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on Utility Models and Prospect Theory |
| By: | Ju, Nengjiu; Miao, Jianjun |
| Abstract: | We propose a novel generalized recursive smooth ambiguity model which allows a three-way separation among risk aversion, ambiguity aversion, and intertemporal substitution. We apply this utility to a consumption-based asset pricing model in which consumption and dividends follow hidden Markov regime-switching processes. Our calibrated model can match the mean equity premium, the mean riskfree rate, and the volatility of the equity premium observed in the data. In addition, our model can generate a variety of dynamic asset pricing phenomena, including the procyclical variation of price-dividend ratios, the countercyclical variation of equity premia and equity volatility, and the mean reversion of excess returns. The key intuition is that an ambiguity averse agent behaves pessimistically by attaching more weight to the pricing kernel in bad times when his continuation values are low. |
| Keywords: | Ambiguity aversion; learning; asset pricing puzzles; model uncertainty; robustness; pessimism |
| JEL: | D81 G12 |
| Date: | 2009–04 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:14737&r=upt |
| By: | Booij, Adam S. (University of Amsterdam); van Praag, Bernard M. S. (University of Amsterdam); van de Kuilen, Gijs (Tilburg University) |
| Abstract: | This paper presents the results of an experiment that completely measures the utility function and probability weighting function for different positive and negative monetary outcomes, using a representative sample of N = 1935 from the general public. The results confirm earlier findings in the lab, suggesting that utility is less pronounced than what is found in classical measurements where expected utility is assumed. Utility for losses is found to be convex, consistent with diminishing sensitivity, and the obtained loss aversion coefficient of 1.6 is moderate but in agreement with contemporary evidence. The estimated probability weighing functions have an inverse-S shape and they imply pessimism in both domains. These results show that probability weighting is also an important phenomenon in the general population. Women and lower educated individuals are found to be more risk averse, in agreement with common findings. Unlike previous studies that ascribed gender differences in risk attitudes solely to differences in the degree utility curvature, however, our results show that this finding is primarily driven by loss aversion and, for women, also by a more pessimistic psychological response towards the probability of obtaining the best possible outcome. |
| Keywords: | loss aversion, utility for gains and losses, prospect theory, subjective probability weighting |
| JEL: | D81 C91 C93 |
| Date: | 2009–04 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp4117&r=upt |
| By: | Geert Bekaert (Columbia Business School, 3022 Broadway, New York, NY 10027, USA.); Marie Hoerova (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.); Martin Scheicher (European Central Bank, Kaiserstrasse 29, D-60311 Frankfurt am Main, Germany.) |
| Abstract: | Implied volatility indices should have information about risk parameters, once they are cleansed of the influence of normal volatility dynamics and macroeconomic uncertainty. Building on intuition from the dynamic asset pricing literature, we uncover unobserved risk aversion and fundamental uncertainty from the observed time series of the VIX and the credit spreads while controlling for realized volatility, expectations about the macroeconomic outlook, and interest rates. We apply this methodology to monthly data from both Germany and the US. We find that implied volatilities contain a substantial amount of information regarding risk aversion whereas credit spreads have a lot to say about both risk aversion and uncertainty. Moreover, there is a significant comovement in the German and US risk aversion. JEL Classification: G12, E44. |
| Keywords: | Economic uncertainty, Risk aversion, Time variation in risk and return, Credit spread, Volatility dynamics. |
| Date: | 2009–03 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:200901037&r=upt |
| By: | Khan, Hayat |
| Abstract: | Taking note of the wide variety and growing list of models in the literature to explain patterns of behavior observed in laboratory experiments, this paper identifies two tests, the Variety Test (ability of a model to explain outcomes under variety or alternative scenarios) and the Psychological Test (ability of a model to conform to psychological intuition), that can be used to judge any model of other regarding preferences. It is argued that for a mathematical model to qualify as a social welfare function, it must simultaneously pass the two tests. It is shown that none of the models proposed to date passes these two tests simultaneously. The paper proposes a generalized model of inequity aversion which parsimoniously explains interior solution in the dictator game and dynamics of outcomes in other games. The paper postulates that ones idea of equitable distribution is state dependent where the state is determined by psychological and structural parameters. The state could be fair, superior or inferior. Individuals in a fair state have zero equity-bias and split the pie evenly. Those in a superior (inferior) state have positive (negative) equity-bias and value more (less) than fair distribution as equitable distribution. Given psychological tendencies of an individual, every experimental design/structure assigns one of the three states to players which lead to individual specific valuation of equity. Prediction about outcomes across different experiments and designs can be made through predicting its impact on equity-bias. All aspects of an individual’s behavior, such as altruism, fairness, reciprocity, self-serving bias, kindness, intentions etc, manifest itself in equity-bias. The model therefore is all-encompassing. |
