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on Utility Models and Prospect Theory |
| By: | Leonid Kogan; Stephen Ross; Jiang Wang; Mark M. Westerfield |
| Abstract: | The hypothesis that financial markets punish traders who make relatively inaccurate forecasts and eventually eliminate the effect of their beliefs on prices is of fundamental importance to the standard modeling paradigm in asset pricing. We establish necessary and sufficient conditions for agents making inferior forecasts to survive and to affect prices in the long run in a general setting with minimal restrictions on endowments, beliefs, or utility functions. We show that the market selection hypothesis is valid for economies with bounded endowments or bounded relative risk aversion, but it cannot be substantially generalized to a broader class of models. Instead, survival is determined by a comparison of the forecast errors to risk attitudes. The price impact of inaccurate forecasts is distinct from survival because price impact is determined by the volatility of traders’ consumption shares rather than by their level. Our results also apply to economies with state-dependent preferences, such as habit formation. |
| JEL: | D51 D53 G1 G11 G12 G14 |
| Date: | 2009–07 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:15189&r=upt |
| By: | Carolina Fugazza; Massimo Guidolin; Giovanna Nicodano |
| Abstract: | Welfare gains to long-horizon investors may derive from time diversification that exploits non-zero intertemporal return correlations associated with predictable returns. Real estate may thus become more desirable if its returns are negatively serially correlated. While it could be important for long horizon investors, time diversification has been mostly investigated in asset menus without real estate and focusing on in-sample experiments. This paper evaluates ex post, out-of-sample gains from diversification when E-REITs belong to the investment opportunity set. We find that diversification into REITs increases both the Sharpe ratio and the certainty equivalent of wealth for all investment horizons and for both Classical and Bayesian (who account for parameter uncertainty) investors. The increases in Sharpe ratios are often statistically significant. However, the out-of sample average Sharpe ratio and realized expected utility of long-horizon portfolios are frequently lower than that of a one-period portfolio, which casts doubts on the value of time diversification. |
| Keywords: | Real estate investment |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2009-001&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:journl:halshs-00376747_v1&r=upt |
| By: | Massimo Guidolin; Francesca Rinaldi |
| Abstract: | The 2007-2008 financial crises has made it painfully obvious that markets may quickly turn illiquid. Moreover, recent experience has taught us that distress and lack of active trading can jump "around" between seemingly unconnected parts of the financial system contributing to transforming isolated shocks into systemic panic attacks. We develop a simple two-period model populated by both standard expected utility maximizers and by ambiguity-averse investors that trade in the market for a risky asset. We show that, provided there is a sufficient amount of ambiguity, market break-downs where large portions of traders withdraw from trading are endogenous and may be triggered by modest re-assessments of the range of possible scenarios on the performance of individual securities. Risk premia (spreads) increase with the proportion of traders in the market who are averse to ambiguity. When we analyze the effect of policy actions, we find that when a market has fallen into a state of impaired liquidity, bringing the market back to orderly functioning through a reduction in the amount of perceived ambiguity may cause further reductions in equilibrium prices. Finally, our model provides stark indications against the idea that policy makers may be able to "inflate" their way out of a financial crisis. |
| Keywords: | Risk ; Capital assets pricing model ; Financial crises ; Federal Reserve System |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2009-020&r=upt |
| By: | Nicolas Jacquemet (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); Robert-Vincent Joule (Laboratoire de Psychologie Sociale - Université de Provence); Stéphane Luchini (GREQAM - Groupe de Recherche en Economie Quantitative d'Aix-Marseille); Jason F. Shogren (University of Wyoming - Department of Economics and Finance, Umeå University - Department of Economics) |
