
on Utility Models and Prospect Theory 
By:  Eran Hanany; Peter Klibanoff 
Abstract:  Dynamic consistency leads to Bayesian updating under expected utility. We ask what it implies for the updating of more general preferences. In this paper, we charac terize dynamically consistent update rules for preference models satisfying ambiguity aversion. This characterization extends to regretbased models as well. As an appli cation of our general result, we characterize dynamically consistent updating for two important models of ambiguity averse preferences: the ambiguity averse smooth am biguity preferences (Klibanoff, Marinacci and Mukerji [Econometrica 73 2005, pp. 18491892]) and the variational preferences (Maccheroni, Marinacci and Rustichini [Econometrica 74 2006, pp. 14471498]). The latter includes maxmin expected utility (Gilboa and Schmeidler [Journal of Mathematical Economics 18 1989, pp. 141153]) and the multiplier preferences of Hansen and Sargent [American Economic Review 91(2) 2001, pp. 6066] as special cases. For smooth ambiguity preferences, we also identify a simple rule that is shown to be the unique dynamically consistent rule among a large class of rules that may be expressed as reweightings of Bayes's rule. 
Keywords:  Updating, Dynamic Consistency, Ambiguity, Regret, Ellsberg, Bayesian, Consequentialism, Smooth Ambiguity 
JEL:  D81 D83 D91 
Date:  2008–07 
URL:  http://d.repec.org/n?u=RePEc:nwu:cmsems:1468&r=upt 
By:  Elena Vigna 
Abstract:  We consider the portfolio selection problem in the accumulation phase of a defined contribution pension scheme in continuous time, and compare the meanvariance and the expected utility maximization approaches. Using the embedding technique pioneered by Zhou and Li (2000) we first find the efficient frontier of portfolios in the twoassets financial market. Then, using standard stochastic optimal control we find the optimal portfolios derived via expected utility for popular utility functions. As a main result, we prove that the optimal portfolios derived with the CARA and CRRA utility functions are not meanvariance efficient. As a corollary, we prove that this holds also in the standard portfolio selection problem in the BlackScholes model. These results can be extended to the n assets case, via the mutual fund theorem. We provide a natural measure of inefficiency based on the difference between optimal portfolio variance and minimal variance, and we show its dependence on risk aversion, Sharpe ratio of the risky asset, time horizon, initial wealth and contribution rate. Numerical examples illustrate the extent of inefficiency of CARA and CRRA utility functions in defined contribution pension schemes. 
Keywords:  Meanvariance approach, efficient frontier, expected utility maximization, defined contribution pension scheme, portfolio selection, risk aversion, Sharpe ratio 
JEL:  C61 D81 G11 G23 
Date:  2009 
URL:  http://d.repec.org/n?u=RePEc:cca:wpaper:108&r=upt 
By:  Braido, Luis (Fundacao Getulio Vargas); da Costa, Carlos (Fundacao Getulio Vargas); Dahlby, Bev (University of Alberta, Department of Economics) 
Abstract:  We generalize the Boadway and Keen (2006) model of adverse selection in a capital market to allow for risk aversion on the part of entrepreneurs. We show that the Boadway and Keen conclusionthat adverse selection leads to excessive investmentdoes not necessarily hold when entrepreneurs are risk averse. We use their framework, with the additional assumption of risk aversion, to analyze the effect of policies that would reduce entrepreneurs' reliance on debt or equity financing by outside investors. We show that such policies, by exposing entrepreneurs to more downside risk, may reduce the level of investment in risky projects, increase inequality and potentially reduce social welfare. 
