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on Utility Models and Prospect Theory |
| By: | Stephen Satchell (University of Cambridge); Susan Thorp (School of Finance and Economics, University of Technology, Sydney) |
| Abstract: | We determine optimal consumption paths under a series of returns scenarios for charitable endowments with distinct tastes over investment risk and inter-temporal substitution. Charities typically prefer smooth consumption paths but are investment-risk tolerant. Using a recursive, Kreps-Porteus utility function, we model the optimal disbursement from an infinitely-lived charitable trust, then, allowing a general form for the returns density, we apply stochastic dominance relations to estimate income/substitution effects whereby a change in future returns influences the current consumption rate. The elasticity of intertemporal substitution rather than risk aversion is key: optimal consumption rises or falls as the elasticity diverges from one. |
| Keywords: | recursive utility; stochastic dominance; inter-temporal choice |
| JEL: | G00 D81 D91 |
| Date: | 2007–12–01 |
| URL: | http://d.repec.org/n?u=RePEc:uts:rpaper:209&r=upt |
| By: | Laszlo Goerke; Markus Pannenberg |
| Abstract: | In an open-shop model of trade union membership with heterogeneity in risk attitudes, a worker's relative risk aversion can affect the decision to join a trade union. Furthermore, a shift in risk attitudes can alter collective bargaining outcomes. Using German panel data (GSOEP) and three novel direct measures of individual risk aversion, we find evidence of a significantly positive relationship between risk aversion and the likelihood of union membership. Additionally, we observe a negative correlation between bargained wages in aggregate and average risk preferences of union members. Our results suggest that an overall increase in risk aversion contributes to wage moderation and promotes employment. |
| Keywords: | Employment, membership, risk aversion, trade union |
| JEL: | J |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:diw:diwsop:diw_sp88&r=upt |
| By: | Privileggi, Fabio |
| Abstract: | Under a cutoff policy, taxpayers can either report income as usual and run the risk of being audited, or report a "cutoff" income and hence pay a threshold tax that guarantees not being audited. Whereas the mainstream literature in this field assumes risk neutrality of taxpayers – with some notable exceptions like Chu (1990) and Glen Ueng and Yang (2001) – this paper assumes risk aversion instead: taxpayers have a Constant Relative Risk Aversion (CRRA) utility function and differ in terms of their relative risk aversion coefficient and income. The novel contribution of this work is that, under certain conditions, the cutoff is accepted by taxpayers with intermediate characteristics in terms of income and relative risk aversion. Contrary to the standard result in the literature, a full separation of types (the rich who accept the cutoff versus the poor who refuse it) does not arise. However, our results confirm that the cutoff policy violates equity, as only some taxpayers directly benefit. Nonetheless, the perception of this drawback may in practice be obfuscated because that exclusion does not necessarily affect only the poor. |
| Keywords: | cutoff, tax evasion, relative risk aversion. |
| JEL: | H26 D89 K42 |
| Date: | 2007–12 |
| URL: | http://d.repec.org/n?u=RePEc:uca:ucapdv:99&r=upt |
| By: | Patrick Roger (Laboratoire de Recherche en Gestion et Economie, Université Louis Pasteur) |
| Abstract: | The disposition effect is a well established phenomenon in the empirical and experimental financial literature. It leads to sell winners too early and to hold losers too long. In this paper, we show that the consciousness of the disposition effect by investors lead them to require a greater risk premium to invest in stocks (when compared to rational investors). We also analyze the role of the evaluation period for disposition investors. We show that the risk premium they require is a decreasing function of the delay between two evaluations of their portfolio. The influence of the evaluation period on the equity premium looks like the one induced by myopic loss aversion (Benartzi-Thaler, 1995) but the origin is different. Valuing more often a portfolio give more occasions to sell winning stocks and then decreases the expected return. This point is analyzed by assuming that returns are driven by a Brownian motion and that investors evaluate their portfolio at regularly spaced dates. |
| Keywords: | Disposition effect, equity premium puzzle, loss aversion, behavioral finance. |
| JEL: | G11 G14 |
| Date: | 2007 |
| URL: | http://d.repec.org/n?u=RePEc:lar:wpaper:2007-01&r=upt |
| By: | Judith Lammers (Tilburg University); Sweder van Wijnbergen (University of Amsterdam) |
