nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2008‒06‒27
nine papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Looking Awkward When Winning and Foolish When Losing: Inequity Aversion and Performance in the Field By Benno Torgler; Markus Schaffner; Bruno S.Frey; Sascha L. Schmidt
  2. Uncertainty and Compound Lotteries: Calibration By Halevy, Yoram; Ozdenoren, Emre
  3. What Good Is Wealth Without Health? The Effect of Health on the Marginal Utility of Consumption By Amy Finkelstein; Erzo F.P. Luttmer; Matthew J. Notowidigdo
  4. Expected Stock Returns and Variance Risk Premia By Tim Bollerslev; Hao Zhou
  5. Equity Aversion By Fershtman, Chaim; Gneezy, Uri; List, John
  6. Dynamic Estimation of Volatility Risk Premia and Investor Risk Aversion from Option-Implied and Realized Volatilities By Tim Bollerslev; Michael Gibson; Hao Zhou
  7. Bounded Decision Making: From Description to Improvement By Dolly Chugh; Katherine Lyford Milkman; Max H. Bazerman
  8. The Talmud On Transitivity By Shlomo Naeh; Uzi Segal
  9. Macroeconomic Determinants of Stock Market Returns, Volatility and Volatility Risk-Premia By Valentina Corradi; Antonio Mele; Walter Distaso

  1. By: Benno Torgler; Markus Schaffner; Bruno S.Frey; Sascha L. Schmidt
    Abstract: The experimental literature and studies using survey data have established that people care a great deal about their relative economic position and not solely, as standard economic theory assumes, about their absolute economic position. Individuals are concerned about social comparisons. However, behavioral evidence in the field is rare. This paper provides an empirical analysis, testing the model of inequity aversion using two unique panel data sets for basketball and soccer players. We find support that the concept of inequity aversion helps to understand how the relative income situation affects performance in a real competitive environment with real tasks and real incentives.
    Keywords: Inequity aversion, relative income, positional concerns, envy, social comparison, performance, interdependent preferences
    JEL: D00 D60 L83
    Date: 2008–06–16
  2. By: Halevy, Yoram; Ozdenoren, Emre
    Abstract: The Ellsberg experiments provide an intuitive illustration that the Savage approach, which reduces subjective uncertainty to risk, is not rich enough to capture many decision makers' preferences. Recent experimental evidence suggests that decision makers reduce uncertainty to compound risk. This work presents a theoretical model of decision making in which preferences are defined on both Savage subjective acts and compound objective lotteries. Preferences are two-stage probabilistically sophisticated when the ranking of acts corresponds to a ranking of the respective compound lotteries induced by the acts through the decision maker's subjective belief. This family of preferences includes various theoretical models that have been proposed in the literature to accommodate non-neutral attitude towards ambiguity. The principle of calibration, which was used by Ramsey and de Finetti, allows an outside observer to relate preferences over acts and compound objective lotteries. If preferences abide by the calibration axioms, the evaluation of the compound lottery induced by an act through the subjective belief coincides with the evaluation of the corresponding compound objective lottery. Calibration provides the foundation that allows one to formalize and understand the tight empirical association between probabilistic sophistication and reduction of compound lotteries, for all two-stage probabilistically sophisticated preferences.
    JEL: D81
    Date: 2008–06–17
  3. By: Amy Finkelstein; Erzo F.P. Luttmer; Matthew J. Notowidigdo
    Abstract: We estimate how the marginal utility of consumption varies with health. To do so, we develop a simple model in which the impact of health on the marginal utility of consumption can be estimated from data on permanent income, health, and utility proxies. We estimate the model using the Health and Retirement Study's panel data on the elderly and near-elderly, and proxy for utility with measures of subjective well-being. We find robust evidence that the marginal utility of consumption declines as health deteriorates. Our central estimate is that a one-standard-deviation increase in the number of chronic diseases is associated with an 11 percent decline in the marginal utility of consumption relative to this marginal utility when the individual has no chronic diseases. The 95 percent confidence interval allows us to reject declines in marginal utility of less than 2 percent or more than 17 percent. Point estimates from a wide range of alternative specifications tend to lie within this confidence interval. We present some simple, illustrative calibration results that suggest that state dependence of the magnitude we estimate can have a substantial effect on important economic problems such as the optimal level of health insurance benefits and the optimal level of life-cycle savings.
    JEL: D12 I1
    Date: 2008–06
  4. By: Tim Bollerslev; Hao Zhou (School of Economics and Management, University of Aarhus, Denmark)
    Abstract: We find that the difference between implied and realized variation, or the variance risk premium, is able to explain more than fifteen percent of the ex-post time series variation in quarterly excess returns on the market portfolio over the 1990 to 2005 sample period, with high (low) premia predicting high (low) future returns. The magnitude of the return predictability of the variance risk premium easily dominates that afforded by standard predictor variables like the P/E ratio, the dividend yield, the default spread, and the consumption-wealth ratio (CAY). Moreover, combining the variance risk premium with the P/E ratio results in an R2 for the quarterly returns of more than twenty-five percent. The results depend crucially on the use of “model-free”, as opposed to standard Black-Scholes, implied variances, and realized variances constructed from high-frequency intraday, as opposed to daily, data. Our findings suggest that temporal variation in both risk-aversion and volatility-risk play an important role in determining stock market returns.
