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on Utility Models and Prospect Theory |
| By: | Patrick Roger (Laboratoire de Recherche en Gestion et Economie, Université de Strasbourg) |
| Abstract: | In this article, a simple paper-and-pencil experiment, based on lottery bonds, shows that financial decisions taken by participants are inconsistent with the traditional view of economic agents as risk averse expected utility maximizers. First, our results cast doubt on the relevance of variance as a measure of risk and put to light the importance of skewness in decision making. The decisions taken by participants are consistent with the optimal distortion of beliefs introduced in Brunnemeier and Parker (2005) and Brunnemeier et al. (2007). As a by-product of this study, we also illustrate the fact that people use heuristics when they choose numbers at random and have, in general, a poor opinion about the rationality of others. |
| Keywords: | Lottery bonds, optimal beliefs, probability distortion, risk aversion. |
| JEL: | D81 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:lar:wpaper:2009-08&r=upt |
| By: | Michèle Cohen (Centre d'Economie de la Sorbonne - Paris School of Economics); Jean-Marc Tallon (Centre d'Economie de la Sorbonne - Paris School of Economics); Jean-Christophe Vergnaud (Centre d'Economie de la Sorbonne) |
| Abstract: | We report in this paper the result of three experiments on risk, ambiguity and time attitude. The first two differed by the population considered (students vs general population) while the third one used a different protocol and concerned students and portfolio managers. We find quite a lot of heterogeneity at the individual level. Of principal interest was the elicitation of risk, time and ambiguity attitudes and the relationship among these (model free) measures. We find that on the student population, there is essentially no correlation. A non negligible fraction of the population behaves in an extremely cautions manner in the risk and ambiguity domain. When we drop this population from the sample, the correlation between our measures is also non significant. We also raise three questions linked to measurement of ambiguity attitudes that come out from our data sets. |
| Keywords: | Experiments, risk aversion, impatience, imprecision aversion. |
| JEL: | C90 D81 C91 |
| Date: | 2009–03 |
| URL: | http://d.repec.org/n?u=RePEc:mse:cesdoc:09029&r=upt |
| By: | Bernard, Carole; Ghossoub, Mario |
| Abstract: | We derive the optimal portfolio choice for an investor who behaves according to Cumulative Prospect Theory. The study is done in a one-period economy with one risk-free asset and one risky asset, and the reference point corresponds to the terminal wealth arising when the entire initial wealth is invested into the risk-free asset. When it exists, the optimal holding is a function of a generalized Omega measure of the distribution of the excess return on the risky asset over the risk-free rate. It conceptually resembles Merton’s optimal holding for a CRRA expected-utility maximizer. We derive some properties of the optimal holding and illustrate our results using a simple example where the excess return has a skew-normal distribution. In particular, we show how a Cumulative Prospect Theory investor is highly sensitive to the skewness of the excess return on the risky asset. In the model we adopt, with a piecewise-power value function with different shape parameters, loss aversion might be violated for reasons that are now well-understood in the literature. Nevertheless, we argue, on purely behavioral grounds, that this violation is acceptable. |
| Keywords: | Cumulative Prospect Theory; Portfolio Choice; Behavioral Finance; Omega Measure. |
| JEL: | D81 G11 |
| Date: | 2009–04–29 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:15446&r=upt |
| By: | Giorgio PIZZUTTO |
| Abstract: | Abstract: Standard theoretical model cannot generate positive and large real bond risk premium under power utility preferences. Following recent developments in equity premium literature we explore bond premium in a long run risk environment with generalized isoleastic preferences. This approach explains equity premium puzzle, but it fails to fit real bond prices and returns. Term premium is negative even if we model exogenous consumption growth with a persistent component and time-varying volatility |
| Keywords: | Asset pricing, long run risk, bond premium puzzle |
| JEL: | G10 G12 |
| Date: | 2008–02–17 |
| URL: | http://d.repec.org/n?u=RePEc:mil:wpdepa:2008-03&r=upt |
