen percent of the ex-post time series variation in quarterly excess returns on the market portfolio over the 1990 to 2005 sample period, with high (low) premia predicting high (low) future returns. The magnitude of the return predictability of the variance risk premium easily dominates that afforded by standard predictor variables like the P/E ratio, the dividend yield, the default spread, and the consumption-wealth ratio (CAY). Moreover, combining the variance risk premium with the P/E ratio results in an R^2 for the quarterly returns of more than twenty-five percent. The results depend crucially on the use of "model-free", as opposed to standard Black-Scholes, implied variances, and realized variances constructed from high-frequency intraday, as opposed to daily, data. Our findings suggest that temporal variation in risk and risk-aversion both play an important role in determining stock market returns.
    Date: 2007
  11. By: Gomes, Orlando
    Abstract: The paper adapts a static model of television advertising into a dynamic scenario. In its original form, the model consists on a profit maximization problem of a television network working in a competitive environment. The network sells commercial time to advertisers and tries to minimize the effects of viewers’ aversion to ads. Viewers are assumed heterogeneous with regard to the preferences over the types of products companies sell through ad time. Into this framework we introduce an intertemporal rule reflecting the possible preference changes of consumers (these are boundedly rational and their utility for different types of products varies over time). The introduction of the intertemporal rule originates interesting dynamic results, namely in what concerns the evolution over time of crucial variables like the total time of broadcasting that networks allocate to advertising or the amount of revenues that satisfies the profit maximization condition. As in the original model, attention will be given to the possibility, that cable television allows, of ad addressability.
    Keywords: Television advertising; Networks’ profit maximization; Heterogeneous viewers; Ad addressability; Bounded rationality; Nonlinear dynamics.
    JEL: L82 C61 M37
    Date: 2006–09
  12. By: Antoine Terracol (GREMARS et Centre d'Economie de la Sorbonne); Jonathan Vaksmann (Centre d'Economie de la Sorbonne)
    Abstract: This paper uses experimental data to examine the existence of a teaching strategy among bounded rational players. If players realize that their own actions modify their opponent's beliefs and actions, they might play certain actions to this specific end ; and forego immediate payoffs if the expected payoffs if the expected payoff gain from a teaching strategy is high enough. Our results support the existence of a teaching strategy in several ways : First they show that players update their beliefs in order to take account of the reaction of their opponents to their own action. Second, we examine if players actually use a teaching strategy by playing an action that induces a poor immediate payoff but is likely to modify the opponent's behavior so that a preferable outcome might emerge in the future. We find strong evidence of such a strategy in the data and confirm this finding within a logistic model which suggests that the future expected payoff that could arise from a teaching strategy has indeed a significant impact on choice probabilities. Finally, we investigate the effective impact of a teaching strategy on achieved outcomes and find that efficient teachers can successfully use teaching in order to reach their favorite outcome at the expense of their opponents.
    Keywords: Game theory, teaching, beliefs, experiment.
    JEL: C72 C91 D83
    Date: 2007–03

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