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on Utility Models and Prospect Theory |
| By: | Elyès Jouini (CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - [CNRS : UMR7534] - [Université Paris Dauphine - Paris IX]); Walter Schachermayer (VUT - Vienna University of Technology - [Technische Universität Wien]); Nizar Touzi (CREST - Centre de Recherche en Économie et Statistique - [INSEE] - [ École Nationale de la Statistique et de l'Administration Économique]) |
| Abstract: | We consider the problem of optimal risk sharing of some given total risk between two economic agents characterized by law-invariant monetary utility functions or equivalently, law-invariant risk measures. We first prove existence of an optimal risk sharing allocation which is in addition increasing in terms of the total risk. We next provide an explicit characterization in the case where both agents' utility functions are comonotone. The general form of the optimal contracts turns out to be given by a sum of options (stop-loss contracts, in the language of insurance) on the total risk. In order to show the robustness of this type of contracts to more general utility functions, we introduce a new notion of strict risk aversion conditionally on lower tail events, which is typically satisfied by the semi-deviation and the entropic risk measures. Then, in the context of an AV@R-agent facing an agent with strict monotone preferences and exhibiting strict risk aversion conditional on lower tail events, we prove that optimal contracts again are European options on the total risk. |
| Keywords: | Monetary utility functions, comonotonicity, Pareto optimal allocations |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:hal:papers:halshs-00176606_v1&r=upt |
| By: | Elyès Jouini (CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - [CNRS : UMR7534] - [Université Paris Dauphine - Paris IX]); Selima Ben Mansour (CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - [CNRS : UMR7534] - [Université Paris Dauphine - Paris IX]); Clotilde Napp (CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - [CNRS : UMR7534] - [Université Paris Dauphine - Paris IX]); Jean-Michel Marin (CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - [CNRS : UMR7534] - [Université Paris Dauphine - Paris IX]); Christian Robert (CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - [CNRS : UMR7534] - [Université Paris Dauphine - Paris IX]) |
| Abstract: | Our aim is to analyze the link between optimism and risk aversion in a subjective expected utility setting and to estimate the average level of optimism when weighted by risk tolerance. This quantity is of particular importance since it characterizes the consensus belief in risk-taking situations with heterogeneous beliefs. Its estimation leads to a nontrivial statistical problem. We start from a large lottery survey (1,536 individuals). We assume that individuals have true unobservable characteristics and that their answers in the survey are noisy realizations of these characteristics. We adopt a Bayesian approach for the statistical analysis of this problem and use an hybrid MCMC approximation method to numerically estimate the distributions of the unobservable characteristics. We obtain that individuals are on average pessimistic and that pessimism and risk tolerance are positively correlated. As a consequence, we conclude that the consensus belief is biased towards pessimism. |
| Keywords: | Bayesian estimation, MCMC scheme, importance sampling, pessimism, risk tolerance, risk aversion, consensus belief |
| Date: | 2007–10–04 |
| URL: | http://d.repec.org/n?u=RePEc:hal:papers:halshs-00176629_v1&r=upt |
| By: | Patarick Leoni (Economics Department, National University of Ireland, Maynooth) |
| Abstract: | In a typical IPO game with first-price auctions, we argue that risk-averse investors always underbid in equilibrium because of subjective interpretations of the firm' communication about its actual value and resulting risk aversion about the likelihood of facing investors with higher valuations. We show that the noisier the investors' inferences of the firm' value (in the sense of first-order stochastic dominance) the higher the underbidding level. Our finding is independent of winner's curse effects and possible irrationality, and allows for a testable theory. |
| Keywords: | IPO underpricing; first-price auction; risk aversion; firm' communication |
| JEL: | C7 D81 G12 G32 |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:may:mayecw:n1770807&r=upt |
| By: | Elyès Jouini (CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - [CNRS : UMR7534] - [Université Paris Dauphine - Paris IX]); Vincent Porte (CALYON - Calyon - [Calyon]) |
| Abstract: | In this article, we characterize efficient contingent claims in a context of transaction costs and multidimensional utility functions. The dual formulation of utility maximization helps us outline the key notion of cyclic anticomonotonicity. Moreover, after defining a utility price in this multidimensional setting, we provide a measure of strategies inefficiency and a tool allowing to effectively compute this measure with the help of cyclic anticomonotonicity. |
| Keywords: | cyclic anticomonotonicity, utility maximization, transaction |
| Date: | 2007–10–04 |
| URL: | http://d.repec.org/n?u=RePEc:hal:papers:halshs-00176619_v1&r=upt |
| By: | John Bryant (Vocat International) |
| Abstract: | This paper expands on points of a paper by the author, published earlier in 2007. Additional analyses are set out on the issue of the economic cycle and the boundary between products of economic value and flows of value between them. |
