nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2008‒12‒21
eleven papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Risk Aversion, Stochastic Dominance, and Rules of Thumb: Concept and Application By Vivek Dehejia
  2. Additive utility in prospect theory By Han Bleichrodt; Ulrich Schmidt; Horst Zank
  3. S-shaped utility, subprime crash and the black swan By de Farias Neto, Joao Jose
  4. International Income Comparisons and Location Choice: Methodology, Analysis, and Implications. By Vivek Dehejia; Marcel Voia
  5. (Over-)Stylizing experimental findings and theorizing with sweeping generality By Werner Güth; Hartmut Kliemt; M. Vittoria Levatia
  6. Can Median-Maximizing Behavior Be Rational? By Vivek Dehejia; Jiankang Zhang
  7. Recursive utilities with a variable bound on impatience By Jaśkiewicz, Anna; Matkowski, Janusz; Nowak, Andrzej
  8. Modelling preference heterogeneity in stated choice data: an analysis for public goods generated by agriculture By Colombo, Sergio; Hanley, Nick; Louviere, Jordan
  9. Individual investors and volatility By Foucault, Thierry; Themar, David; Sraer, David
  10. Isolating the Systematic Component of a Single Stock’s (or Portfolio’s) Standard Deviation By Cara Marshall
  11. Dual use of budgeting in uncertainty contexts: Explorative study of senior sales and marketing managers By Löning, Hélène; Besson, M.; Mendoza, Carla

  1. By: Vivek Dehejia (Department of Economics, Carleton University, CESifo, Munich, Germany.)
    JEL: D81
    Date: 2008–01–14
  2. By: Han Bleichrodt; Ulrich Schmidt; Horst Zank
    Date: 2008
  3. By: de Farias Neto, Joao Jose
    Abstract: I propose an S-shaped utility function of consumption which, combined with an heterogeneous agents and external habit setting, fits well the first order moments of the American financial and macroeconomic time series relevant for the equity premium puzzle in the second half of XX century. The average relative risk aversion of the agents remains in the 0-3 range. A "black swan"-kind phenomenon makes two of the 50 years considered (the two oil shocks) responsible for half the average of the stochastic discount factor, thus bringing the annual subjective discount factor to a very low level, around 0.5, which solves the risk-free puzzle. The shape of the relative risk aversion function of consumption suggests an explanation for the 2008 suprime crash akin to the breaking of waves on a beach in a lifecycle overlapping generations model.
    Keywords: financial puzzles; subprime crash; black swan; S-shaped utility
    JEL: G12 D91 E44
    Date: 2008–12–12
  4. By: Vivek Dehejia (Department of Economics, Carleton University, CESifo, Munich, Germany.); Marcel Voia (Department of Economics, Carleton University)
    Abstract: This paper contributes to ongoing debates on international income comparisons by deploying a novel methodology for constructing empirical distribution functions for the United States and Canada over the period 1993 - 2000. We also conduct tests for first, second, third order stochastic dominance and of intersection of distributions, to determine which,if either, country might be a preferred destination for migration. Our findings are for that all of the years for which there is comparable data, the Canadian income distribution second order stochastically dominates the US income distribution. We provide an interpretation in terms of expected utility theory, considering the case of log utility, and relate our findings to an argument by Joseph Stiglitz, that in the face of skewness of income distributions a potential migrant should look at the median rather than the mean. It turns out that Stiglitz's intuition is correct, at least in the context of our study.
    Keywords: Non-parametrics, Finite Mixtures, Heterogeneous Income Distribution, Stochastic Dominance, Kolmogorov-Smirnov type statistic, Bootstrap.
    JEL: C12 D31 D63 D81
    Date: 2008–02–05
  5. By: Werner Güth (Max Planck Institute of Economics, Jena, Germany); Hartmut Kliemt (Frankfurt School of Finance & Management, Frankfurt am Main, Germany); M. Vittoria Levatia (Dipartimento di Scienze Economiche e Metodi Matematici, University of Bari, Italy)
    Abstract: Human decision making is a process guided by different and partly competing motivations that can each dominate behavior and lead to different effects depending on strength and circumstances. "Over-stylizing" neglects such competing concerns and context-dependence, although it facilitates the emergence of elaborate general theories. We illustrate by examples from social dilemma experiments and inequality aversion theories that sweeping empirical claims should be avoided.
    Keywords: Context-dependent preferences, Experimental economics, Equity theories.
    JEL: A11 D63 D70
    Date: 2008–12–09
  6. By: Vivek Dehejia (Department of Economics, Carleton University); Jiankang Zhang (Department of Economics, Carleton University)
    Abstract: In this note, we consider a perennial problem in single-person choice theory, that is, characterizing choice under uncertainty. In particular, we consider a hypothesis put forward by Joseph Stiglitz (2005), suggesting that median-maximing behavior may be optimal under certain circumstances, and consider how it might best be rationalized within choice theory as it is currently conceived. As is well known, median-maximizing behavior is not generally optimal in the classical VNM framework. Our main result is that it is possible to rationalize the Stiglitz hypothesis in the Machina-Schmeidler (1992) framework of probabilistic sophistication.
