nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2008‒07‒30
nine papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Financial Risk Aversion and Household Asset Diversification By Nataliya Barasinska; Dorothea Schäfer; Andreas Stephan
  2. Non-Bayesian decision theory ante-litteram: the case of G. L. S. Shackle By Carlo Zappia
  3. 'CHOOSER DEPENDANT' PREFERENCES, AND ATTITUDES de se By Vittorioemanuele Ferrante
  4. Ambiguous Money Distribution And The Price Stickiness Phenomenon: A Rationale From An Ambiguous Rational Expectations Approach By Marcello Basili; Stefano Dalle Mura
  5. Revealed Conflicting Preferences By Attila Ambrus; Kareen Rozen
  6. Lowest Unique Bid over the Internet: Ability, Lottery or Scam? By Andrea Gallice
  7. Multiple Priors as Similarity Weighted Frequencies By Jürgen Eichberger; Ani Guerdjikova
  8. A Short Note on the Infinite Decision Puzzle By Garcia-Fronti, Javier
  9. Individual Investors and Volatility By Foucault, Thierry; Sraer, David; Thesmar, David

  1. By: Nataliya Barasinska; Dorothea Schäfer; Andreas Stephan
    Abstract: This paper explores the relationship between risk attitude and asset diversification in household portfolios. We first examine the impact of manifested risk aversion on the total number of distinct assets held in a portfolio (naive diversification). The second part of the paper focuses on a more sophisticated strategy of diversification and asks whether financial theory is compatible with observed diversification patterns. Based on the German Socioeconomic Panel which provides unique measures of individual propensity for taking risk, the results of the regression analysis show that, along with some socioeconomic characteristics, the propensity for taking investment risk is an important predictor of a household's diversification strategy. However, some of our findings are strongly at odds with what the concept of mean-variance utility suggests.
    Keywords: Household finances, diversification, financial portfolio
    JEL: D14 G11
    Date: 2008
  2. By: Carlo Zappia
    Abstract: This paper deals with the intellectual environment in which George L. S. Shackle’s theory of decision making was formulated and first discussed. Shackle’s approach had a great impact on decision theory in late 1940s and early 1950s being the single formalised attempt to discard the probability framework in the description of behaviour under uncertainty - a goal shared by Knight and Keynes. Against Shackle, Arrow defended the use of probability theory in decision making, by denying that the Knightian distinction between risk and uncertainty had any behavioural significance, and paving the way to Savage’s Foundations of Statistics as the new mainstream reference. Through an assessment of the reception of Shackle’s theory the paper presents the way a number of theoretical economists, psychologists, and mathematicians were interested in the viability of a formally structured alternative to theories of behaviour using probability statements to describe uncertainty. The paper aim to show that the lively but concentrated discussion on alternative decisional criteria Shackle was part of is crucial to understand the multifarious developments observed in modern decision theory in the last twenty years or so. Indeed, as discussed in a twin paper by Basili and Zappia, Shackle’s theory was a much more viable alternative to subjective expected utility than both its contemporary critics and modern decision theorists have recognised.
    Keywords: Decision theory, uncertainty, Shackle.
    JEL: B16 D81
    Date: 2008–06
  3. By: Vittorioemanuele Ferrante (Università degli Studi di Firenze, Dipartimento di Scienze Economiche)
    Abstract: Sen’s 'chooser dependence' of preferences generates issues of indexicality which, we claim, can in fact be reduced to a specification of the content of preferences within a standard approach, by means of Lewis’ theory of attitudes de se. While context sensitivity of preferences can be dealt with by the addition to the outcomes of choice of their relevant mereological contexts, indexical sensitivity requires the content of preferences to include (the nature of) the decision maker him/herself. The result is a naturalistic internalization of preferences, which become object of preference, belief, and action. Keywords: Preferences, utility, choice, attitudes, mereology, properties.