| Keywords: | Thermodynamics, economics, Le Chatelier, entropy, utility, money, equilibrium, value, energy |
| Date: | 2007–10 |
| URL: | http://d.repec.org/n?u=RePEc:voc:wpaper:ten22007&r=upt |
| By: | Dutta, Bhaskar (Department of Economics, University of Warwick) |
| Abstract: | A long tradition in welfare economics and moral philosophy, dating back at least to Sidgwick(1907) is the idea that all generations must be treated alike. Perhaps, the most forceful assertion of this idea comes from Ramsey (1928) who declared that any argument for preferring one generation over another must come “merely from the weakness of the imagination”. The “equal treatment of all generations” or the intergenerational equity principle has been formalised in the subsequent literature as the axiom of Anonymity, which requires that two infinite utility streams be judged indifferent to one another if one can be obtained from the other through a permutation of utilities of a finite number of generations. Since it also seems “natural” to require that any social evaluation of infinite utility streams respond positively to an increase in the utility of any generation, the Pareto Axiom is also desirable. Unfortunately, Diamond(1965) showed that there is no social welfare function satisfying these axioms along with a continuity axiom. In a more recent paper, Basu and Mitra( 2003) prove a more general result by showing that the continuity axiom is superfluous |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:wrk:warwec:819&r=upt |
| By: | Massimo Egidi |
| Abstract: | Despite the great effort that has been dedicated to the attempt to redefine expected utility theory on the grounds of new assumptions, modifying or moderating some axioms, none of the alternative theories propounded so far had a statistical confirmation over the full domain of applicability. Moreover, the discrepancy between prescriptions and behaviors is not limited to expected utility theory. In two other fundamental fields, probability and logic, substantial evidence shows that human activities deviate from the prescriptions of the theoretical models. The paper suggests that the discrepancy cannot be ascribed to an imperfect axiomatic description of human choice, but to some more general features of human reasoning and assumes the “dual-process account of reasoning” as a promising explanatory key. This line of thought is based on the distinction between the process of deliberate reasoning and that of intuition; where in a first approximation, “intuition” denotes a mental activity largely automatized and inaccessible from conscious mental activity. The analysis of the interactions between these two processes provides the basis for explaining the persistence of the gap between normative and behavioral patterns. This view will be explored in the following pages: central consideration will be given to the problem of the interactions between rationality and intuition, and the correlated “modularity” of the thought. |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:trn:utwpce:0706&r=upt |
| By: | Llussá, Fernanda; Tavares, José |
| Abstract: | In this paper we organize the literature on the economics of terrorism around seven different topics, offering a comprehensive view of the literature with a view to identifying questions that remain unanswered. The chosen topic areas are: The Measurement of Terrorist Activity, The Nature of Terrorists, The Utility Cost of Terrorism, The Impact of Terrorism on Aggregate Output, Terrorism and Specific Sectors of Activity, Terrorism and Economic Policy, and Counter-Terrorism. In a sense, we proceed from measurement issues to studies of the characteristics of terrorists and terrorist organizations, the consequences of terrorism on individual utility and, aggregate output and on specific sectors of activity, as well as the impact of terrorism on fiscal and monetary policies. We conclude with an examination of the economics literature on counter-terrorism measures. For each of the topics above, we present what the literature has achieved, the important questions that remain open and the type of data that would help researchers make progress. In our discussion, we identify the main papers in the literature and the issue(s) where each made a contribution, presenting a brief individual summary for these papers, organized along the topic areas. |
| Keywords: | Counter-Terrorism; Economics of Terrorism; Nature of Terrorists; Output Costs; Utility Costs |
| JEL: | A12 D10 E20 H00 K00 O11 |
| Date: | 2007–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:6509&r=upt |
| By: | Andrew Vivian |
| Abstract: | We examine the UK equity premium over more than a century using dividend growth to estimate expectations of capital gains employing the approach of Fama and French (2002). Over recent decades estimated equity premia implied by dividend growth have been much lower than that produced by average stock returns for the UK market as a whole; a finding corroborated by all economic sub-sectors. Our empirical analysis suggests this is primarily due to a declining discount rate, during the latter part of the 20th Century, which would rationally stimulate unanticipated equity price rises during this period. Thus, we conclude that historical stock returns over recent decades have been above investors’ expectations. |
| Keywords: | Equity Premium; Expected Returns; Dividend Growth Predictability |
| JEL: | G10 G12 |
| Date: | 2007–09 |
| URL: | http://d.repec.org/n?u=RePEc:san:crieff:0711&r=upt |