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on Utility Models and Prospect Theory |
| By: | Wing-Keung Wong; Raymond H. Chan |
| Abstract: | Levy and Levy (2002, 2004) develop the Prospect and Markowitz stochastic dominance theory with S-shaped and reverse S-shaped utility functions for investors. In this paper, we extend Levy and Levy’s Prospect Stochastic Dominance theory (PSD) and Markowitz Stochastic Dominance theory (MSD) to the first three orders and link the corresponding S-shaped and reverse S-shaped utility functions to the first three orders. We also provide experiments to illustrate each case of the MSD and PSD to the first three orders and demonstrate that the higher order MSD and PSD cannot be replaced by the lower order MSD and PSD. Prospect theory has been regarded as a challenge to the expected utility paradigm. Levy and Levy (2002) prove that the second order PSD and MSD satisfy the expected utility paradigm. In our paper we take Levy and Levy’s results one step further by showing that both PSD and MSD of any order are consistent with the expected utility paradigm. Furthermore, we formulate some other properties for the PSD and MSD including the hierarchy that exists in both PSD and MSD relationships; arbitrage opportunities that exist in the first orders of both PSD and MSD; and that for any two prospects under certain conditions, their third order MSD preference will be ‘the opposite’ of or ‘the same’ as their counterpart third order PSD preference. By extending Levy and Levy’s work, we provide investors with more tools for empirical analysis, with which they can identify the first order PSD and MSD prospects and discern arbitrage opportunities that could increase his/her utility as well as wealth and set up a zero dollar portfolio to make huge profit. Our tools also enable investors to identify the third order PSD and MSD prospects and make better choices. |
| Keywords: | Prospect stochastic dominance, Markowitz stochastic dominance, risk seeking, risk averse, S-shaped utility function, reverse S-shaped utility function |
| Date: | 2009–05 |
| URL: | http://d.repec.org/n?u=RePEc:mos:moswps:2005-08&r=upt |
| By: | Udo Broll; Jack E. Wahl; Wing-Keung Wong |
| Abstract: | This note analyzes export production in the presence of exchange rate uncertainty under mean-variance preferences. We present the elasticity of risk aversion, since this elasticity concept permits a distinct investigation of risk and expectation effects on exports. Counterintutitive results are possible, e.g. though the home currency is revaluating (devaluating) exports of the firm increase (decrease). This fact may contribute to the explanation of disturbing empirical results. |
| Keywords: | Exchange rate risk, trade, elasticity of risk aversion, meanvariance model, devaluation |
| JEL: | F21 F31 |
| Date: | 2009–05 |
| URL: | http://d.repec.org/n?u=RePEc:mos:moswps:2005-07&r=upt |
| By: | Hopfensitz, Astrid |
| Abstract: | When investment is repeated, previous outcomes (winning/losing) as well as the current budget level (gain/loss domain) influence decisions. The first is related to the so-called "gamblers fallacy". The second to value function relative to some reference point. Both effects have been extensively studied, however not their interaction. We present a meta-study of five experiments initially conducted to investigate myopic-loss-aversion. We observe that investment is related to the number of previous winning rounds as well as to the current budget position relative to a reference point. These effects persist when the analysis is extended to settings with restricted flexibility concerning investment. |
| Keywords: | reference point; gamblers fallacy; meta study; experiment; risk taking; myopic loss aversion |
| JEL: | D81 G11 C91 |
| Date: | 2009–06–25 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:16096&r=upt |
| By: | Guang-zhen Sun |
| Abstract: | We offer simple and intuitive proofs of the Euler equation and the maximum principle based on Gossen’s Second Law, one of the best known results in economics. |
| Keywords: | Euler equation, Gossen’s second law, Marginal utility, Maximum principle. |
| JEL: | C61 D91 |
| Date: | 2009–05 |
| URL: | http://d.repec.org/n?u=RePEc:mos:moswps:2005-14&r=upt |
| By: | Weinberg, Bruce A. (Ohio State University) |
| Abstract: | People use information about their ability to choose tasks. If more challenging tasks provide more accurate information about ability, people who care about and who are risk averse over their perception of their own ability will choose tasks that are not sufficiently challenging. Overestimation of ability raises utility by deluding people into believing that they are more able than they are in fact. Moderate overestimation of ability and overestimation of the precision of initial information leads people to choose tasks that raise expected output, however extreme overconfidence leads people to undertake tasks that are excessively challenging. Consistent with our results, psychologists have found that moderate overconfidence is both pervasive and advantageous and that people maintain such beliefs by underweighting new information about their ability. |
| Keywords: | overconfidence, behavioral economics, information processing |
| Date: | 2009–07 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp4285&r=upt |
| By: | Ignacio Velez-Pareja |
