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on Utility Models and Prospect Theory |
| By: | Yuri Golubev; Wolfgang Härdle; Roman Timonfeev |
| Abstract: | The behaviour of market agents has always been extensively covered in the literature. Risk averse behaviour, described by von Neumann and Morgenstern (1944) via a concave utility function, is considered to be a cornerstone of classical economics. Agents prefer a fixed profit over uncertain choice with the same expected value, however lately there has been a lot of discussion about the reliability of this approach. Some authors have shown that there is a reference point where market utility functions are convex. In this paper we have constructed a test to verify uncertainty about the concavity of agents’ utility function by testing the monotonicity of empirical pricing kernels (EPKs). A monotone decreasing EPK corresponds to a concave utility function while non-monotone decreasing EPK means non-averse pattern on one or more intervals of the utility function. We investigated the EPK for German DAX data for years 2000, 2002 and 2004 and found the evidence of non-concave utility functions: H0 hypothesis of monotone decreasing pricing kernel was rejected at 5% and 10% significance level in 2002 and at 10% significance level in 2000. |
| Keywords: | Risk Aversion, Pricing kernel |
| JEL: | G12 C12 |
| Date: | 2008–01 |
| URL: | http://d.repec.org/n?u=RePEc:hum:wpaper:sfb649dp2008-001&r=upt |
| By: | Einat Neuman (University Center of Ariel); Shoshana Neuman (Bar-Ilan University, CEPR and IZA) |
| Abstract: | A Discrete Choice Experiment (DCE) in the health-care sector is used to test the loss aversion theory that is derived from reference-dependent preferences: The absolute subjective value of a deviation from a reference point is generally greater when the deviation represents a loss than when the same-sized change is perceived as a gain. As far as is known, this paper is the first to use a DCE to test the loss aversion theory. A DCE appears to be a highly suitable tool for this testing because it estimates the marginal valuations of attributes, based on deviations from a reference point (a constant scenario). Moreover, loss aversion can be examined for each attribute separately. A DCE can also be applied to nontraded goods with non-tangible attributes. A health-care event is used for empirical illustration: The loss aversion theory is tested within the context of preference structures for maternity-ward attributes, estimated using data entailing 3850 observations from a sample of 542 women who recently gave birth. Seven hypotheses are presented and tested. Overall, significant support for behavioral loss aversion theories was found. |
| Keywords: | preferences, attributes, loss aversion, reference-dependence, Discrete Choice Experiment, maternity-wards |
| JEL: | D01 D12 I19 |
| Date: | 2007–12 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp3238&r=upt |
| By: | Lorán Chollete; Randi Næs (Norges Bank (Central Bank of Norway)); Johannes A. Skjeltorp (Norges Bank (Central Bank of Norway)) |
| Abstract: | Is the effect of liquidity risk on asset prices sensitive to our choice of liquidity proxy? In addressing this fundamental question, we achieve two main results. First, when we estimate factor models on a broad range of liquidity measures we uncover a profound distinction between trade and order based liquidity. Second, although the order based factor provides a better signal of available liquidity, we find that only the factor related to information risk explains expected returns both in a theoretical liquidity-CAPM model and in a linear pricing framework. Our results suggest a surprising fragility of liquidity-based asset pricing. |
| Keywords: | CPAM, Liquidity risk, Liquidity factor, Order based measure, Trade based measure, Information risk |
| JEL: | G12 G14 |
| Date: | 2007–06–28 |
| URL: | http://d.repec.org/n?u=RePEc:bno:worpap:2007_03&r=upt |
| By: | Lionel Page (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, Westminster Business School - University of Westminster); Louis Lévy-Garboua (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, CIRANO - Centre interuniversitaire de recherche en analyse des organisations - Université du Québec à Montréal, Ecole d'économie de Paris - Paris School of Economics - Université Panthéon-Sorbonne - Paris I); Claude Montmarquette (CIRANO - Centre interuniversitaire de recherche en analyse des organisations - Université du Québec à Montréal, Université de Montréal - Département de Sciences Economique - Université de Montréal) |
