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on Utility Models and Prospect Theory |
| By: | Georgescu, Irina |
| Keywords: | Risk Aversion, Risk Premium, Possibility Theory |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:amr:wpaper:476&r=upt |
| By: | Skander J. Van den Heuvel |
| Abstract: | Agents with standard, time-separable preferences do not care about the temporal distribution of risk. This is a strong assumption. For example, it seems plausible that a consumer may find persistent shocks to consumption less desirable than uncorrelated fluctuations. Such a consumer is said to exhibit temporal risk aversion. This paper examines the implications of temporal risk aversion for asset prices. The innovation is to work with expected utility preferences that (i) are not time-separable, (ii) exhibit temporal risk aversion, (iii) separate risk aversion from the intertemporal elasticity of substitution, (iv) separate short-run from long-run risk aversion and (v) yield stationary asset pricing implications in the context of an endowment economy. Closed form solutions are derived for the equity premium and the risk free rate. The equity premium depends only on a parameter indexing long-run risk aversion. The risk-free rate instead depends primarily on a separate parameter indexing the desire to smooth consumption over time and the rate of time preference. |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2008-37&r=upt |
| By: | Pavlo R. Blavatskyy |
| Abstract: | Preference reversals occur when different (but formally equivalent) elicitation methods reveal conflicting preferences over two alternatives. This paper shows that when people have fuzzy preferences i.e. when they choose in a probabilistic manner, their observed decisions can generate systematic preference reversals. A simple model of probabilistic choice and valuation can account for a higher incidence of standard (nonstandard) preference reversals for certainty (probability) equivalents and it can also rationalize the existence of strong reversals. An important methodological contribution of the paper is a new definition of a probabilistic certainty/probability equivalent of a risky lottery. |
| Keywords: | Preference reversal, probabilistic choice, certainty equivalent, probability equivalent, valuation |
| JEL: | D01 D80 D81 C91 |
| Date: | 2008–08 |
| URL: | http://d.repec.org/n?u=RePEc:zur:iewwpx:383&r=upt |
| By: | Zhang, Yan |
| Abstract: | In his paper "Does utility curvature matter for indeterminacy", Kim (2005) analyzed the relationship among the utility function form, curvature and indeterminacy, concluding that the relationship between curvature and indeterminacy is not robust in neoclassical growth model and the indeterminacy may disappear under the utility specification as in Greenwood et.al (1998). The models he discussed are confined within one sector closed economy. Weder (2001), Meng and Velasco (2004) extend the Benhabib and Farmer (1996) and Benhabib and Nishimura (1998)'s closed economy two sector models into open economy, showing that indeterminacy can occur under small external effects, independently of the intertemporal elasticities in consumption. Meng and Velasco (2003) went further, showing the independence between the elasticity of labor supply and indeterminacy in open economy. Under nonseparable utility forms like in King, Plosser and Rebelo (1988, henceforth KPR) or Bennett-Farmer (2000) form, do we still have this property? In other words, is the independence between curvature and indeterminacy in small open economy models robust to the specification of the utility functions? In this note, I tackle this issue under two different versions of nonseparable utility functions commonly used in the literature. The answer is "yes" to KPR form but "no" to Bennett-Farmer form. Endogenous time preference and consumable nontradable goods are two elements to deliver this result. |
| Keywords: | Indeterminacy; Endogenous time preference |
| JEL: | F4 E32 |
| Date: | 2008–05 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:10045&r=upt |
| By: | Vardas, Giannis; XEPAPADEAS, Anastasios |
| Abstract: | We analyze ecosystem management under `unmeasurable' Knightian uncertainty or ambiguity which, given the uncertainties characterizing ecosystems, might be a more appropriate framework relative to the classic risk case (measurable uncertainty). This approach is used as a formal way of modelling the precautionary principle in the context of least favorable priors and maxmin criteria. We provide biodiversity management rules which incorporate the precautionary principle. These rules take the form of either safety margins and minimum safety standards or optimal harvesting under precautionary approaches. |