| By: | Eric Danan Ani Guerdjikovaz Alexander Zimper (Université de Cergy-Pontoise, THEMA, 33 boulevard du Port, F-95000 Cergy-Pontoise, Cornell University, Department of Economics, Uris Hall 462, Ithaca, NY 14853, USA, University of Johannesburg, Department of Economics and Econometrics, PO Box 524 Aucland Park, 2006 Johannesburg, South Africa) |
| Abstract: | We present a system of behavioral axioms for preferences over menus that is motivated by three assumptions. First, the decision maker is uncertain ex ante (i.e. at the time of choosing a menu) about her ex post (i.e. at the time of choosing an option within her chosen menu) preferences over options, and she anticipates that this subjective uncertainty will only resolve after the ex post stage. Second, she is averse to ex post indecisiveness (i.e. to having to choose between options that she cannot rank with certainty). Third, when evaluating a menu she discards options that are dominated (i.e. inferior to another option whatever her ex post preferences may be) and restricts attention to the undominated ones. Under these assumptions, the decision maker has a preference for commitment in the sense of preferring menus with fewer undominated alternatives. We derive a representation in which the decision maker's uncertainty about her ex post preferences is captured by means of a subjective state space, which in turn determines which options are undominated in a given menu, and in which the decision maker fears, whenever indecisive, to choose an option that will turn out to be the worst (undominated) one according to the realization of her ex post preferences. |
| Keywords: | Opportunity sets, subjective uncertainty, indecisiveness, dominance |
| JEL: | D81 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:ema:worpap:2009-04&r=upt |
| By: | Moreira, Bruno; Matsushita, Raul; Da Silva, Sergio |
| Abstract: | A recent neurobiology study showed that monkeys systematically prefer risky targets in a visual gambling task. We set a similar experiment with preschool children to assess their attitudes toward risk and found the children, like the monkeys, to be risk seeking. This suggests that adult humans are not born risk averse, but become risk averse. Our experiment also suggests that this behavioral change may be due to learning from negative experiences in their risky choices. We also showed that though emotional states and predetermined prenatal testosterone can influence children’s preferences toward risk, these factors could not override learning experiences. |
| Keywords: | Risk; Children |
| JEL: | D81 C92 D87 |
| Date: | 2008–11–01 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:15516&r=upt |
| By: | Antonio Mele; Francesco Sangiorgi |
| Abstract: | This paper studies asset markets in which ambiguity averse investors face Knightian uncertainty about expected payoffs. The same investors, however, might wish to resolve their uncertainty, although not risk, by just purchasing information. In these markets, uninformed and, hence, ambiguity averse, agents may coexist with informed agents, as a result of a rational information acquisition process. Moreover, there are complementaries in information acquisition, multiplicity of equilibria, history-dependent prices, and large price swings occurring after small changes in the uncertainty surrounding the asset expected payoffs. Our model suggests the importance of uncertainty, as a new channel for episodes of extreme price volatility, media frenzies and media glooms. |
| Date: | 2009–06 |
| URL: | http://d.repec.org/n?u=RePEc:fmg:fmgdps:dp633&r=upt |
| By: | Anna MAFFIOLETTI; Michele SANTONI |
| Abstract: | This paper presents the results of two experiments testing reaction to risk and uncertainty of a sample of 66 Italian university students. Risky prospects were based on games of chance, while uncertain lotteries were based on the forthcoming results of either the May 2001 Italian general political election or the June 2004 election for the European Parliament. We computed decision weights for risk and uncertainty; we also collected data as regards the subjects’ degree of belief, expressed by probability judgements, for the same uncertain events. Our results show that the subjects’ behaviour is consistent with expected utility theory as regards risk, but not under uncertainty. In particular, our subjects show a strong superadditivity in the decision weights and the possibility effect (lower subadditivity) is stronger than the certainty effect (upper subadditivity). There is also evidence that emotions, actual competence and confidence positively affect the possibility effect, whereas they do not have any influence on the certainty effect, reinforcing the lack of symmetry between the two effects |