    Keywords: Return Predictability, Implied Variance, Realized Variance, Equity Risk Premium, Variance Risk Premium, Time-Varying Risk Aversion
    JEL: G12 G14
    Date: 2007–08–16
  5. By: Fershtman, Chaim; Gneezy, Uri; List, John
    Abstract: Models of inequity aversion and fairness have dominated the behavioural economics landscape in the last decade. This study gathers data from 240 subjects exposed to variants of two of the major experimental games - dictator and trust - that are employed to provide important empirical content to these models. With a set of simple laboratory treatments that focus on a manipulation of an important feature of real markets, competition over resources, we show that extant behavioural models are unable to explain data drawn from realistic manipulations of either game. Our empirical results highlight that if placed in an environment wherein socially acceptable actions provide one person with a greater portion of the rents, people will put forth extra effort to secure those rents, to the detriment of the other player. In this manner, when one can earn more than the other player through actions deemed customary, people reveal a preference for equity aversion, not inequity aversion. We propose an alternative modelling approach that can explain these data as well as accommodate other major data patterns observed in the experimental literature.
    Keywords: Equity Aversion; Social Preferences; Social Status
    JEL: C91 Z13
    Date: 2008–06
  6. By: Tim Bollerslev; Michael Gibson; Hao Zhou (School of Economics and Management, University of Aarhus, Denmark)
    Abstract: This paper proposes a method for constructing a volatility risk premium, or investor risk aversion, index. The method is intuitive and simple to implement, relying on the sample moments of the recently popularized model-free realized and option-implied volatility measures. A small-scale Monte Carlo experiment confirms that the procedure works well in practice. Implementing the procedure with actual S&P500 option-implied volatilities and high-frequency five-minute-based realized volatilities indicates significant temporal dependencies in the estimated stochastic volatility risk premium, which we in turn relate to a set of macro-finance state variables. We also find that the extracted volatility risk premium helps predict future stock market returns.
    Keywords: Stochastic Volatility Risk Premium, Model-Free Implied Volatility, Model-Free Realized Volatility, Black-Scholes, GMM Estimation, Return Predictability
    JEL: G12 G13 C51 C52
    Date: 2007–08–16
  7. By: Dolly Chugh (New York University, Stern School of Business); Katherine Lyford Milkman (Harvard Business School); Max H. Bazerman (Harvard Business School, Negotiation, Organizations & Markets Unit)
    Abstract: The optimal moment to address the question of how to improve human decision making has arrived. In recent research, judgment and decision-making scholars have moved beyond the concept of bounded rationality to recognize a broader set of bounds that affect decision making. We specify a taxonomy that assembles the field's knowledge about these decision-making bounds and organizes efforts toward deepening this knowledge and developing strategies for improvement. Specifically, we group five identified decision-making bounds into three broad categories: bounds on information processing, bounds on the optimal weighting of priorities, and bounds on noticing information. The first category encompasses bounded rationality, the first bound to be discovered and studied extensively. The second category encompasses bounded willpower and bounded self-interest. The third category encompasses two recently identified bounds: bounded ethicality and bounded awareness. By organizing diverse theories into a clear framework, the taxonomy should aid researchers and educators in identifying new strategies for improving decision making.
    Date: 2008–06
  8. By: Shlomo Naeh (Hebrew University); Uzi Segal (Boston College)
    Abstract: Transitivity is a fundamental axiom in Economics that appears in consumer theory, decision under uncertainty, and social choice theory. While the appeal of transitivity is obvious, observed choices sometimes contradict it. This paper shows that treatments of violations of transitivity al- ready appear in the rabbinic literature, starting with the Mishnah and the Talmud (1st–5th c CE). This literature offers several solutions that are similar to those used in the modern economic literature, as well as some other solutions that may be adopted in modern situations. We analyze several examples. One where nontransitive relations are acceptable; one where a violation of transitivity leads to problems with extended choice functions; and a third where a nontransitive cycle is deliberately created (to enhance justice).
    Keywords: transitivity, Talmud
    Date: 2008–06–23
  9. By: Valentina Corradi; Antonio Mele; Walter Distaso
    Abstract: This paper introduces a no-arbitrage framework to assess how macroeconomic factors help explain the risk-premium agents require to bear the risk of .uctuations in stock market volatility. We develop a model in which return volatility and volatility risk-premia are stochastic and derive no-arbitrage conditions linking volatility to macroeconomic factors. We estimate the model using data related to variance swaps, which are contracts with payo¤s indexed to nonparametric measures of realized volatility. We .nd that volatility risk-premia are strongly countercyclical, even more so than standard measures of return volatility.
    Date: 2008–06

This nep-upt issue is ©2008 by Alexander Harin. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
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