| Keywords: | Knightian uncertainty; ambiguity; risk; precautionary principle; biodiversity management; optimal harvesting; robust control. |
| JEL: | D81 Q20 |
| Date: | 2008–08–10 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:10236&r=upt |
| By: | Roxana Chiriac; Valeri Voev (School of Economics and Management, University of Aarhus, Denmark) |
| Abstract: | This paper proposes a methodology for modelling time series of realized covariance matrices in order to forecast multivariate risks. The approach allows for flexible dynamic dependence patterns and guarantees positive definiteness of the resulting forecasts without imposing parameter restrictions. We provide an empirical application of the model, in which we show by means of stochastic dominance tests that the returns from an optimal portfolio based on the model’s forecasts second-order dominate returns of portfolios optimized on the basis of traditional MGARCH models. This result implies that any risk-averse investor, regardless of the type of utility function, would be better-off using our model. |
| Keywords: | Forecasting, Fractional integration, Stochastic dominance, Portfolio optimization, Realized covariance |
| JEL: | C32 C53 G11 |
| Date: | 2008–09–02 |
| URL: | http://d.repec.org/n?u=RePEc:aah:create:2008-39&r=upt |
| By: | Alberto Alesina; Richard Holden |
| Date: | 2008–08–29 |
| URL: | http://d.repec.org/n?u=RePEc:cla:levrem:122247000000002358&r=upt |
| By: | Georgescu, Irina |
| Keywords: | Revealed Preference, Fuzzy, Choice Function |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:amr:wpaper:475&r=upt |
| By: | Velu, C.; Iyer, S. |
| Abstract: | This paper discusses the importance of paradoxes of irrationality for managers by elaborating upon the rational basis for the adoption of non-equilibrium strategies in game theory. It does so by revisiting the one-shot Traveler's Dilemma game, proposing a solution which reconciles the anomaly between the empirical findings and the theoretical predictions of the Nash equilibrium suggested by the game. We contend that this seeming irrationality may be based upon the subjective probabilities of the players. We proffer an alternative basis upon which beliefs in game theory might be formed - 'returns-based beliefs' - and we present the corresponding numerical results for the Traveler's Dilemma game. We show that as long as the penalty is not too severe, then players are likely to play a high claim strategy. Our results correspond very closely to other empirical studies of the Traveler's Dilemma. Therefore, we argue that understanding the rational basis for game-theoretic paradoxes of irrationality might have important and practical uses for managerial decision-making. |
| Keywords: | Traveler's Dilemma, Rationality, Subjective Probabilities, Returns-Based Beliefs. |
| JEL: | C72 D43 |
| Date: | 2008–05 |
| URL: | http://d.repec.org/n?u=RePEc:cam:camdae:0826&r=upt |
| By: | Lisa R. Anderson (Department of Economics, College of William and Mary); Jennifer M. Mellor (Department of Economics, College of William and Mary) |
| Abstract: | We examine the stability of risk preference within subjects by comparing measures obtained from two elicitation methods, an economics experiment with real monetary rewards and a survey with questions on hypothetical gambles. The survey questions have been validated by numerous empirical studies of investment, insurance demand, smoking and alcohol use, and recent studies have shown the experimental measure is associated with several real-world risky behaviors. For the majority of subjects, we find that risk preferences are not stable across elicitation methods. In interval regression models, subjects’ risk preference classifications from survey questions on job-based gambles are not associated with risk preference estimates from the experiment. However, we find that risk classifications from inheritance-based gambles are significantly associated with the experimental measure. We identify some subjects for whom risk preference estimates are more strongly correlated across elicitation methods, suggesting that unobserved subject traits like comprehension or effort influence risk preference stability. |
| Keywords: | Risk Preferences, Laboratory Experiment, Survey |
| JEL: | C9 D8 |
| Date: | 2008–08–12 |
| URL: | http://d.repec.org/n?u=RePEc:cwm:wpaper:74&r=upt |