|
on Utility Models and Prospect Theory |
| By: | Harin, Alexander |
| Abstract: | The principle of uncertain future: the probability of a future event contains an (hidden) uncertainty. The first consequence of the principle: the real values of high probabilities are lower than the preliminarily determined ones; conversely, the real values of low probabilities can be higher than the preliminarily determined ones. The first consequence provides an uniform solution of the underweighting of high and the overweighting of low probabilities, of the Allais paradox, risk aversion, loss aversion, the equity premium puzzle, the “fourfold pattern” paradox, etc. The second consequence: the present probability system of a future event is incomplete. The second consequence provides a solution of the incompleteness of systems of preferences, of ambiguity aversion, of the Ellsberg paradox, etc. |
| Keywords: | uncertainty; risk; utility; choice; decisions; probability |
| JEL: | D81 C5 A1 E17 B4 D01 |
| Date: | 2008–04–08 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:8168&r=upt |
| By: | Adrian Bruhin (Socioeconomic Institute, University of Zurich) |
| Abstract: | This study compares the performance of Prospect Theory versus Stochastic Expected Utility Theory at fitting data on decision making under risk. Both theories incorporate well-known deviations from Expected Utility Maximization such as the Allais paradox or the fourfold pattern of risk attitudes. Stochastic Expected Utility Theory parsimoniously extends the standard microeconomic model, whereas Prospect Theory, the benchmark for aggregate choice so far, is based on psychological findings. First, the two theories' fit to representative choice is assessed for two experimental data sets, one Swiss and one Chinese. In a second step, finite mixture regressions reveal a consistent mix of two different behavioral types suggesting that researchers may take individual heterogeneity into account in order to avoid aggregation bias. |
| Keywords: | stochastic expected etility theory, prospect theory, finite mixture models |
| JEL: | D81 C49 |
| Date: | 2008–03 |
| URL: | http://d.repec.org/n?u=RePEc:soz:wpaper:0803&r=upt |
| By: | Pavlo R. Blavatskyy |
| Abstract: | This paper presents an axiomatic model of probabilistic choice under risk. In this model, when it comes to choosing one lottery over another, each alternative has a chance of being selected, unless one lottery stochastically dominates the other. An individual behaves as if he compares lotteries to a reference lottery—a least upper bound or a greatest lower bound in terms of weak dominance. The proposed model is compatible with several well-known violations of expected utility theory such as the common ratio effect and the violations of the betweenness. Necessary and sufficient conditions for the proposed model are completeness, weak stochastic transitivity, continuity, common consequence independence, outcome monotonicity, and odds ratio independence. |
| Keywords: | Probabilistic choice, first-order stochastic dominance, expected utility theory, random utility model, risk |
| JEL: | C91 D81 |
| Date: | 2008–04 |
| URL: | http://d.repec.org/n?u=RePEc:zur:iewwpx:364&r=upt |
| By: | John D Hey; Gianna Lotito; Anna Maffioletti |
| Abstract: | In this paper we examine the performance of theories of decision making under uncertainty/ambiguity from the perspective of their descriptive and predictive power, taking into account the relative parsimony of the various theories. To this end, we employ an innovative experimental design which enables us to reproduce ambiguity in the laboratory in a transparent and non-probabilistic way. We find that judging theories on the basis of their theoretical appeal, or on their ability to do well in testing contexts, is not the same as judging them on the basis of their explanatory and predictive power. We also find that the more elegant theoretical models do not perform as well as simple rules of thumb. |
| Keywords: | Ambiguity, Bingo Blower, Choquet Expected Utility, Decision Field Theory, Decision Making, Expected Utility, Hurwicz Criterion, (Gilboa and Schmeidler) MaxMin EU, (Gilboa and Schmeidler) MaxMax EU, (Ghirardato) Alpha-Model, MaxMin, MaxMax, Minimum Regret, Prospect Theory, Uncertainty. |
| JEL: | D81 C91 |
| Date: | 2008–04 |
| URL: | http://d.repec.org/n?u=RePEc:yor:yorken:08/04&r=upt |
| By: | Ulrich Schmidt; Michael Stolpe |
| Abstract: | Several experimental studies observed substantial violations of transitivity in decisions between risky lotteries over monetary outcomes. The goal of our experiment is to test whether these violations also affect the evaluation of health states. A particular feature of our experimental design is that it takes into account the possible role of decision errors in generating violations of transitivity. Since we find neither substantial nor systematic deviations from transitive choice behaviour, we can conclude that previously reported violations do not seem to bias health utility measurement. |
