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on Utility Models and Prospect Theory |
| By: | Voorneveld, Mark (Dept. of Economics, Stockholm School of Economics) |
| Abstract: | We provide characterizations of preferences representable by a Cobb-Douglas utility function. |
| Keywords: | Preferences; Utility theory; Cobb-Douglas |
| JEL: | C60 D01 |
| Date: | 2008–10–10 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:hastef:0701&r=upt |
| By: | Patrick Roger (Laboratoire de Recherche en Gestion et Economie, Université Louis Paster) |
| Abstract: | In a recent paper entitled “Putting Risk in its Proper Place”, Eeckhoudt and Schlesinger (2006) established a theorem linking the sign of the n-th derivative of an agent’s utility function to her preferences among pairs of simple lotteries. We characterize these lotteries and show that, in a given pair, they only differ by their moments of order greater than or equal to n. When the n-th derivative of the utility function is positive (negative) and n is odd (even), the agent prefers a lottery with higher (lower) n+2p-th moments for p belonging to the set of positive integers. This result links the preference for disaggregation of risks across states of nature and the structure of moments preferred by mixed risk averse agents. It can be viewed as a generalization of a proposition appearing in Ekern (1980) which focused only on the differences in the n-th moments. |
| Keywords: | Risk apportionment, mixed risk aversion, prudence, temperance. |
| JEL: | D81 |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:lar:wpaper:2008-17&r=upt |
| By: | David Dillenberger (Department of Economics, University of Pennsylvania) |
| Abstract: | We study a decision maker (DM) who has recursive preferences over compound lotteries and who cares about the way uncertainty is resolved over time. DM has preferences for one-shot resolution of uncertainty (PORU) if he always prefers any compound lottery to be resolved in a single stage. We establish an equivalence between dynamic PORU and static preferences that are identified with the behavior observed in Allais-type experiments. We define the gradual resolution premium and demonstrate its magnifying effect when combined with the usual risk premium. In an intertemporal context, PORU capture "loss aversion with narrow framing". |
| Keywords: | recursive preferences over compound lotteries, resolution of uncertainty, Allais paradox, narrow framing, negative certainty independence. |
| JEL: | D80 D81 |
| Date: | 2008–10–10 |
| URL: | http://d.repec.org/n?u=RePEc:pen:papers:08-036&r=upt |
| By: | Fabian Herweg; Daniel Müller; Philipp Weinschenk |
| Abstract: | This paper extends the standard principal-agent model with moral hazard to allow for agents having reference- dependent preferences according to Köszegi and Rabin (2006, 2007). The main finding is that loss aversion leads to fairly simple contracts. In particular, when shifting the focus from standard risk aversion to loss aversion, the optimal contract is a simple bonus contract, i.e. when the agent's performance exceeds a certain threshold he receives a fixed bonus payment. Moreover, if the agent is sufficiently loss averse, it is shown that the first-order approach is not necessarily valid. If this is the case the principal may be unable to fine-tune incentives. Strategic ignorance of information by the principal, however, allows to overcome these problems and may even reduce the cost of implementation. |
| Keywords: | Agency Model; Moral Hazard; Reference-Dependent Preferences; Loss Aversion |
| JEL: | D8 M1 M5 |
| Date: | 2008–09 |
| URL: | http://d.repec.org/n?u=RePEc:bon:bonedp:bgse17_2008&r=upt |
| By: | Stephan Bartke; Reimund Schwarze |
| Abstract: | Research findings have proven that the willingness to take risks is distributed heterogeneously among individuals. In the general public, there is a widely held notion that individuals of certain nationalities tend to hold certain typical risk preferences. Furthermore, religious beliefs are thought to explain differences in risk-preparedness on the individual level. We analyze these two possible determinants of individual risk attitudes: nationality and religion. First addressing the study of risk attitudes in a literature review, we then test our hypotheses empirically using the large, representative German Socio-Economic Panel (SOEP). To understand the importance of nationality, we focus on emigrants to Germany. The key findings are: (1) Nationality is not a valid determinant of risk attitudes. It can be broken down into several constituent factors including religion. (2) Religiousness is a significant determinant of risk attitudes. Religious persons are less risk-tolerant than atheists. Moreover, religious affiliation matters: Muslims are less risk-tolerant than Christians. |
| Keywords: | Risk Aversion, Nationality, Immigrants, Religion, Germany |
| JEL: | D10 D80 D81 J15 Z12 |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:diw:diwsop:diw_sp131&r=upt |
| By: | Patrick Roger (Laboratoire de Recherche en Gestion et Economie, Université Louis Paster) |
| Abstract: | Capital protected notes are very popular structured products since the internet bubble burst in 2000. Investors are protected against large losses they could suffer if they were investing directly in the underlying index or portfolio of stocks. It then seems intuitive that such products are attractive for loss averse investors. However, using a simple version of cumulative prospect theory, we show that these products are not attractive when the investor takes either the underlying index or the risk-free investment as the reference point. She always prefer an investment in the index or in the risk-free portfolio, depending on her coefficient of loss aversion. |