| Keywords: | Uncertainty, Subadditivity, Emotions, Competence, Confidence |
| JEL: | D81 |
| Date: | 2007–09–18 |
| URL: | http://d.repec.org/n?u=RePEc:mil:wpdepa:2007-31&r=upt |
| By: | Giorgio PIZZUTTO |
| Abstract: | Real interest rates, long run risks and business cycles. Standard theoretical model under power utility preferences generates time series for real yields and output that are not consistent with the cyclical properties of the macroeconomic data. In particular real interest rates of the model are highly procyclical, while measured real interest rates are countercyclical. Following recent developments in equity premium literature we explore this question in a long run risk environment with generalized isoleastic preferences. This approach explains equity premium puzzle, but it fails to fit real bond prices and their dynamics in relation to business cycles if we model exogenous consumption growth with a persistent component and time-varying volatility. |
| Keywords: | Asset pricing, long run risk, bond premium puzzle, business cycles |
| JEL: | G10 G12 |
| Date: | 2008–02–29 |
| URL: | http://d.repec.org/n?u=RePEc:mil:wpdepa:2008-05&r=upt |
| By: | Tomoki Fujii (School of Economics, Singapore Management University); Ryuichiro Isikawa |
| Abstract: | We investigate how childbirth affects intrahousehold resource allocation for married Japanese couples. We develop reduced-form and structural-form sepcifications from a unified theoretical framework. Under a weak set of assumptions, we can focus on private goods to track the changes in intrahousehold resource allocation. Our estimation results show that the allocation of resources within household tend to move to the disadvantage of women after childbirth. One additional child is associated with at least 2.6 percentage points decrease in women's private expenditure share. Our estimation results reject the income-pooling hypothesis, and show that women are more risk averse than men. |
| Keywords: | Childbirth, Bargaining, Intrahousehold allocation, Relative risk aversion, Japan |
| JEL: | D11 D12 D13 J12 |
| Date: | 2008–10 |
| URL: | http://d.repec.org/n?u=RePEc:siu:wpaper:11-2008&r=upt |
| By: | Tolga Koker |
| Date: | 2009–06–09 |
| URL: | http://d.repec.org/n?u=RePEc:cla:levarc:814577000000000264&r=upt |
| By: | Bernard De Meyer (Centre d'Economie de la Sorbonne); Ehud Lehrer (School of Mathematical Sciences - Tel Aviv University); Dinah Rosenberg (LAGA Institut Galilée - Université Paris 13) |
| Abstract: | In a Bayesian game some players might receive a noisy signal regarding the specific game actually being played before it starts. We study zero-sum games where each player receives a partial information about his own type and no information about that of the other player and analyze the impact the signals have on the payoffs. It turns out that the functions that evaluate the value of information share two property. The first is Blackwell monotonicity, which means that each player gains from knowing more. The second is concavity on the space of conditional probabilities. |
| Keywords: | Value of information, Blackwell monotonicity, concavity. |
| JEL: | C72 C73 D80 D82 D83 |
| Date: | 2009–05 |
| URL: | http://d.repec.org/n?u=RePEc:mse:cesdoc:09035&r=upt |
| By: | Enrico G. De Giorgi; Shane Legg |
| Abstract: | This paper extends the model with narrow framing suggested by Barberis and Huang (2009) to also account for probability weighting and a convex-concave value function in the specification of cumulative prospect theory preferences on narrowly framed assets. We show that probability weighting is needed in order that investors reduce their holding of narrowly framed risky assets in the presence of negative skewness and high Sharpe ratios, which are typical characteristics of stock index returns. The model with framing and probability weighting can thus explain the stock participation puzzle under realistic assumptions on stock market returns. We also show that a convex-concave value function generates wealth effects that are consistent with empirical observations on stock market participation. Finally, we address the asset pricing implications of probability weighting in the model with narrow framing and show that in the case of negative skewness the equity premium of narrowly framed assets is much higher than when probability weighting is not taken into account. |