| Keywords: | Transitivity, Health utility, Errors |
| JEL: | D81 I10 C91 |
| Date: | 2008–03 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1412&r=upt |
| By: | Knutson, Brian; Wimmer, G. Elliott; Kuhnen, Camelia; Winkielman, Piotr |
| Abstract: | In functional magnetic resonance imaging (FMRI) research, nucleus accumbens (NAcc) activation spontaneously increases prior to financial risk taking. Since anticipation of diverse rewards can increase NAcc activation, even incidental reward cues may influence financial risk-taking. Using event-related FMRI, we predicted and found that anticipation of viewing rewarding stimuli (erotic pictures for 15 heterosexual males) increased financial risk taking, and that this effect was partially mediated by increases in NAcc activation. These results are consistent with the notion that incidental reward cues influence financial risk taking by altering anticipatory affect, and so identify a neuropsychological mechanism that may underlie effective emotional appeals in financial, marketing, and political domains. |
| Keywords: | neuroeconomics; neurofinance; brain; financial risk taking; risk preferences; decision making; nucleus accumbens; striatum; reward cues; FMRI; brain imaging |
| JEL: | D81 G11 C91 |
| Date: | 2008–03 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:8013&r=upt |
| By: | Yoonhee Tina Chang (School of Management, University of Bath); Catherine Waddams Price (Centre for Competition Policy, University of East Anglia) |
| Abstract: | Competition Authorities are introducing new informational remedies to help consumers search and switch more actively. Using a specially commissioned data set, and unique direct estimates of the gains, search and switching time which consumers anticipate, we examine the determinants of consumer activity in eight markets. We find that expected costs (and to some extent gains) do influence consumers as a utility maximising model would predict; but that their role is small, and other factors, particularly experience of switching in other markets, are also influential. We conclude that consumers’ confidence in their own estimates is crucial in encouraging market activity. |
| Keywords: | consumer behaviour, search and switching, informational remedies |
| JEL: | D12 D83 L51 L88 L98 |
| Date: | 2008–02 |
| URL: | http://d.repec.org/n?u=RePEc:ccp:wpaper:wp08-15&r=upt |
| By: | Julio Davila (Centre d'Economie de la Sorbonne et Paris School of Economics) |
| Abstract: | I establish, in simple deterministic overlapping generations economies, that if each agent holds rationally formed expectations in the sense that any other expectations justifying his choices imply a smaller likelihood for the history he observes with limited memory, then there are rationally formed expectations equilibria exhibiting an excess volatility that no rational expectations equilibrium can match. Given that the limited records or finite memory case may arguably be the relevant one from a positive viewpoint, this result suggests that the possibility of excess volatility as an equilibrium phenomenon has been downplayed by the use of the rational expectations hypothesis. |
| Keywords: | Expectations, rationality, volatility. |
| JEL: | D51 D84 D91 |
| Date: | 2008–02 |
| URL: | http://d.repec.org/n?u=RePEc:mse:cesdoc:b08019&r=upt |
| By: | Lönnbark, Carl (Department of Economics, Umeå University) |
| Abstract: | In this note it is argued that the estimation error in Value-at-Risk predictors gives rise to underestimation of portfolio risk. We propose a simple correction and find in an empirical illustration that it is economically relevant. |
| Keywords: | Estimation Error; Finance; Garch; Prediction; Risk Management |
| JEL: | C32 C51 C53 G10 |
| Date: | 2008–03–26 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:umnees:0734&r=upt |
| By: | Buly A. Cardak (Department of Economics and Finance, La Trobe University); Roger Wilkins (Melbourne Institute of Applied Economic and Social Research, The University of Melbourne) |
| Abstract: | We study the portfolio allocation decisions of Australian households using the relatively new Household Income and Labour Dynamics in Australia (HILDA) survey. We focus on household allocations to risky financial assets. Our empirical analysis considers a range of hypothesised determinants of these allocations. We find background risk factors posed by labour income uncertainty and health risk are important. Credit constraints and observed risk preferences play the expected role. A positive age gradient is identified for risky asset holdings and homeownership is associated with greater risky asset holdings. A unifying theme for many of our empirical findings is the important role played by financial awareness and knowledge in determining risky asset holdings. Many non-stockholding households appear to lack the experience and financial literacy that might enable them to benefit from direct investment in stocks. |
| Date: | 2008–02 |
| URL: | http://d.repec.org/n?u=RePEc:iae:iaewps:wp2008n02&r=upt |