| Keywords: | Structured finance, prospect theory, loss aversion, capital protection. |
| JEL: | G11 |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:lar:wpaper:2008-16&r=upt |
| By: | Eike B. Kroll (Faculty of Economics and Management, Otto-von-Guericke University Magdeburg); Bodo Vogt (Faculty of Economics and Management, Otto-von-Guericke University Magdeburg) |
| Abstract: | Experimental economists have discovered various violations of expected utility theory and offered alternative models that can explain laboratory results. This study discovers a new violation in risky choices that cannot be explained by theories like Prospect Theory, Disappoint- ment or Regret Theory. In an experimental setting using a between- subject design, the influence of a dominated alternative on certainty equivalents is shown. One group of subjects was offered a series of choices between a lottery ticket with a 50-50 chance of winning and a sure payoff. A second group was offered the same choice plus a third alternative, that as it turned out was not chosen by any participant. As a result, the average chosen sure payoff in the second group was higher than in the first group. That means, by adding a dominated alternative to a choice set, the certainty equivalent of a lottery is in- creased. |
| Date: | 2008–09 |
| URL: | http://d.repec.org/n?u=RePEc:mag:wpaper:08028&r=upt |
| By: | Eike B. Kroll (Faculty of Economics and Management, Otto-von-Guericke University Magdeburg); Bodo Vogt (Faculty of Economics and Management, Otto-von-Guericke University Magdeburg) |
| Abstract: | This paper investigates decisions about inter-temporal tradeoffs. The objective of the study is to explore the valuation of time itself without tradeoffs between time and consequences. In an experimental study subjects made decisions about waiting time, where the time was subject to risk. We find that subjects are risk-seeking for decisions about time, which leads to the conclusion that waiting time is experienced as a loss. Subjects in this experiment show similar choice patters as can be seen in studies about money when losses are involved. |
| Date: | 2008–09 |
| URL: | http://d.repec.org/n?u=RePEc:mag:wpaper:08027&r=upt |
| By: | Roxana Chiriac (Universität Konstanz); Valeri Voev |
| 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. |
| Date: | 2008–09–01 |
| URL: | http://d.repec.org/n?u=RePEc:knz:cofedp:0806&r=upt |
| By: | Alain Chateauneuf (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I); Michel Grabisch (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I); Agnès Rico (LIRIS - Laboratoire d'Informatique en Images et Systèmes d'Information - CNRS : UMR5205 - Université Claude Bernard - Lyon I - Université Lumière - Lyon II - Institut National des Sciences Appliquées de Lyon - Ecole Centrale de Lyon) |
| Abstract: | The aim of the paper is to present under uncertainty, and in an ordinal framework, an axiomatic treatment of the Sugeno integral in terms of preferences which parallels some earlier derivations devoted to the Choquet integral. Some emphasis is given to the characterization of uncertainty aversion. |
| Keywords: | Sugeno integral; uncertainty aversion; preference relations; ordinal information |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:halshs-00327700_v1&r=upt |
| By: | Arthur Robson (Dept. of Economics, Simon Fraser University); Larry Samuelson (Cowles Foundation, Yale University) |
| Abstract: | We examine the evolutionary foundations of intertemporal preferences. When all the risk affecting survival and reproduction is idiosyncratic, evolution selects for agents who maximize the discounted sum of expected utility, discounting at the sum of the population growth rate and the mortality rate. Aggregate uncertainty concerning survival rates leads to discount rates that exceed the sum of population growth rate and death rate, and can push agents away from exponential discounting. |
| Keywords: | Discounting, Evolution, Present bias, Time preference |
| JEL: | D1 D9 |
| Date: | 2008–10 |
| URL: | http://d.repec.org/n?u=RePEc:cwl:cwldpp:1678&r=upt |
| By: | Fernandez, Pablo (IESE Business School) |
| Abstract: | This paper is a review of the recommendations about the equity premium found in the main finance and valuation textbooks. We review several editions of books written by authors such as Brealey and Myers; Copeland, Koller and Murrin (McKinsey); Ross, Westerfield and Jaffe; Bodie, Kane and Marcus; Damodaran; Copeland and Weston; Van Horne; Bodie and Merton; Stowe et al.; Pratt; Penman; Bruner; Weston & Brigham; and Arzac. We highlight the confusing message of the textbooks regarding the equity premium and its evolution. The main confusion arises from not distinguishing among the four concepts that the word equity premium designates: historical equity premium (hep), expected equity premium, required equity premium (rep) and implied equity premium (IEP). Some confusion also arises from not recognizing that although the HEP is the same for all investors, the REP, the EEP and the IEP are different for different investors. A unique IEP requires assuming homogeneous expectations for expected growth (g), but there are several pairs (IEP, g) that satisfy current prices. We claim that different investors have different REPs and that it is impossible to determine the REP for the market as a whole, because it does not exist. |
| Keywords: | equity premium; equity premium puzzle; required market risk premium; historical market risk premium; expected market risk premium; risk premium; market risk premium; market premium; |
| JEL: | G12 G31 G32 |
| Date: | 2008–04–20 |
| URL: | http://d.repec.org/n?u=RePEc:ebg:iesewp:d-0745&r=upt |