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on Utility Models and Prospect Theory |
| By: | Martins-da-Rocha, V. F. |
| Abstract: | Recently Kajii and (2008) proposed to characterize interim efficient allocations in an exchange economy under asymmetric information when uncertainty is represented by multiple posteriors.When agents have Bewley's incomplete preferences, Kajii and Ui (2008) proposed a necessary and sufficient condition on the set of posteriors.However, when agents have Gilboa--Schmeidler's MaxMin expected utility preferences, they only propose a sufficient condition.The objective of this paper is to complete Kajii and Ui's work by proposing a necessary and sufficient condition for interim efficiency for various models of ambiguity aversion and in particular MaxMin expected utility.Our proof is based on a direct application of some results proposed by Rigotti, Shannon and Stralecki (2008). |
| Date: | 2009–07–14 |
| URL: | http://d.repec.org/n?u=RePEc:fgv:epgewp:696&r=upt |
| By: | Ivan Moscati; Paola Tubaro |
| Abstract: | Rational choice theory (RCT) models decision makers as utility maximizers and is often defended via an as-if argument. According to this argument, although real individuals do not consciously maximize their utility function, their choices can be explained as if they were generated by utility maximization. An alternative model is random-choice, which assumes that decision makers pick up an element from a given set according to a uniform distribution on the set. In this paper we examine a series of experiments that compare RCT and the random-choice model as alternative explanations of consumer demand, and investigate how these experiments contribute to clarifying the actual scope of RCT and the shortcomings of the standard as-if defense of it. |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:pse:psecon:2009-21&r=upt |
| By: | Alison L. Booth; Patrick Nolen |
| Abstract: | Women and men may differ in their propensity to choose a risky outcome because of innate preferences or because pressure to conform to gender-stereotypes encourages girls and boys to modify their innate preferences. Single-sex environments are likely to modify students' risk-taking preferences in economically important ways. To test this, we designed a controlled experiment in which subjects were given an opportunity to choose a risky outcome - a real-stakes gamble with a higher expected monetary value than the alternative outcome with a certain payoff - and in which the sensitivity of observed risk choices to environmental factors could be explored. The results of our real-stakes gamble show that gender differences in preferences for risk-taking are indeed sensitive to whether the girl attends a single-sex or coed school. Girls from single-sex schools are as likely to choose the real-stakes gamble as boys from either coed or single sex schools, and more likely than coed girls. Moreover, we found that gender differences in preferences for risk-taking are sensitive to the gender mix of the experimental group, with girls being more likely to choose risky outcomes when assigned to all-girl groups. This suggests that observed gender differences in behaviour under uncertainty found in previous studies might reflect social learning rather than inherent gender traits. |
| Date: | 2009–07–20 |
| URL: | http://d.repec.org/n?u=RePEc:esx:essedp:672&r=upt |
| By: | Maria Grith; Wolfgang Härdle; Juhyun Park |
| Abstract: | Pricing kernels play a major role in quantifying risk aversion and investors' preferences. Several empirical studies reported that pricing kernels exhibit a common pattern across different markets. Mostly visual inspection and occasionally numerically summarise are used to make comparison. With increasing amount of information updated every day, the empirical pricing kernels can be viewed as an object evolving over time. We propose a systematic modelling approach to describing the evolution of the empirical pricing kernels. The approach is based on shape invariant models. It captures the common features contained in the shape of the functions and at the same time characterises the variability between the pricing kernels based on a few interpretable parameters. The method is demonstrated with the European options and returns values of DAX index. |
| Keywords: | pricing kernels, risk aversion, risk neutral density |
| JEL: | C22 C23 E31 |
| Date: | 2009–07 |
| URL: | http://d.repec.org/n?u=RePEc:hum:wpaper:sfb649dp2009-038&r=upt |
| By: | Michel De Lara (CERMICS - Centre d'Enseignement et de Recherche en Mathématiques et Calcul Scientifique - Ecole Nationale des Ponts et Chaussées) |
| Abstract: | Consider an agent taking two successive decisions to maximize his expected utility under uncertainty. After his first decision, a signal is revealed that provides information about the state of nature. The observation of the signal allows the decision-maker to revise his prior and the second decision is taken accordingly. Assuming that the first decision is a scalar representing consumption, the \emph{precautionary effect} holds when initial consumption is less in the prospect of future information than without (no signal). \citeauthor{Epstein1980:decision} in \citep*{Epstein1980:decision} has provided the most operative tool to exhibit the precautionary effect. Epstein's Theorem holds true when the difference of two convex functions is either convex or concave, which is not a straightforward property, and which is difficult to connect to the primitives of the economic model. Our main contribution consists in giving a geometric characterization of when the difference of two convex functions is convex, then in relating this to the primitive utility model. With this tool, we are able to study and unite a large body of the literature on the precautionary effect. |