| Abstract: | The explanation of social inequalities in education is still a debated issue in economics. Recent empirical studies tend to downplay the potential role of credit constraint. This article tests a different potential explanation of social inequalities in education, specifically that social differences in aspiration level result in different educational choices. Having existed for a long time in the sociology of education, this explanation can be justified if aspiration levels are seen as reference points in a Prospect Theory framework. In order to test this explanation, this article applies the method of experimental economics to the issue of education choice and behaviour. One hundred twenty-nine individuals participated in an experiment in which they had to perform a task over fifteen stages grouped in three blocks or levels. In order to continue through the experiment, a minimum level of success was required at the end of each level. Rewards were dependent on the final level successfully reached. At the end of each level, participants could either choose to stop and take their reward or to pay a cost to continue further in order to possibly receive higher rewards. To test the impact of aspiration levels, outcomes were either presented as gains or losses relative to an initial sum. In accordance with the theoretical predictions, participants in the loss framing group choose to go further in the experiment. There was also a significant and interesting gender effect in the loss framing treatment, such that males performed better and reached higher levels. |
| Keywords: | Education inequality, Prospect Theory, Experimental Economics |
| Date: | 2007–12 |
| URL: | http://d.repec.org/n?u=RePEc:hal:papers:halshs-00203145_v1&r=upt |
| By: | Emmanuel Farhi; Iván Werning |
| Abstract: | This paper derives an intertemporal optimality condition for economies with private information, focusing on a class of recursive preferences. By comparing it to the situation where agents can freely save in a risk-free asset market, we derive the optimal savings distortions necessary for constrained optimality. Our recursive preferences are homogeneous and satisfy a balanced growth condition, while allowing us to separate the role of risk aversion and intertemporal elasticity of substitution. We perform some quantitative exercises that disentangle the respective roles played by these two parameters play in opt8imal distortions and the implied welfare gains. |
| JEL: | H0 |
| Date: | 2008–01 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:13720&r=upt |
| By: | Fu, Qiang; Lu, Jingfeng |
| Abstract: | This paper proposes a multi-winner noisy-ranking contest model. Contestants are ranked in a descending order by their perceived outputs, and rewarded by their ranks. A contestant's perceivable output increases with his/her autonomous effort, but is subject to random perturbation. We establish, under plausible conditions, the equivalence between our model and the family of (winner-take-all and multi-winner) lottery contests built upon ratio-form contest success functions. Our model thus provides a micro foundation for this family of often studied contests. In addition, our approach reveals a common thread that connects a broad class of seeming disparate competitive activities and unifies them in the nutshell of ratio-form success functions. |
| Keywords: | Multi-Winner Contest; Contest Success Function; Noisy Ranking |
| JEL: | C7 |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:6679&r=upt |
| By: | Stéphane Loisel (SAF - EA2429 - Laboratoire de Science Actuarielle et Financière - Université Claude Bernard - Lyon I); Claude Lefèvre (Département de Mathématique - Université Libre de Bruxelles) |
| Abstract: | This paper is concerned with the compound Poisson risk model and two generalized models with still Poisson claim arrivals. One extension incorporates inhomogeneity in the premium input and in the claim arrival process, while the other takes into account possible dependence between the successive claim amounts. The problem under study for these risk models is the evaluation of the probabilities of (non-)ruin over any horizon of finite length. The main recent methods, exact or approximate, used to compute the ruin probabilities are reviewed and discussed in a unified way. Special attention is then paid to an analysis of the qualitative impact of dependence between claim amounts. |
| Keywords: | compound Poisson model; ruin probability; finite-time horizon; recursive methods; (generalized) Appell polynomials; non-constant premium; non-stationary claim arrivals; interdependent claim amounts; impact of dependence; comonotonic risks; heavy-tailed distributions |
| Date: | 2007–12 |
| URL: | http://d.repec.org/n?u=RePEc:hal:papers:hal-00201377_v1&r=upt |
| By: | Ludovic Renou; Karl H. Schlag |
