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on Utility Models and Prospect Theory |
| By: | Ales Cerný; Fabio Maccheroni; Massimo Marinacci; Aldo Rustichini |
| Abstract: | We report a surprising link between optimal portfolios generated by a special type of variational preferences called divergence preferences (cf. [8]) and optimal portfolios generated by classical expected utility. As a special case we connect optimization of truncated quadratic utility (cf. [2]) to the optimal monotone mean-variance portfolios (cf. [9]), thus simplifying the computation of the latter. |
| Keywords: | optimal portfolio, truncated quadratic utility, monotone mean-variance preferences, divergence preferences, HARA utility |
| JEL: | G11 D81 C61 |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:cca:wpaper:79&r=upt |
| By: | LEROUX, Marie-Louise (Université catholique de Louvain (UCL). Center for Operations Research and Econometrics (CORE)); PONTHIERE, Grégory |
| Abstract: | This paper studies the normative problem of redistribution between agents who can influence their survival probability through private health spending, but who differ in their attitude towards the risks involved in the lotteries of life to be chosen. For that purpose, we develop a two-period model where agents's preferences on lotteries of life can be represented by a mean and variance utility function allowing, unlike the expected utility form, some – agent-specific – sensitivity to what Allais (1953) calls the 'dispersion of psychological values'. It is shown that if agents ignore the impact of their health expenditures on the return of their savings, the decentralization of the first-best optimum requires not only intergroup lump-sum transfers, but, also, group-specific taxes on health spending. Under asymmetric information, we find that a subsidy on savings is optimal, whereas group-specific taxes on health spending are of ambiguous signs. |
| Keywords: | longevity, risk, lotteries of life, expected utility theory, health spending. |
| JEL: | D81 H21 I12 I18 J18 |
| Date: | 2008–06 |
| URL: | http://d.repec.org/n?u=RePEc:ctl:louvco:2008039&r=upt |
| By: | C-René Dominique |
| Abstract: | This note reviews consumers’ preference orderings in economics and shows that irrationality is a poor explanation for apparent violations of some axioms of order. Apparent violations seem to be better explained by the fact that consum-ers’ utility functions, if they exist at all, might not even belong to the class of quasi-concave functions. However, the main task of markets is the determination of equilibrium price vectors. The note shows in addition that, in Walrasian structures, quasi-concave utility functions are unnecessary for the determination of equilibrium price vectors. |
| Keywords: | Walrasian structures preference orderings irrationality utility functions and equilibrium price vectors. |
| JEL: | A1 A10 A14 |
| Date: | 2008–10–10 |
| URL: | http://d.repec.org/n?u=RePEc:eei:rpaper:eeri_rp_2008_10&r=upt |
| By: | Stefano Iezzi (Bank of Italy, Economics, Research and International Relations area) |
| Abstract: | In a choice model of risky assets the role of risk aversion is analyzed. The measure of risk preference comes from a direct subjective survey question and it is considered as an imperfect information about the true risk attitude of investors. Misclassification between the true and the observed risk aversion is explicitly taken into account in the empirical model. A Data Augmentation approach, a Bayesian procedure for incomplete-data problems, is applied on data from the 2006 Survey of Household Income and Wealth by the Bank of Italy. Results indicate that when misclassification of investors is taken into account model estimates show the good performance of the subjective question when used as a control in a portfolio choice models. Moreover risk aversion emerges as a strong predictor of the probability to hold risky assets. The analysis also shows that probability of misclassification decreases as latent risk aversion increases, that means that more risk tolerant investors tend to be classified erroneously more often than less risk tolerant investors. |
| Keywords: | Portfolio choice, risk attitude, misclassification error, Bayesian analysis |
| JEL: | I31 I32 D63 D31 |
| Date: | 2008–09 |
| URL: | http://d.repec.org/n?u=RePEc:bdi:wptemi:td_692_08&r=upt |
| By: | Alaoui, Larbi |
| Abstract: | There are a number of cases in which individuals do not expect to find out which outcome occurs. The standard von Neumann-Morgenstern Expected Utility model cannot be used in these cases, since it does not distinguish between lotteries for which the outcomes are observed by the agent and lotteries for which they are not. This paper provides an axiomatic model that makes this distinction. A representation theorem is then obtained. This framework admits preferences for observing the outcome, and preferences for remaining in doubt. Doubt-proneness and doubt-aversion are defined, and the relation between risk-aversion, caution and doubt-attitude is explored. The model builds on the standard vNM framework, but other frameworks can also be extended to allow for preferences for observing the outcomes and preferences for remaining in doubt. A methodology for this extension is also provided. This framework can accommodate behavioral patterns that are inconsistent with the vNM model, and which have let to significantly different models. In particular, this framework accommodates self-handicapping, in which an agent chooses to impair his own performance. It also admits a status-quo bias, even though it does not allow for framing effects. In a political economy setting, voters have incentive to remain ignorant even if information is costless. |