| Keywords: | value of information; uncertainty; learning; precautionary effect; support function |
| Date: | 2009–07–23 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-00406939_v1&r=upt |
| By: | Driesen Bram; Perea Andrés; Peters Hans (METEOR) |
| Abstract: | We consider bargaining games under the assumption that bargainers are loss averse, i.e. experience disutility from obtaining an outcome lower than some reference point. We follow the approach of Shalev (2002) by imposing the self-supporting condition on a solution. Given a bargaining game, we say outcome z is self-supporting under a given bargaining solution, whenever transforming the game using outcome z as reference point, yields a transformed game in which the solution is z.We show that n-player bargaining games have a unique self-supporting outcome under the Kalai-Smorodinsky (KS) solution. We define a bargaining solution, giving exactly this outcome, and characterize it by the standard axioms of Scale Invariance [SI], Individual Monotonicity [IM], and Strong Individual Rationality [SIR], and a novel axiom called Proportional Concession Invariance [PCI].A bargaining solution satisfies PCI if moving the utopia point in the direction of the solution outcome, does not change this outcome. |
| Keywords: | microeconomics ; |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:umamet:2009032&r=upt |
| By: | Charles F. Manski |
| Abstract: | Research on collective provision of private goods has focused on distributional considerations. This paper studies a class of problems of decision under uncertainty in which the argument for collective choice emerges from the mathematics of aggregating individual payoffs. Consider decision making when each member of a population has the same objective function, which depends on an unknown state of nature. If agents knew the state of nature, they would make the same decision. However, they may have different beliefs or may use different decision criteria. Hence, they may choose different actions even though they share the same objective. Let the set of feasible actions be convex and the objective function be concave in actions, for all states of nature. Then Jensen's inequality implies that consensus choice of the mean privately-chosen action yields a larger aggregate payoff than does individualistic decision making, in all states of nature. If payoffs are transferable, the aggregate payoff from consensus choice may be allocated to Pareto dominate individualistic decision making, in all states of nature. I develop these ideas. I also use Jensen's inequality to show that a planner with the power to assign actions to the members of the population should not diversify. Finally, I give a version of the collective choice result that holds with consensus choice of the median rather than mean action. |
| JEL: | D7 D81 H42 |
| Date: | 2009–07 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:15172&r=upt |
| By: | Ramazan Gencay (Department of Economics, Simon Fraser University); Nikola Gradojevic (Faculty of Business Administration, Lakehead University) |
| Abstract: | We develop a dynamic framework to identify aggregate market fears ahead of a major market crash through the skewness premium of European options. Our methodology is based on measuring the distribution of a skewness premium through a q-Gaussian density and a maximum entropy principle. Our findings indicate that the October 19th, 1987 crash was predictable from the study of the skewness premium of deepest out-of-the-money options about two months prior to the crash |
| Keywords: | Non-additive Entropy, Shannon Entropy, Tsallis Entropy, q-Gaussian Distribution, Skewness Premium |
| JEL: | G1 C40 |
| Date: | 2009–01 |
| URL: | http://d.repec.org/n?u=RePEc:rim:rimwps:wp28_09&r=upt |
| By: | James Feigenbaum; Frank N. Caliendo; Emin Gahramanov |
| Abstract: | Contrary to the usual presumption that welfare is maximized if consumers behave rationally, we show in a two-period overlapping generations model that there always exists a rule of thumb that can weakly improve upon the lifecycle/permanent-income rule in general equilibrium with irrational households. The market-clearing mechanism introduces a pecuniary externality that individual rational households do not consider when making decisions, but a publically shared rule of thumb can exploit this effect. For typical calibrations, the improvement of the welfare of irrational households is robust to the introduction of rational agents. Generalizing to a more realistic lifecycle model, we find in particular that the Save More Tomorrow Plan can confer higher lifetime utility than the permanent-income rule in general equilibrium. |
| Keywords: | consumption, saving, coordination, lifecycle/permanent income hypothesis, SMarT Plan, general equilibrium, rules of thumb, pecuniary externality |