| Abstract: | This study analyses the relation between perceived health status and intertemporal choice. We use data from experiments with real monetary rewards conduEted among students in South Africa to estimate risk and time preferences. These experimental data, based on muitiple price lists developed by Coller & Williams (1999), Holt & Laury (2002), and Harrison et al. (2002, 2005), show that HIV+ agents and participants that perceive to have a high HIV contraction risk are less risk-averse. Although the latter group displays higher discount rates, HP positive agents seem to have substantially lower discount rates, indicating longer time horizons in spite of their lowered life expectancy. However, we show that direct estimates of discount rates can be seriously biased estimators of the pure rate of time preference when other factors than just the pure rate of time preference are not considered simultaneously. We correct for differential mortality risk, risk aversion and differences in anticipated future marginal utility increases and price in these factors when calculating pure rates of time preference from observed discount rates. Once these factors are taken into account, HIV+ agents’ time preferences conform to expectations. |
| Keywords: | discount rate; risk aversion; perceived HIV infection risk; mortality; time preferences; marginal utility; hyperbolic discounting |
| JEL: | D81 D91 I18 |
| Date: | 2007–12–18 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:uvatin:20070098&r=upt |
| By: | Thomann, Christian; Pascalau, Razvan; von der Schulenburg, J.-Matthias Graf; Gas, Bruno |
| Abstract: | This article extends the theory of corporate risk management to encompass highly dynamic risks. Taking Viscusi's (1989) prospective reference from the context of individual decision making and applying it to a corporate context we propose a theory of how corporations process new information. Using unique data on all terrorism insurance policies sold in Germany we find support for this concept of risk-updating by showing that the demand for terrorism insurance is strongly determined by the recent occurrence of terrorist attacks. |
| Keywords: | Corporate Insurance; Risk Management; Terrorism Insurance; Expected Utility; Prospect Theory. |
| JEL: | D81 D83 G32 |
| Date: | 2007–12–13 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:7221&r=upt |
| By: | René van den Brink (Vrije Universiteit Amsterdam); René Levinsky (Max Planck Institute of Economics, Jena, Germany); Miroslav Zeleny (Charles University, Prague, Czech Republic) |
| Abstract: | The Shapley value of a cooperative transferable utility game distributes the dividend of each coalition in the game equally among its members. Given exogenous weights for all players, the corresponding weighted Shapley value distributes the dividends proportionally to their weights. In this contribution we define the balanced solution which assigns weights to players such that the corresponding weighted Shapley value of each player is equal to her weight. We prove its existence for all monotone transferable utility games, discuss other properties of this solution, and deal with its characterization through a reduced game consistency. |
| Keywords: | Balanced solution; Proportionality; Reduced game consistency; Weighted Shapley value |
| JEL: | C71 |
| Date: | 2007–10–12 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:uvatin:20070073&r=upt |
| By: | Jean-Marc Bonnisseau (Paris School of Economics and Universitè Paris 1 Panthèon-Sorbonne); Elena L. del Mercato (University of Salerno and CSEF) |
| Abstract: | We consider a general model of pure exchange economies with consumption externalities. Households may have different consumption sets and each consumption set is described by a function called possibility function. Utility and possibility functions depend on the consumptions of all households. Our goal is to give sufficient conditions for the regularity of such economies. We prove that, generically, economies are regular in the space of endowments and possibility functions. |
| Keywords: | Externalities, consumption constraints, competitive equilibrium, regular economies |
| JEL: | C62 D50 D62 |
| Date: | 2008–02–11 |
| URL: | http://d.repec.org/n?u=RePEc:sef:csefwp:195&r=upt |
| By: | C. Mirjam van Praag (University of Amsterdam); Peter H. Versloot (University of Amsterdam) |