Keywords:  adverse selection; capital markets; inefficiency; risk and entrepreneurship 
JEL:  D82 G14 O16 O17 
Date:  2009–03–16 
URL:  http://d.repec.org/n?u=RePEc:ris:albaec:2009_015&r=upt 
By:  Bruno Deffains; Eric Langlais 
Abstract:  For contemporary legal theory, law is essentially an interpretative and hermeneutics practice (Ackerman (1991), Horwitz (1992)). A straightforward consequence is that legal disputes between parties are motivated by their divergent interpretations regarding what the law says on their case. This point of view fits well with the growing evidence showing that litigants’ cognitive performances display optimistic bias or selfserving bias (Babcock and Lowenstein (1997)). This paper provides a theoretical analysis of the influence of such a cognitive bias on pretrial negotiations. However, we also consider that this effect is mitigated because of the litigants’ confidence in their own ability to predict the verdict; we model this issue assuming that litigants are risk averse in the sense of Yaari (1987), i.e. they display a kind of (rational) probability distortion which is also well documented in experimental economics. In a model à la Bebcuck (1984), we show that the consequences of selfserving bias are partially consistent with the "optimistic model", but that parties’ risk aversion has more ambiguous/unpredictable effects. These results contribute to explaining that the beliefs in the result of the trial are not sufficient in themselves to understand the behaviors of litigants. As suggested by legal theory, the confidence the parties have in their beliefs is probably more important. 
Keywords:  litigation, selfserving bias, risk aversion 
JEL:  D81 K42 
Date:  2009 
URL:  http://d.repec.org/n?u=RePEc:drm:wpaper:20098&r=upt 
By:  Luc LAUWERS 
Abstract:  The existence of a Paretian and finitely anonymous ordering in the set of infinite utility streams implies the existence of a nonRamsey set (a nonconstructive object whose existence requires the axiom of choice). Therefore, each Paretian and finitely anonymous quasiordering either is incomplete or does not have an explicit description. Hence, the possibility results of Svensson (1980) and of Bossert, Sprumont, and Suzumura (2006) do require the axiom of choice. 
Keywords:  Intergenerational justice; Pareto; Multiperiod social choice; Axiom of choice; Constructivism. 
JEL:  D60 D70 D90 
Date:  2009–02 
URL:  http://d.repec.org/n?u=RePEc:ete:ceswps:ces09.05&r=upt 
By:  Oleg Badunenko; Nataliya Barasinska; Dorothea Schäfer 
Abstract:  This study questions the popular stereotype that women are more risk averse than men in their investment decisions. The analysis is based on microlevel data from largescale surveys of private households in five European countries. We enrich the conventional approach to examination of gender differences by explicitly controlling for investors' selfperceived risk aversion. Our results confirm the gender stereotype only partially. We find that women are less likely to hold risky assets. However, female owners of risky assets allocate an equal or even a higher share of their wealth to these assets than men. Our findings suggest that especially in case of women, the declared attitude toward financial risks may be misleading as it does not necessarily reflect the actual willingness to bear risks. 
Keywords:  gender, risk aversion, financial behavior 
JEL:  G11 J16 
Date:  2009 
URL:  http://d.repec.org/n?u=RePEc:diw:diwfin:diwfin6020&r=upt 
By:  Hui Chen; Jianjun Miao; Neng Wang 
Abstract:  Entrepreneurs face significant nondiversifiable business risks. We build a dynamic incomplete markets model of entrepreneurial finance to demonstrate the important implications of nondiversifiable risks for entrepreneurs' interdependent consumption, portfolio allocation, financing, investment, and business exit decisions. The optimal capital structure is determined by a generalized tradeoff model where leverage via risky nonrecourse debt provides significant diversification benefits. More riskaverse entrepreneurs default earlier, but also choose higher leverage, even though leverage makes his equity more risky. Nondiversified entrepreneurs demand both systematic and idiosyncratic risk premium. Cashout option and external equity further improve diversification and raise the entrepreneurâ€™s valuation of the firm. Finally, entrepreneurial risk aversion can overturn the riskshifting incentives induced by risky debt. 
JEL:  E2 G11 G31 G32 
Date:  2009–04 
URL:  http://d.repec.org/n?u=RePEc:nbr:nberwo:14848&r=upt 