| JEL: | C61 D11 E21 |
| Date: | 2009–02–10 |
| URL: | http://d.repec.org/n?u=RePEc:dkn:econwp:eco_2009_01&r=upt |
| By: | Lena Vogel (Department for Economics and Politics, University of Hamburg); Jan-Oliver Menz (Department for Economics and Politics, University of Hamburg); Ulrich Fritsche (Department for Economics and Politics, University of Hamburg) |
| Abstract: | Building on the hypotheses of loss aversion with respect to price increases and availability of frequently bought goods, Brachinger (2006,2008) constructs an alternative index of perceived inflation (IPI), which can reproduce the jump in the measure for perceived inflation after the Euro introduction in Germany that was not observable in standard HICP inflation. We test the hypotheses of Prospect Theory with regard to households’ inflation perceptions underlying Brachinger’s IPI in a panel estimation for 12 European countries. There is evidence that perceptions react more strongly to ‘losses’ in inflation than to ‘gains’ before the Euro cash changeover, but not afterwards. Moreover, we find empirical support for the availability hypothesis, stating that frequently bought goods have a stronger influence on inflation perceptions than the overall price index. |
| Keywords: | Inflation Perceptions, Prospect Theory, Dynamic Panel |
| JEL: | D81 D82 E52 C33 |
| URL: | http://d.repec.org/n?u=RePEc:hep:macppr:200903&r=upt |
| By: | S. DOBBELAERE; R. I. LUTTENS; B. PETERS |
| Abstract: | We study a two-stage R&D project with an abandonment option. Two types of uncertainty influence the decision to start R&D. Demand uncertainty is modelled as a lottery between a proportional increase and decrease in demand. Technical uncertainty is modelled as a lottery between a decrease and increase in the cost to continue R&D. We relate differences in uncertainty to differences in risk premia. We deduct testable hypotheses on the basis of which we empirically analyze the impact of uncertainty on the decision to start an R&D project. Using data for about 4000 German firms in manufacturing and services (CIS IV), our model predictions are strongly confirmed. |
| Keywords: | Investment under uncertainty, R&D, demand uncertainty, technical uncertainty,entry threat |
| JEL: | D21 D81 L12 O31 |
| Date: | 2009–05 |
| URL: | http://d.repec.org/n?u=RePEc:rug:rugwps:09/585&r=upt |
| By: | Xun Tang (Department of Economics, University of Pennsylvania) |
| Abstract: | We address two issues in nonparametric structural analyses of dynamic binary choice processes (DBCP). First, the DBCP is not testable and decision makers’ single-period payoffs (SPP) cannot be identified even when the distribution of unobservable states (USV) is known. Numerical examples show setting SPP from one choice to arbitrary utility levels to identify that from the other can lead to errors in predicting choice probabilities under counterfactual state transitions. We propose two solutions. First, if a data generating process (DGP) has exogenous variations in observable state transitions, the DBCP becomes testable and SPP is identified. Second, exogenous economic restrictions on SPP (such as ranking of states by SPP, or shape restrictions) can be used to recover the identified set of rationalizable counterfactual choice probabilities (RCCP) that are consistent with model restrictions. The other (more challenging) motivating issue is that when the USV distribution is not known, misspecification of the distribution in structural estimation leads to errors in counterfactual predictions. We introduce a simple algorithm based on linear programming to recover sharp bounds on RCCP. This approach exploits the fact that some stochastic restrictions on USV (such as independence from observable states) and economic restrictions on SPP can be represented (without loss of information for counterfactual analyses) as linear restrictions on SPP and distributional parameters of USV. We use numerical examples to illustrate the algorithm and show sizes of identified sets of RCCP can be quite small relative to the outcome space. |
| Keywords: | Dynamic discrete choice models, counterfactual outcomes, rationalizability, non-parametric and semiparametric identification |
| JEL: | C13 C14 C25 |
| Date: | 2009–06–20 |
| URL: | http://d.repec.org/n?u=RePEc:pen:papers:09-022&r=upt |
| By: | Lanfranchi, Joseph; Narcy, Mathieu; Larguem, Makram |
| Abstract: | In this paper, we intend to evaluate the determinants of the decision utility of workers from the for-profit and nonprofit sectors. In our setting, decision utility is the weight assigned by workers to the expected benefits from job offers. For that purpose, we use the methodology of conjoint analysis that collects experimental data on workers’ stated preferences towards hypothetical job offers characterized by ten attributes. Intrinsic motivation of nonprofit workers is investigated by specifically analyzing the influence on decision utility of three of these attributes, namely wages, working time and loyalty from the employer. The results show evidence of motivational differences between the two groups. First, nonprofit workers attain their maximum decision utility at a longer working time, showing superior intrinsic motivation for work. Furthermore, they are ready to abandon a higher percentage of their wage in order to work for another extra hour than for-profit workers as long as the working week is inferior to 33 hours. Finally, our findings show that for-profit workers evaluate more highly job offers with labour contract including explicit clause where higher effort is exchanged for employer’s loyalty. In contrast, nonprofit workers do not obtain higher utility from such a deal. We interpret this result as evidence of their intrinsic motivation. As the nature of the implicit goals pursued in the nonprofit sector provides them with high work morale, they do not obtain any gain in utility from an explicit clause of employer’s loyalty. |