| Abstract: | This paper examines to what extent recent empirical evidence can collectively and systematically substantiate the claim that entrepreneurship has important economic value. Hence, a systematic review is provided that answers the question: What is the contribution of entrepreneurs to the economy in comparison to non-entrepreneurs? We study the relative contribution of entrepreneurs to the economy based on four measures that have most widely been studied empirically. Hence, we answer the question: What is the contribution of entrepreneurs to (i) employment generation and dynamics, (ii) innovation, and (iii) productivity and growth, relative to the contributions of the entrepreneurs’ counterparts, i.e. the ‘control group’? A fourth type of contribution studied is the role of entrepreneurship in increasing individuals’ utility levels. Based on 57 recent studies of high quality that contain 87 relevant separate analyses, we conclude that entrepreneurs have a very important – but specific – function in the economy. They engender relatively much employment creation, productivity growth and produce and commercialize high quality innovations. They are more satisfied than employees. More importantly, recent studies show that entrepreneurial firms produce important spillovers that affect regional employment growth rates of all companies in the region in the long run. However, the counterparts cannot be missed either as they account for a relatively high value of GDP, a less volatile and more secure labor market, higher paid jobs and a greater number of innovations and they have a more active role in the adoption of innovations. |
| Keywords: | entrepreneur; entrepreneurship; self-employment; productivity; economic development; growth; employment; innovation; patents; R&D; research; development; utility; remuneration; income |
| JEL: | J01 L26 |
| Date: | 2007–08–27 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:uvatin:20070066&r=upt |
| By: | Giulio Bottazzi; Giovanna Devetag; Francesca Pancotto |
| Abstract: | In this work we describe a laboratory experiment on the emergence and coordination of expectations in a pure exchange framework. We consider a simple two asset economy with a riskless bond and a risky stock. Each market is composed of six experimental subjects who act as financial advisors of myopic risk-averse utility maximizing investors and are rewarded according to how well their forecasts perform in the market. In one treatment subjects must only make forecasts of the future return; in a second treatment they must also provide a confidence range for their prediction. The realized asset price is derived from a Walrasian market equilibrium equation with feedback from individual forecasts. We use subjects' confidence range as as indirect measure of perceived risk, and we analyze the aggregate dynamics of the resulting markets. Our experimental markets present substantial volatility that in some cases tend to increase with time, and no evidence of bubble formation. The treatment in which subjects must provide a confidence range presents lower price fluctuation compared to the baseline treatment. Finally, the behavior of subjects may often be described by simple linear forecasting rules. |
| Keywords: | experimental economics, expectations, coordination, asset pricing |
| JEL: | C91 C92 D84 G12 G14 |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:trn:utwpce:0801&r=upt |
| By: | Luigi Mittone; Lucia Savadori |
| Abstract: | In two laboratory studies involving 285 undergraduate students presented with a one-shot real choice we observe a systematic influence of time delay on the preferences for two lotteries, equal in expected value, but different in the degree of probability and outcome. The more the outcome is postponed (2 weeks, 1 month, 3 months, 6 months), the more individuals prefer the lottery offering a higher value (400 Euro) but a lower probability (.02) compared to the one offering a lower value (14 Euro) but a higher probability (.60). We explain these findings assuming a savoring hypothesis according to which, for highly emotional events, individuals prefer to postpone the desirable outcome, enjoying the savoring experience of anticipating the future emotions. It also suggests that for decisions where uncertainty resolution is postponed in the future, people will underweight the probability and overweight the outcome. |
| Keywords: | intertemporal choice, time delay, time horizon, gambles, risk |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:trn:utwpce:0802&r=upt |
| By: | De Waegenaere, A.M.B.; Wielhouwer, J.L. (Tilburg University, Center for Economic Research) |
| Abstract: | We consider a principal-agent setting in which a manager?s compensation de- pends on a noisy performance signal, and the manager is granted the right to choose an (accounting) method to determine the value of the performance signal. We study the effect of the degree of such reporting discretion, measured by the number of acceptable methods, on the optimal contract, the expected cost of com- pensation and the manager?s expected utility. We find that while an increase in reporting discretion never harms the manager, the effect on the expected cost of compensation is more subtle. We identify three main effects of increased report- ing discretion and characterize the conditions under which the aggregate of these three effects will lead to a higher or lower cost of compensation. |
| Keywords: | managerial compensation;reporting flexibility. |
| JEL: | D82 D86 M41 |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:kubcen:200821&r=upt |