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on Utility Models and Prospect Theory |
| By: | Drew Fudenberg; David K Levine |
| Date: | 2007–08–02 |
| URL: | http://d.repec.org/n?u=RePEc:cla:levarc:843644000000000332&r=upt |
| By: | Jianjun Miao (Department of Economics, Boston University and Department of Finance, the Hong Kong University of Science and Technology); Neng Wang (Columbia Business School) |
| Abstract: | Many economic decisions can be described as an option exercise or optimal stopping problem under uncertainty. Motivated by experimental evidence such as the Ellsberg Paradox, we follow Knight (1921) and distinguish risk from uncertainty. To afford this distinction, we adopt the multiple-priors utility model. We show that the impact of ambiguity on the option exercise decision depends on the relative degrees of ambiguity about continuation payoffs and termination payoffs. Consequently, ambiguity may accelerate or delay option exercise. We apply our results to investment and exit problems, and show that the myopic NPV rule can be optimal for an agent having an extremely high degree of ambiguity aversion. |
| Keywords: | industry ambiguity, multiple-priors utility, real options, optimal stopping problem |
| JEL: | D81 G31 |
| Date: | 2007–03 |
| URL: | http://d.repec.org/n?u=RePEc:bos:wpaper:wp2007-017&r=upt |
| By: | Patrick Gagliardini; Paolo Porchia; Fabio Trojani |
| Abstract: | This paper studies the term structure implications of a simple structural economy in which the representative agent displays ambiguity aversion, modeled by Multiple Priors Recursive Utility. Bond excess returns reflect a premium for ambiguity, which is observationally distinct from the risk premium of affine yield curve models. The ambiguity premium can be large even in the simplest logutility model and is non zero also for stochastic factors that have a zero risk premium. A calibrated low-dimensional two-factor economy with ambiguity is able to reproduce the deviations from the expectations hypothesis documented in the literature, without modifying in a substantial way the nonlinear mean reversion dynamics of the short interest rate. In this economy, we do not find any apparent tradeoffs between fitting the first and second moments of the yield curve and the large equity premium. |
| Keywords: | General Equilibrium, Term Structure of Interest Rates, Ambiguity Aversion, Expectations Hypothesis, Campbell-Shiller Regression |
| JEL: | C68 G12 G13 |
| Date: | 2007–07 |
| URL: | http://d.repec.org/n?u=RePEc:usg:dp2007:2007-29&r=upt |
| By: | Alonso, Irasema (Yale University); Prado, Jr., Jose Mauricio (Institute for International Economic Studies, Stockholm University) |
| Abstract: | We examine the potential importance of consumer ambiguity aversion for asset prices and how consumption ‡fluctuations influence consumer welfare. First, considering a simple Mehra-Prescott-style endowment economy with a representative agent facing consumption fluctuations calibrated to match U.S. data, we study to what extent ambiguity aversion can deliver asset prices that are consistent with data: a high return on equity and a low return on riskfree bonds. For some configurations of preference parameters— a discount factor, a degree of relative risk aversion, and a measure of ambiguity aversion— we find that it can. Then, we use these parameter configurations to investigate how much consumers would be willing to pay to reduce endowment fluctuations to zero, thus delivering a Lucas-style welfare cost of fluctuations. These costs turn out to be very large: consumers are willing to pay over 10% of consumption in permanent terms. |
| Keywords: | Ambiguity aversion; asset prices; business cycle |
| JEL: | D14 E32 G12 |
| Date: | 2007–08–06 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:iiessp:0752&r=upt |
| By: | Jawwad Noor (Department of Economics, Boston University) |
| Abstract: | Experiments on time preference document numerous .ndings that seem to con- tradict the standard model of intertemporal choice. These .ndings are based on how subjects choose between delayed rewards. This paper shows that if subjects integrate such rewards with their consumption plans, and expect changes in future consump- tion, then except for violations of basic properties like transitivity, the standard model (with CRRA utility) can rationalize all the popular experimental .ndings: preference reversals, dynamic inconsistency, hyperbolic discounting, magnitude e¤ect, sign e¤ect, delay-speedup asymmetry etc. It is demonstrated formally that the standard model has no peculiar testable implications for subjects.preferences between delayed money rewards, which is the data of typical experiments. A testable implication of the model is derived in the richer setting with risky prospects as rewards. |
| Keywords: | Discounted Utility, Exponential discounting, Preference Reversals, Dy- namic Inconsistency, Hyperbolic discounting, Sign E¤ect, Magnitude E¤ect. |
| JEL: | D11 |
| Date: | 2007–07 |
| URL: | http://d.repec.org/n?u=RePEc:bos:wpaper:wp2007-029&r=upt |
| By: | Thomas Dohmen (Institute for the Study of Labor, IZA); Armin Falk (IZA and University of Bonn); David Huffman (Institute for the Study of Labor, IZA); Uwe Sunde (IZA and University of Bonn); Juergen Schupp (German Institute for Economic Research, DIW); Gert Wagner (Berlin University of Technology, DIW, and Cornell University) |
| Abstract: | This paper presents new evidence on the distribution of risk attitudes in the population, using a novel set of survey questions and a representative sample of roughly 22,000 individuals living in Germany. Using a question that asks about willingness to take risks in general, on an 11-point scale, we find evidence of heterogeneity across individuals, and show that willingness to take risks is negatively related to age and being female, and positively related to height and parental education. We test the behavioral relevance of this survey measure by conducting a complementary field experiment, based on a representative sample of 450 subjects, and find that the general risk question is a good predictor of actual risk-taking behavior. We then use a more standard lottery question to measure risk preferences in our sample of 22,000, and find similar results regarding heterogeneity and determinants of risk preferences, compared to the general risk question. The lottery question also makes it possible to estimate the coefficient of relative risk aversion for each individual in the sample. Using five questions about willingness to take risks in specific domains - car driving, financial matters, sports and leisure, career, and health - the paper also studies the impact of context on risk attitudes, finding a strong but imperfect correlation across contexts. Using data on a collection of risky behaviors from different contexts, including traffic offenses, portfolio choice, smoking, occupational choice, participation in sports, and migration, the paper compares the predictive power of all of the risk measures. Strikingly, the general risk question predicts all behaviors whereas the standard lottery measure does not. The best predictor for any specific behavior is typically the corresponding context-specific measure. |
| Keywords: | Risk Preferences, Experimental Validation, Field Experiment, SOEP, Gender Differences, Context, Age, Height, Subjective Well-Being, Migration, Occupational Choice, Health |
| JEL: | D0 D1 D80 D81 C91 C93 J16 J24 J61 I1 |
| Date: | 2005–11 |
| URL: | http://d.repec.org/n?u=RePEc:feb:wpaper:2096&r=upt |
| By: | Daniel J. Benjamin; James J. Choi; A. Joshua Strickland |
| Abstract: | In two laboratory experiments, we examine whether norms associated with one's social identity affect time and risk preferences. When we make ethnic identity salient to Asian-American subjects, they make more patient choices. When we make race salient to black subjects, non-immigrant blacks (but not immigrant blacks) make more risk-averse choices. Making gender identity salient causes choices to conform to gender norms the subject believes are relatively more common. Our results provide evidence that identity effects play a role in shaping U.S. demographic patterns in economic behaviors and outcomes. |
| JEL: | C91 Z10 |
| Date: | 2007–08 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:13309&r=upt |