| Keywords: | nonprofit workers; intrinsic motivation; conjoint analysis |
| JEL: | J28 L31 C91 |
| Date: | 2009–04 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:16359&r=upt |
| By: | Alain Abou; Georges Prat |
| Abstract: | Semi-annual surveys carried out by J. Livingston on a panel of experts have enabled us to compute the expected returns over the time span 1-semester and 2-semesters ahead on a portfolio made up of US industrial stocks. We calculated about 3000 individual ex-ante equity risk premia over the period 1952 to 1993 (82 semesters) defined as the difference between these expected stock returns and the risk-free forward rate given by zero coupon bonds. Unlike any other study, our contribution is to analyse premia deduced from surveys data, at the micro level, per date and over a long period. Three main conclusions may be drawn from our analysis of these ex-ante premia. First, the mean values of these premia are closer to the predictions derived from the consumption-based asset pricing theory than the ones obtained for the ex-post premia. Second, the experts' professional affiliation appears to be a significant criterion in discriminating premia. Third, in accordance with the Arbitrage Pricing Theory, individual ex-ante premia depend both on macroeconomic and idiosyncratic common factors: the former are represented by a set of macroeconomic variables observable by all agents, and the latter by experts’ personal forecasts about the future state of the economy, as defined by expected inflation and industrial production growth rate. |
| Keywords: | Stock price expectations, equity risk premium, survey micro data |
| JEL: | D81 D84 E44 G12 G14 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:drm:wpaper:2009-25&r=upt |
| By: | Agnese Vitali (Carlo F. Dondena Centre for Research on Social Dynamics, Università Bocconi); Francesco C. Billari (Carlo F. Dondena Centre for Research on Social Dynamics, IMQ and IGIER, Università Bocconi); Alexia Prskawetz (Vienna Institute of Demography, Austrian Academy of Sciences); Maria Rita Testa (Vienna Institute of Demography, Austrian Academy of Sciences) |
| Abstract: | The discussion on the causes of the most recent fertility decline in Europe, and in particular on the emergence of lowest low fertility, emphasises the relevance of cultural factors in addition to economic ones. Being part of such a cultural framework, the heterogeneity of preferences concerning the “career vs. family” dichotomy has been systematised in the “Preference Theory” approach developed by Catherine Hakim. So far, however, this heterogeneity in preferences has been underinvestigated in a comparative framework. This paper makes use of new comparative data from the 2004/05 Round of the European Social Survey to test the links between individual-level preferences and both fertility outcomes and intentions in a variety of social settings. Results confirm a link between work-family lifestyle preferences and realised fertility in a variety of European countries, while they do not support the relevance of lifestyle preferences for fertility intentions. |
| Keywords: | Preference Theory, low and lowest low fertility, Europe, European Social Survey, welfare regime. |
| Date: | 2009–05 |
| URL: | http://d.repec.org/n?u=RePEc:vid:eudgrp:0702&r=upt |
| By: | Jan Pieter Krahnen; Christian Wilde |
| Abstract: | This paper analyzes the risk properties of typical asset-backed securities (ABS), like CDOs or MBS, relying on a model with both macroeconomic and idiosyncratic components. The examined properties include expected loss, loss given default, and macro factor dependencies. Using a two-dimensional loss decomposition as a new metric, the risk properties of individual ABS tranches can directly be compared to those of corporate bonds, within and across rating classes. By applying Monte Carlo Simulation, we find that the risk properties of ABS differ significantly and systematically from those of straight bonds with the same rating. In particular, loss given default, the sensitivities to macroeconomic risk, and model risk differ greatly between instruments. Our findings have implications for understanding the credit crisis and for policy making. On an economic level, our analysis suggests a new explanation for the observed rating inflation in structured finance markets during the pre-crisis period 2004-2007. On a policy level, our findings call for a termination of the 'one-size-fits-all' approach to the rating methodology for fixed income instruments, requiring an own rating methodology for structured finance instruments. |
| Keywords: | credit risk, risk transfer, systematic risk |
| JEL: | G21 G28 |
| Date: | 2009–06 |
| URL: | http://d.repec.org/n?u=RePEc:fra:franaf:203&r=upt |