| Keywords: | Experimental Economics; Social Preferences; Other Regarding Preferences; Inequity aversion |
| JEL: | D63 A13 C92 C0 D64 C91 |
| Date: | 2009–01–19 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:14701&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 non-Ramsey set (a nonconstructive object whose existence requires the axiom of choice). Therefore, each Paretian and finitely anonymous quasi-ordering 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; Multi-period social choice; Axiom of choice; Constructivism. |
| JEL: | D60 D70 D90 |
| Date: | 2009–03 |
| URL: | http://d.repec.org/n?u=RePEc:ete:ceswps:ces09.06&r=upt |
| By: | Robert S. Gazzale (Williams College); Julian Jamison (Yale University); Alexander Karlan (Williams College); Dean S. Karlan |
| Abstract: | We conduct a two-phase laboratory experiment, separated by several weeks. In the first phase, we conduct urn games intended to measure ambiguity aversion on a representative population of undergraduate students. In the second phase, we invite the students back with four different solicitation treatments, varying in the ambiguity of information regarding the task and the payout of the laboratory experiment. We find that those who return do not differ from the overall pool with respect to their ambiguity version. However, no solicitation treatment generates a representative sample. The ambiguous task treatment drives away the ambiguity averse disproportionally, and the detailed task treatment draws in the ambiguity averse disproportionally. |
| Keywords: | laboratory experimental methods, experimental economics, laboratory selection effects |
| JEL: | B40 C81 C90 C91 D80 D83 |
| Date: | 2009–03 |
| URL: | http://d.repec.org/n?u=RePEc:wil:wileco:2009-01&r=upt |
| By: | Carlsson, Fredrik (Department of Economics, School of Business, Economics and Law, Göteborg University); Martinsson, Peter (Department of Economics, School of Business, Economics and Law, Göteborg University); Qin, Ping (Department of Economics, School of Business, Economics and Law, Göteborg University); Sutter, Matthias (Department of Public Finance, University of Innsbruck) |
| Abstract: | We study household decision making in a high-stakes experiment with a random sample of households in rural China. Spouses have to choose between risky lotteries, first separately and then jointly. We find that spouses’ individual risk preferences are more similar the richer the household and the higher the wife’s relative income contribution. A couple’s joint decision is typically determined by the husband, but women who contribute relatively more to the household income, women in high-income households, women with more education than their husbands, and women with communist party membership have a stronger influence on the joint decision.<p> |
| Keywords: | Household decision making; Risk; Field experiment; China |
| JEL: | C91 C92 C93 D10 |
| Date: | 2009–04–20 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:gunwpe:0356&r=upt |
| By: | Abigail Barr; Chris Wallace; Jean Ensminger; Juan Camilo Cárdenas |
| Abstract: | Data from three bargaining games—the Dictator Game, the Ultimatum Game, and the Third-Party Punishment Game—played in 15 societies are presented. The societies range from US undergraduates to Amazonian, Arctic, and African hunter-gatherers. Behaviour within the games varies markedly across societies. The paper investigates whether this behavioural diversity can be explained solely by variations in inequality aversion. Combining a single parameter utility function with the notion of subgame perfection generates a number of testable predictions. While most of these are supported, there are some telling divergences between theory and data: uncertainty and preferences relating to acts of vengeance may have influenced play in the Ultimatum and Third- Party Punishment Games; and a few subjects used the games as an opportunity to engage in costly signalling. |
| Date: | 2009–03–05 |
| URL: | http://d.repec.org/n?u=RePEc:col:000089:005427&r=upt |
| By: | Argenton, C.; Willems, B.R.R. (Tilburg University, Center for Economic Research) |