    JEL: D81
    Date: 2008–11–03
  7. By: Jaśkiewicz, Anna; Matkowski, Janusz; Nowak, Andrzej
    Abstract: Abstract: In this paper we study a new class of recursive utilities in dynamic choice processes in a stochastic environment. The basic idea is to introduce a variable measure of impatience for an economic agent. In the literature, this kind of measure is presented by a Lipschitz constant (often a contraction coefficient) concerning the aggregator. In this paper, on the other hand, the contraction property is described by some increasing real-valued function. When this function is linear, then our theory coincides with the well-known case. We make use of an extension of the Banach contraction principle given by Matkowski to derive recursive utilities and solve the associated dynamic programming problem. We present two approaches in order to take into account randomness of future outcomes. Our first approach is in spirit of the von Neumann-Morgenstern concept and is based on the notion of expectation. We construct a recursive utility on the space of trajectories of the process and then take its expected value. It turns out that the associated optimization problem leads to a non-stationary dynamic programming and an infinite system of Bellman equations, which result in obtaining persistently optimal policies. In our second approach, we construct recursive utilities on the space of policies of an agent that have a natural interpretation. The associated optimization problem leads to a solution of a single Bellman equation and deriving a stationary optimal policy for the agent. Our theory is enriched by various applications , e.g., to many growth stochastic models.
    Keywords: Koopmans' equation; Recursive utility; Nonlinear contraction mapping theorem; Dynamic programming; Bellman equation
    JEL: C60
    Date: 2008–11–29
  8. By: Colombo, Sergio; Hanley, Nick; Louviere, Jordan
    Abstract: Stated choice models based on the random utility framework are becoming increasingly popular in the applied economics literature. The need to account for respondents' preference heterogeneity in such models has motivated researchers in agricultural, environmental, health and transport economics to apply random parameter logit and latent class models. In most of the published literature these models incorporate heterogeneity in preferences through the systematic component of utility. An alternative approach is to investigate heterogeneity through the random component of utility, and covariance heterogeneity models are one means of doing this. In this paper we compare these alternative ways of incorporating preference heterogeneity in stated choice models and evaluate how the selection of approach affects welfare estimates in a given empirical application. We find that a Latent Class approach fits our data best but all the models perform well in terms of out-of-sample predictions. Finally, we discuss what criteria a researcher can use to decide which approach is most appropriate for a given data set.
    Keywords: choice experiments; covariance heterogeneity model; agri-environmental policy; landscape values; latent class model; preference heterogeneity; random parameter logit model; error component models; welfare measure s
    Date: 2008–12
  9. By: Foucault, Thierry; Themar, David; Sraer, David
    Abstract: In this paper, the authors test the hypothesis that individual investors contribute to the idiosyncratic volatility of stock returns because they act as noise traders.
    Keywords: Idiosyncratic volatility; Retail investors; Noise trading
    JEL: G11 G12 G14
    Date: 2008–07–01
  10. By: Cara Marshall (Department of Economics, Queens College of the City University of New York)
    Abstract: This paper revisits the roots of modern portfolio theory and the recognition that a stock’s (or a stock portfolio’s) risk can be decomposed into a systematic component and an unsystematic component, and, further, that only the former should contribute to expected return. However, instead of isolating the systematic component of risk by recasting the risk in terms of a stock’s beta coefficient, I choose to decompose the standard deviation, or variance if one prefers the original risk measure, directly into its systematic and unsystematic components allowing one to focus on systematic risk and yet remain in the mean/standard deviation (or mean/variance) space. When the standard deviation of return is decomposed into its systematic and unsystematic components, an “adjusted CML” can be derived and it is easily shown that this adjusted CML is equivalent to Sharpe’s SML. This alternative way of looking at systematic and unsystematic risk offers easily accessible insights into the very nature of risk. This has a number of interesting implications including, but not limited to, reducing the computational complexities in calculating the relevant portion of a portfolio’s volatility, facilitating sophisticated dispersion trades, estimating risk-adjusted returns, and improving risk-adjusted performance measurement. This paper is, in part, pedagogical and, in part, an introduction to an alternative way of measuring systematic and unsystematic risk.
    Keywords: systematic risk, unsystematic risk, capital asset pricing model, dispersion trading, risk adjusted performance measurement
    Date: 2008–09
  11. By: Löning, Hélène; Besson, M.; Mendoza, Carla
    Abstract: Based on prior accounting literature and Simons’ framework (1990, 1995), the authors explore the use of budgets in PEU situations in a qualitative study. They conducted a field-based study and interviewed 14 senior sales and marketing managers from various industries, using projective techniques imported from psychological research.
    Keywords: budgeting; uncertainty; perceived environmental uncertainty (PEU); interactive control system (ICS); sales and marketing managers
    JEL: D81
    Date: 2008–04–01

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