| Keywords: | Narrow framing, cumulative prospect theory, probability weighting function,negative skewness, simulation methods |
| JEL: | D1 D8 G11 G12 |
| Date: | 2009–06 |
| URL: | http://d.repec.org/n?u=RePEc:usg:dp2009:2009-12&r=upt |
| By: | Karl H. Schlag; Andriy Zapechelnyuk |
| Date: | 2009–06–08 |
| URL: | http://d.repec.org/n?u=RePEc:cla:levarc:814577000000000259&r=upt |
| By: | Richard Dennis |
| Abstract: | Model uncertainty has the potential to change importantly how monetary policy should be conducted, making it an issue that central banks cannot ignore. In this paper, I use a standard new Keynesian business cycle model to analyze the behavior of a central bank that conducts policy with discretion while fearing that its model is misspeci?fied. My main results are as follows. First, policy performance can be improved if the discretionary central bank implements a robust policy. This important result is obtained because the central bank's desire for robustness directs it to assertively stabilize inflation, thereby mit- igating the stabilization bias associated with discretionary policymaking. In effect, a fear of model uncertainty can act similarly to a commitment mechanism. Second, exploiting the connection between robust control and uncertainty aversion, I show that the central bank's fear of model misspeci?cation leads it to forecast future outcomes under the be- lief that inflation (in particular) will be persistent and have large unconditional variance, raising the probability of extreme outcomes. Private agents, however, anticipating the policy response, make decisions under the belief that in?ation will be more closely sta- bilized, that is, more tightly distributed, than under rational expectations. Third, as a technical contribution, I show how to solve an important class of linear-quadratic robust Markov-perfect Stackelberg problems. |
| JEL: | E52 E62 C61 |
| Date: | 2008–08 |
| URL: | http://d.repec.org/n?u=RePEc:acb:camaaa:2009-04&r=upt |
| By: | Vorobyev, Oleg Yu.; Goldblatt, Joe Jeff; Finkel, Rebecca |
| Abstract: | The eventological theory of decision-making, the theory of event-based decision-making is a theory of decision-making based on eventological principles and using results of mathematical eventology [1]; a theoretical basis of the practical eventology [2, 3, 4]. The beginnings of this theory which have arisen from event-based representation of the reasonable subject and his decisions in the form of eventological distributions (E-distributions) of sets of events [5] and which are based on the eventological H-theorem [6] are offered. The illustrative example of the eventological decision-making by the reasonable subject on his own event-based behaviour in the financial or share market is considered. |
| Keywords: | eventology; event-based decision-making; eventological H-theorem |
| JEL: | D7 C0 G0 |
| Date: | 2008–01–15 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:15619&r=upt |
| By: | Emmanuel Farhi; Samuel Paul Fraiberger; Xavier Gabaix; Romain Ranciere; Adrien Verdelhan |
| Abstract: | How much of carry trade excess returns can be explained by the presence of disaster risk? To answer this question, we propose a simple structural model that includes both Gaussian and disaster risk premia and can be estimated even in samples that do not contain disasters. The model points to a novel estimation procedure based on currency options with potentially different strikes. We implement this procedure on a large set of countries over the 1996--2008 period, forming portfolios of hedged and unhedged carry trade excess returns by sorting currencies based on their forward discounts. We find that disaster risk premia account for about 25% of expected carry trade excess returns in advanced countries. |
| JEL: | E44 F31 |
| Date: | 2009–06 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:15062&r=upt |
| By: | Harin, Alexander |
| Abstract: | A general forecasting correcting formula, as a framework for long-use and standardized forecasts, is created. The formula provides new forecasting resources and new possibilities for expansion of forecasting including economic forecasting into the areas of municipal needs, middle-size and small-size business and, even, to individual forecasting. |
| Keywords: | forecasting; prediction; planning; correction; |
| JEL: | O2 H68 C53 D8 |
| Date: | 2009–06–03 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:15533&r=upt |