| Keywords: | Decision theory; Value of information; Doubt; Unobserved outcomes; Unresolved lotteries |
| JEL: | D80 |
| Date: | 2008–10–25 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:11411&r=upt |
| By: | Asher A. Blass; Saul Lach; Charles F. Manski |
| Abstract: | When data on actual choices are not available, researchers studying preferences sometimes pose choice scenarios and ask respondents to state the actions they would choose if they were to face these scenarios. The data on stated choices are then used to estimate random utility models, as if they are data on actual choices. Stated choices may differ from actual ones because researchers typically provide respondents with less information than they would have facing actual choice problems. Elicitation of choice probabilities overcomes this problem by permitting respondents to express uncertainty about their behavior. This paper shows how to use elicited choice probabilities to estimate random utility models with random coefficients and applies the methodology to estimate preferences for electricity reliability in Israel. |
| JEL: | C25 C42 D12 L51 L94 |
| Date: | 2008–10 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:14451&r=upt |
| By: | Marc-Arthur Diaye (CEE - Centre d'Etudes de l'Emploi - Ministère de la recherche - Ministère chargé de l'Emploi, EPEE - centre d'Etudes des Politiques Economiques de l'université d'Evry - Université d'Evry-Val d'Essonne); François Gardes (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I); Christophe Starzec (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I) |
| Abstract: | The purpose of this paper is twofold. We first point out that violation of rationality axioms (SARP, GARP, WARP) do not necessarily lead to a non-rational behavior. Second, our tests of axioms SARP, GARP and WARP over a Polish panel data (1987-90) show that over the 3630 households only 240 violate the three axioms. However these 240 violations are not caused by the non-respect of demand theory axioms but by the changing of preferences over the period. A logistic regression confirms the robustness of the test since the more the real expenditure increases in absolute value, the more the probability of violating the axioms increases (the respect of the axioms by the 3390 households is not due to an increase of the real expenditure). Moreover, changing in the composition of the family structure increases the probability of being inconsistent. It seems therefore that the 240 apparent violations are due to the appearance of new constraints, which increase the shadow prices of the goods. In order to explain these 240 households’ preference changes, we build an econometric model of prices including an observed monetary component and an unobserved non-monetary component expressing the constraints faced by the agent. The estimation of this econometric model shows that the agents who apparently violate the axioms have these complete price changes superior to those of the agents who respect the axioms. Thus the agents who apparently violate the axioms faced during the period a change of their non-monetary resources and the appearance of new constraints. |
| Keywords: | Rationality, GARP, Non-parametric tests, Shadow prices. |
| Date: | 2008–04–01 |
| URL: | http://d.repec.org/n?u=RePEc:hal:cesptp:halshs-00268829_v1&r=upt |
| By: | Jean J., GABSZEWICZ; Joana, RESENDE |
| Abstract: | This paper analyses price competition under product differentiation when goods are defined in a two dimensional characteristic space, and consumers do not know which firm sells which quality. Equilibrium prices consist of two additive terms, which balance consumersÕ relative valuation of goodsÕ expected quality and consumersÕ preferences for variety. However the relative importance of these terms differ under vertical and horizontal dominance |
| Keywords: | product differentiation, variety, quality, uncertainty |
| JEL: | D43 D80 L15 |
| Date: | 2008–08–27 |
| URL: | http://d.repec.org/n?u=RePEc:ctl:louvec:2008027&r=upt |
| By: | Ferre De Graeve (Federal Reserve Bank of Dallas); Maarten Dossche (National Bank of Belgium, Research Department); Marina Emiris (National Bank of Belgium, Research Department); Henri Sneessens (Catholic University of Louvain-La-Neuve); Raf Wouters (National Bank of Belgium, Research Department) |
| Abstract: | We analyze financial risk premiums and real economic dynamics in a DSGE model with three types of agents - shareholders, bondholders and workers - that differ in participation in the capital market and in terms of risk aversion. Aggregate productivity and distribution risk are shared among these agents via the bond market and via an efficient labor contract. The result is a combination of volatile returns to capital and a highly cyclical consumption process for the shareholders, which are two important ingredients for generating high and countercyclical risk premiums. These risk premiums are consistent with a strong propagation mechanism through an elastic supply of labor, rigid real wages and a countercyclical labor share. We discuss the implications for the real and nominal component of the risk premium on equity and bonds. We show how these premiums react to changes in the volatility of the shocks, as experienced during the great moderation. We also analyze the effects of changes in monetary policy behavior and the resulting inflation dynamics. |
| JEL: | E32 E44 G12 |
| Date: | 2008–10 |
| URL: | http://d.repec.org/n?u=RePEc:nbb:reswpp:200810-25&r=upt |