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on Utility Models and Prospect Theory |
| By: | Lau, Chi-Lei Oscar |
| Abstract: | A disturbing feature of the conventional objective function for intertemporal decisions under uncertainty is that the agent's attitudes toward intertemporal substitution and risk aversion are entangled. This paper shows that, in contrast to common perception, the two attitudes can be completely disentangled under the expected utility theorem (EUT) by modeling each of them successively in two steps. The conventional form is nested as a special case where the functions describing the two attitudes are identical. The proposed framework requires only the standard axioms of the EUT, in addition to a regulatory assumption. It is flexible in accommodating different combinations of the two attitudes, indifferent to the timing of resolution of uncertainty, intuitive to interpret, and extendable to multiple goods. The objective function under the proposed framework is time inconsistent according to Strotz's (1955) definition. I argue that Strotz's notion of time consistency is misguided. It is constructed based on a priori assumption that the agent should continuously forget history as time progresses. But this means the agent is either chronically amnesiac or self-contradictory. To be truly consistent, the agent should have one and only one objective function, determined at birth, throughout his entire life. As history unfolds, the agent updates his information set, but not his objective function. |
| Keywords: | Intertemporal substitution; Risk aversion; Expected utility theorem; Time consistency; Equity premium puzzle |
| JEL: | D81 G12 D91 E21 |
| Date: | 2008–11–06 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:11482&r=upt |
| By: | Sarolta Laczó (Toulouse School of Economics (Gremaq)) |
| Abstract: | This paper examines how cooperation in an insurance game depends on risk preferences and the riskiness of income. It considers a dynamic game where commitment is limited, and characterizes the level of cooperation as measured by the reciprocal of the discount factor above which perfect risk sharing is self-enforcing. When agents face no aggregate risk, there is more cooperation, if (i) the utility function is more concave, and if (ii) income is more risky considering a mean-preserving spread or an SSD deterioration. However, (ii) no longer holds when insurance can only be incomplete, because of the interplay of idiosyncratic and aggregate risk. In the case of exponential (isoelastic) utility, cooperation depends positively on both the coefficient of absolute (relative) risk aversion and the standard deviation (coefficient of variation), and is independent of mean income. This paper also relates the level of cooperation to informal insurance transfers and the smoothness of consumption when perfect risk sharing is not achieved. |
| Keywords: | informal insurance, limited commitment, risk preferences, riskiness, comparative statics, dynamic stochastic games |
| JEL: | C73 D80 |
| Date: | 2008–10 |
| URL: | http://d.repec.org/n?u=RePEc:has:discpr:0821&r=upt |
| By: | Simone Cerreia-Vioglio; Fabio Maccheroni; Massimo Marinacci; Luigi Montrucchio |
| Abstract: | We introduce a notion of complete monotone quasiconcave duality and we show that it holds for important classes of quasiconcave functions. |
| Keywords: | Quasiconcavity, Quasiconvexity, Duality, Indirect Utility |
| JEL: | C65 |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:cca:wpaper:80&r=upt |
| By: | Moore, Rebecca |
| Abstract: | This paper compares three approaches to using attitudinal data to describe heterogeneous preferences for non-market goods. Two latent class models and one random parameter logit model are included. Each model makes different assumptions about the role of attitudes in the decision process. Specifically, each model assumes a different relationship between attitudes and preferences and these differences are discussed in terms of economic and social psychology theory. The three models are then used to examine individual preferences for water clarity improvements in Green Bay, Wisconsin. The results suggest that the choice of models has important implications on the quantitative results and on the nature of the preference heterogeneity, but does not affect the qualitative implications of the results. The estimates of expected WTP were nearly identical across the three models. |
| Keywords: | Institutional and Behavioral Economics, Public Economics, Resource /Energy Economics and Policy, |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:ags:aaea08:6488&r=upt |
| By: | Francis X. Diebold (Department of Economics, University of Pennsylvania); Georg H. Strasser (Department of Economics, Boston College) |
| Abstract: | We argue for incorporating the financial economics of market microstructure into the financial econometrics of asset return volatility estimation. In particular, we use market microstructure theory to derive the cross-correlation function between latent returns and market microstructure noise, which feature prominently in the recent volatility literature. The cross-correlation at zero displacement is typically negative, and cross-correlations at nonzero displacements are positive and decay geometrically. If market makers are sufficiently risk averse, however, the cross-correlation pattern is inverted. Our results are useful for assessing the validity of the frequently-assumed independence of latent price and microstructure noise, for explaining observed crosscorrelation patterns, for predicting as-yet undiscovered patterns, and for making informed conjectures as to improved volatility estimation methods. |
| Keywords: | Realized volatility, Market microstructure theory, High-frequency data, Financial econometrics |
| JEL: | G14 G20 D82 D83 C51 |
| Date: | 2008–10–09 |
| URL: | http://d.repec.org/n?u=RePEc:boc:bocoec:693&r=upt |
| By: | Chang, Jae Bong; Lusk, Jayson L.; Norwood, F. Bailey |
| Abstract: | We compare the ability of three preference elicitation methods (hypothetical choices, non-hypothetical choices, and non-hypothetical rankings) and three discrete-choice econometric models (the multinomial logit, the independent availability logit, and the random parameter logit) to predict actual retail shopping behavior in three different product categories (ground beef, wheat flour, and dishwashing liquid). Overall, across all methods, we find a reasonably high level of external validity. Our results suggest that the non-hypothetical elicitation approaches, especially the non-hypothetical ranking, outperformed the hypothetical choice experiment in predicting retail sales. We also find that the random parameter logit can have superior predictive performance, but that the multinomial logit predicts equally well in some circumstances. |
| Keywords: | contingent valuation, choice experiments, experimental economics, external validity, field experiment, Agribusiness, Consumer/Household Economics, Marketing, Research Methods/ Statistical Methods, |
| Date: | 2008 |
| URL: | http://d.repec.org/n?u=RePEc:ags:aaea08:43600&r=upt |