| Abstract: | This paper introduces the concept of minimax regret equilibrium, a close relative of Nash equilibrium, which accommodates the possibility that players are uncertain about the rationality and conjectures of their opponents. We provide several applications of our concept. In particular, we consider price-setting environments and show that optimal pricing policy follows a non-degenerate distribution. The induced price dispersion is consistent with experimental and empirical observations (Baye and Morgan (2004)). |
| Keywords: | minimax regret; rationality; price dispersion; auction |
| JEL: | C7 |
| Date: | 2008–01 |
| URL: | http://d.repec.org/n?u=RePEc:lec:leecon:08/2&r=upt |
| By: | Graham Loomes (School of Economics, University of East Anglia); Chris Starmer (School of Economics, University of Nottingham); Robert Sugden (School of Economics, University of East Anglia) |
| Abstract: | Previous studies suggest that two otherwise robust ‘anomalies’ – preference reversals and disparities between buying and selling valuations – are eroded when respondents participate in repeated markets. We report an experiment which investigates whether this is true when factors neglected in previous studies are controlled, and which distinguishes between anomalies revealed in the behaviour of individual market participants and anomalies revealed in market prices. Our results confirm the decay of buy/sell disparities, but not of preference reversal. This raises doubts about the hypothesis that, in general, repeated markets reveal anomaly-free preferences, even among the marginal traders who determine prices. |
| Keywords: | preference reversal, willingness to accept, willingness to pay, repeated market. |
| JEL: | C91 |
| Date: | 2007–11 |
| URL: | http://d.repec.org/n?u=RePEc:cdx:dpaper:2007-10&r=upt |
| By: | Mitreanu, Cristian |
| Abstract: | The article, "A Business-Relevant View of Human Nature," provides a new theory of human nature, and aims to bring it to the center of our understanding of business, or commerce, creating a strong foundation for new business and economic principles and practices. The article has three parts. In the first section, the author identifies and discusses the fundamental drives that characterize all forms of life. Building upon these findings, he then develops the unique view of human nature in the second section. Finally, in the last section, he highlights the new perspectives on business that can be generated with the help of the new theory of human nature. |
| JEL: | D0 M0 B0 M1 A1 B5 |
| Date: | 2007–11–19 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:6560&r=upt |
| By: | Daniel Rondeau; John A. List |
| Abstract: | This study designs a natural field experiment linked to a controlled laboratory experiment to examine the effectiveness of matching gifts and challenge gifts, two popular strategies used to secure a portion of the $200 billion annually given to charities. We find evidence that challenge gifts positively influence contributions in the field, but matching gifts do not. Methodologically, we find important similarities and dissimilarities between behavior in the lab and the field. Overall, our results have clear implications for fundraisers and provide avenues for future empirical and theoretical work on charitable giving. |
| JEL: | C9 C93 H4 |
| Date: | 2008–01 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:13728&r=upt |
| By: | Enzo Dia |
| Abstract: | Banking intermediaries help to coordinate different agents’ plans, reducing the uncertainty that might otherwise hamper transactions because of disruptive “lemon” problems. By establishing trust relationships based on private information, banks allow risk pooling and provide insurance to different classes of agents, act as market makers, and provide services that save transaction and notary costs. “Lemon” problems are also important to understand the difference between market pricing of the risk of bonds and the banks’ pricing of the risk of loans. In the first case risk is priced on the basis of freely available information, relying heavily on the informational content of statistical time series. The resulting equilibria, though, are fragile, because they are subject to abrupt regime changes as new information becomes public. Banks, on the contrary, price loans on the basis of their private information, and they can thus provide insurance against different kinds of shocks. Given the opacity of their activities, and the huge externalities that their entrepreneurial choices imply, banks must be subject to an extensive regulation, imposing a transparent disclosure of their risk taking activities. |
| Keywords: | Banks; Credit; Uncertainty; Information Costs; Trust |
| Date: | 2007–11 |
| URL: | http://d.repec.org/n?u=RePEc:mib:wpaper:130&r=upt |