| Abstract: | Este es material de curso del libro Decisiones Empresariales bajo Riesgo e Incertidumbre. El nivel del libro es basico. Se usan muy pocas matematicas y puede ser usado por gerentes. En este quinto capitulo se presenta la teoria clasica de la utilidad cardinal y se ilustran los tres casos mas conocidos de actitudes hacia el riesgo: aversion al riesgo, neutralidad al riesgo y propension al riesgo. Tambien se presenta el concepto de certeza equivalente. Se mencionan las limitaciones de la teoria de la utilidad cardinal. Se incluye una breve referencia a la teoria prospectiva de Kahneman y Tversky. Se ilustran los conceptos de aversion al riesgo con un ejemplo de una loteria de la vida real. |
| Date: | 2009–06–30 |
| URL: | http://d.repec.org/n?u=RePEc:col:000162:005686&r=upt |
| By: | Missaka Warusawitharana; Jessica A. Wachter |
| Abstract: | We examine the evidence on excess stock return predictability in a Bayesian setting in which the investor faces uncertainty about both the existence and strength of predictability. Departing from previous studies, we allow the regressor to be stochastic. When we apply our methods to the dividend-price ratio and payout yield, we find that even investors who are quite skeptical about the existence of predictability sharply modify their views in favor of predictability when confronted by the historical time series of returns and predictor variables. We find that taking into account the stochastic properties of the regressor has a substantial impact on the investor's inference about returns. |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2009-26&r=upt |
| By: | Aldashev, Gani; Kirchsteiger, Georg; Sebald, Alexander |
| Abstract: | It is a persistent finding in psychology and experimental economics that people's behavior is not only shaped by outcomes but also by decision-making procedures. In this paper we develop a general framework capable of modelling these procedural concerns. Within the context of psychological games we define procedures as mechanisms that influence the probabilities of reaching different endnodes. We show that for such procedural games a sequential psychological equilibrium always exists. Applying this approach within a principal-agent context we show that the way less attractive jobs are allocated is crucial for the effort exerted by agents. This prediction is tested in a field experiment, where some subjects had to type in data, whereas others had to verify the data inserted by the typists. The controllers' wage was 50% higher than that of the typists. In one treatment the less attractive typists' jobs were allocated directly, whereas in the other treatment the allocation was done randomly. As predicted, random allocation led to higher effort levels of the typists than direct appointment. |
| Keywords: | Appointment Procedures; Procedural Concerns; Psychological Game Theory |
| JEL: | A13 C70 C93 D63 |
| Date: | 2009–07 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7365&r=upt |
| By: | Alfred Galichon (Department of Economics, Ecole Polytechnique - CNRS : UMR7176 - Polytechnique - X); Ivar Ekeland (Canada Research Chair in Mathematical Economics - University of British Columbia); Marc Henry (Départment de sciences économiques - Université de Montréal, CIRANO - Montréal - , CIREQ - Centre Interuniversitaire de Recherche en Economie Quantitative) |
| Abstract: | We propose a multivariate extension of a well-known characterization by S. Kusuoka of regular and coherent risk measures as maximal correlation functionals. This involves an extension of the notion of comonotonicity to random vectors through generalized quantile functions. Moreover, we propose to replace the current law invari- ance, subadditivity and comonotonicity axioms by an equivalent property we call strong coherence and that we argue has more natural economic interpretation. Finally, we refor- mulate the computation of regular and coherent risk measures as an optimal transportation problem, for which we provide an algorithm and implementation. |
| Keywords: | regular risk measures, coherent risk measures, comonotonicity, maximal correlation, optimal transportation, strongly coherent risk measures. |
| Date: | 2009–07–06 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-00401828_v1&r=upt |
| By: | Radosveta Ivanova-Stenzel (Department of Economics, Humboldt-University of Berlin); Timothy Salmon (Department of Economics, Florida State University) |
| Abstract: | Most prior theoretical and experimental work involving auction choice has assumed bidders only find out their value after making a choice of which auction to enter. In this paper we examine whether or not subjects knowing their value prior to making an auction choice impacts their choice decision and/or the outcome of the auctions. The results show a strong impact. Subjects with low values choose the first price sealed bid auction more often while subjects with high values choose the ascending auction more often. The average number of bidders in both formats ended up being on average the same, but due to the self-selection bias the ascending auction raised as much revenue on average as the first price sealed bid auction. The two formats also generate efficiency levels that are roughly equivalent though the earnings of bidders are higher in the ascending auction. |
| Keywords: | bidder preferences, private values, sealed bid auctions, ascending auctions, endogenous entry |
| JEL: | C91 D44 |
| Date: | 2009–06 |
| URL: | http://d.repec.org/n?u=RePEc:fsu:wpaper:wp2009_06_02&r=upt |