    Date: 2008
  4. By: Marcello Basili; Stefano Dalle Mura
    Abstract: This paper shows that ambiguity – as opposed to risk – may lead to sticky prices even with fully rational agents. Attitude towards ambiguity is assumed, as supported by theoretical literature and experimental evidence, to be asymmetric in the form of ambiguity aversion towards uncertain gains and ambiguity seeking towards losses. In this setting that price stickiness follows a change in the money supply level that does not alter the distribution of money constitutes a self fulfilling expectations equilibrium. That is the average (expected) result, but other interesting cases can occur (price overshooting and an inverse relationship between prices economic activity). Money neutrality remains true in the long run. The main result is carried out in a model where ambiguity concerns firms’ ignorance about the relationship between the stock of money and money distribution.
    Keywords: ambiguity, multiple priors, price stickiness.
    JEL: D81 E52 O42
    Date: 2008–07
  5. By: Attila Ambrus (Harvard University); Kareen Rozen (Cowles Foundation, Yale University)
    Abstract: We model a DM as a collection of utility functions (selves, rationales) and an aggregation rule (a theory of how selves are activated by choice sets). The DM’s choice function is rationalized by a collection of selves and an aggregator if it selects the unique maximizer of aggregate utility. For a general class of aggregators, we show that the number of selves required to rationalize a choice function is at most a linear function of the number of IIA violations exhibited. We provide simple conditions for checking when an aggregator can rationalize all choice functions with enough selves; and provide a minimal set of behaviors that an aggregator can rationalize with a fixed number of selves. We apply the framework to choice over menus and examine the revealed preference implications of IIA violations for the subjec­tive state-space. While consistent with evidence in psychology on multiple selves, our framework also has implications for models of collective house-hold behavior and marketing models of multiattribute goods.
    Keywords: Multiple selves, IIA violations, Context-dependent choice, Rationalizability, Complexity
    JEL: D11 D13 D71
    Date: 2008–07
  6. By: Andrea Gallice
    Abstract: A lowest unique bid auction allocates a good to the agent who submits the lowest bid that is not matched by any other bid. This peculiar auction format is getting increasingly popular over the internet. We show that such a selling mechanism is unprofitable if bidders are rational but can become highly lucrative if bidders are myopic. In this second case, we analyze the key role played by the existence of some private signals that the seller sends to the bidders. Data about actual auctions confirm the profitability of the mechanism and the bounded rationality of the bidders.
    Keywords: Lowest Unique Bid Auctions, Signals, Bounded Rationality.
    JEL: D44 C72 D82
    Date: 2008–06
  7. By: Jürgen Eichberger (University of Heidelberg, Department of Economics); Ani Guerdjikova (Cornell University, Department of Economics)
    Abstract: In this paper, we consider a decision-maker who tries to learn the distribution of outcomes from previously observed cases. For each observed sequence of cases the decision-maker predicts a set of priors expressing his beliefs about the underlying probability distribution. We impose a version of the concatenation axiom introduced in BILLOT, GILBOA, SAMET AND SCHMEIDLER (2005) which insures that the sets of priors can be represented as a weighted sum of the observed frequencies of cases. The weights are the uniquely determined similarities between the observed cases and the case under investigation.
    Date: 2008–07
  8. By: Garcia-Fronti, Javier
    Abstract: This work draws on the Supertask literature1 in order to better understand the conceptual and physical possibility of an infinite decision puzzle presented by Barrett and Arntzenius (1999, 2002). The first section presents the puzzle and two possible objections documented in the literature. The next section argues that cardinality and tracking considerations play a key role in understanding the puzzle. The work concludes with a discussion about some implications for the decision theory.
    Keywords: supertask infinite decision puzzle
    JEL: G11 B41
    Date: 2008–07–01
  9. By: Foucault, Thierry; Sraer, David; Thesmar, David
    Abstract: We test the hypothesis that individual investors contribute to the idiosyncratic volatility of stock returns because they act as noise traders. To this end, we consider a reform that makes short selling or buying on margin more expensive for retail investors relative to institutions, for a subset of French stocks. If retail investors are noise traders, theory implies that the volatility of stocks affected by the reform should decrease relative to other stocks. This prediction is borne out by the data. Moreover, around the reform, we observe a significant decrease in (i) the magnitude of returns reversals, and (ii) the Amihud ratio for the stocks affected by the reform relative to other stocks. We show that these findings are also consistent with models in which individual investors, acting as noise traders, are a source of volatility.
    Keywords: Idiosyncratic volatility; Noise trading; Retail investors
    JEL: G11 G12 G14
    Date: 2008–07

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