| Abstract: | It is well established that an incumbent firm may use exclusivity contracts so as to monopolize an industry or deter entry. Such an anticompetitive practice could be tolerated if it were associated with sufficiently large efficiency gains, e.g. insuring buyers against price volatility. In this paper we study the trade-off between positive effects (risk sharing) and negative effects (exclusion) of exclusivity contracts. We revisit the seminal model of Aghion and Bolton (1987) under risk-aversion and show that although exclusivity contracts induce optimal risk-sharing, they can be used not only to deter the entry of a more efficient rival on the product market but also to crowd out financial investors willing to insure the buyer at competitive rates. We further show that in a world without financial investors, purely financial bilateral instruments, such as forward contracts, achieve optimal risk sharing without distorting product market outcomes. Thus, there is no room for an insurance defense of exclusivity contracts. |
| Keywords: | exclusivity;contracts;monopolization;risk-aversion;risk-sharing;damages |
| JEL: | D43 D86 K21 L12 L42 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:kubcen:200924&r=upt |
| By: | Marc-Arthur Diaye (ENSAI - Ecole Nationale de la Statistique et de l'Analyse de l'Information, CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I); François Gardes (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris); Christophe Starzec (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I) |
| Abstract: | This paper contributes to the discussion of the compatibility of consumers' behavior in "real" life with GARP. Within expenditure panel data we observe a relatively low rate of violation (240 out of 3630 households). We show that these violations do not imply an "irrational" behavior of the agents, but can be attributed to a change in the agents' choice conditions during a period of time, which includes a shift from a centrally planned towards a market oriented economy. |
| Keywords: | GARP, shadow prices. |
| Date: | 2009–04 |
| URL: | http://d.repec.org/n?u=RePEc:hal:cesptp:halshs-00376747_v1&r=upt |
| By: | Jean-Pierre Dubé; Güenter J. Hitsch; Peter E. Rossi |
| Abstract: | For many consumer packaged goods products, researchers have documented a form of state dependence whereby consumers become “loyal†to products they have consumed in the past. That is, consumers behave as though there is a utility premium from continuing to purchase the same product as they have purchased in the past or, equivalently, there is a psychological cost to switching products. However, it has not been established that this form of state dependence can be identified in the presence of consumer heterogeneity of an unknown form. Most importantly, before this inertia can be given a structural interpretation and used in policy experiments such as counterfactual pricing exercises,alternative explanations which might give rise to similar consumer behavior must be ruled out. We develop a flexible model of heterogeneity which can be given a semi-parametric interpretation and rule out alternative explanations for positive state dependence such as autocorrelated choice errors, consumer search, or consumer learning. |
| JEL: | D12 L0 M31 |
| Date: | 2009–04 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:14912&r=upt |
| By: | Björn Bick; Holger Kraft; Claus Munk |
| Abstract: | The utility-maximizing consumption and investment strategy of an individual investor receiving an unspanned labor income stream seems impossible to nd in closed form and very difficult to nd using numerical solution techniques. We suggest an easy procedure for nding a specic, simple, and admissible consumption and investment strategy, which is near-optimal in the sense that the wealth equivalent loss compared to the unknown optimal strategy is very small. We first explain and implement the strategy in a simple setting with constant interest rates, a single risky asset, and an exogenously given income stream, but we also show that the success of the strategy is robust to changes in parameter values, to the introduction of stochastic interest rates, and to endogenous labor supply decisions. |
| JEL: | G11 |
| Date: | 2009–03 |
| URL: | http://d.repec.org/n?u=RePEc:fra:franaf:202&r=upt |
| By: | Peter Grösche; Christoph M. Schmidt; Colin Vance |
| Abstract: | Identifying the incidence of free-ridership is significant to a range of issues relevant to program evaluation, including the calculation of net program benefits and more general assessments of political acceptability. Estimates of freeridership in the area of energy policy frequently rely on ex-post surveys that ask program participants whether they would have behaved differently in the absence of program support.The present paper proposes an ex-ante approach to the calculation of the free-rider share using revealed preference data on home renovations from Germany’s residential sector.We employ a discretechoice model to simulate the effect of grants on renovation choices, the output from which is used to assess the extent of free-ridership under a contemporary subsidy program. Aside from its simplicity, a key advantage of the approach is that it bestows policymakers with an estimate of free-ridership prior to program implementation. |
| Keywords: | Energy efficiency, residential sector,random utility model, discrete choice simulation |
| JEL: | C25 D12 Q4 |
| Date: | 2009–03 |
| URL: | http://d.repec.org/n?u=RePEc:rwi:repape:0099&r=upt |