| Abstract: | Eliciting sincere preferences for non-market goods remains a challenge due to hypothetical bias - the so-called gap between hypothetical monetary values and real economic commitments. The gap arises because people either overstate hypothetical values or understate real commitments or a combination of both. Herein we examine whether the traditional real-world institution of the solenn oath can improve preference elicitation. Applying the social psychology theory on the oath as a truth-telling-commitment device, we ask our bidders to swear on their honour to give honest answers prior to participating in an incentive-compatible second-price auction. Results from our induced valuation testbed treatments suggest the oath-only auctions outperform all other auctions (real, hypothetical, and real-with-oath). In our homegrown valuation treatments eliciting preferences for dolphin protection, the oath-only design induced people to treat as binding both their budget constraint (i.e., lower values on the high end of the value distribution) and participation constraint (i.e., positive values rather than zero bids used to opt out of auction). Our oath-only results are robust to extra training on the auction and to consequential wording about the reason for the oath. |
| Keywords: | Oath, commitment, Vickrey auction, hypothetical bias, induced values, homegrown values. |
| Date: | 2009–06 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:halshs-00396721_v1&r=upt |
| By: | David Haugh; Patrice Ollivaud; David Turner |
| Abstract: | This paper analyses recent large movements in the yield spread for sovereign bonds as between Germany and other euro area countries. While the general increase in risk aversion that has characterised the financial crisis is an important factor on its own, it is found that this has also magnified the importance of fiscal performance, in particular as measured by the ratio of debt service to tax receipts and expected fiscal deficits. Moreover, there is evidence to suggest that such effects are non-linear, so that incremental deteriorations in fiscal performance lead to ever larger increases in the spread. These findings imply that financial market reaction could become an increasingly important constraint on fiscal policy for some countries, a feature which was much less apparent in the years prior to the financial crisis when general risk aversion was abnormally low.<P>Quels sont les déterminants des primes de risque des États ? : Une analyse récente de la zone euro<BR>Cet article analyse les récents mouvements importants des écarts de taux des obligations d’État des pays de la zone euro avec l’Allemagne. L’augmentation généralisée de l’aversion au risque qui a accompagné la crise financière est un facteur important en soi. L’article montre en outre que ce phénomène a amplifié l’impact des performances budgétaires, en particulier quand elles sont mesurées par le ratio du service de la dette aux recettes fiscales et par les déficits budgétaires anticipés. De plus, ces effets se révèlent non linéaires, ce qui se traduit par le fait que les détériorations supplémentaires des performances budgétaires amènent à des augmentations toujours plus importantes des écarts de taux. Ces résultats suggèrent que les réactions des marchés financiers pourraient devenir une contrainte de plus en plus importante à la politique budgétaire de certains pays, une caractéristique qui était beaucoup moins visible durant les années antérieures à la crise où l’aversion générale au risque était anormalement basse. |
| Keywords: | fiscal policy, politique budgétaire, déficit budgétaire, interest rate, taux d'intérêt, deficit, debt, dette, bond market, marché obligataire, government bonds, obligations d’État |
| JEL: | E43 E63 G12 |
| Date: | 2009–07–22 |
| URL: | http://d.repec.org/n?u=RePEc:oec:ecoaaa:718-en&r=upt |
| By: | Emilio Barucci (Department of Mathematics, Politecnico di Milano); Marco Tolotti (Department of Applied Mathematics, University of Venice) |
| Abstract: | We analyze a class of binary dynamic models inspired by [4] on agents’ choices and social interaction. The main feature of our analysis is that agents are heterogeneous, in particular their attitude to interact with the choices of the other agents changes over time endogenously. Although dynamic approaches to the study of models with heterogeneous agents have been already applied in different fields, to our knowledge a complete study of an endogenously varying population of agents has not yet been pursued. As observed in [3], the main problem is given by the fact that with heterogeneous agents the system may be non reversible. We address these problems, we describe the (possible multiple) steady states of the processes involved, we analyze local and global stability and we discuss the similarities and the differences with respect to the literature. Applications are also provided. |
| Keywords: | heterogeneous agent models, intensity-based models, mean field interactions, random utilities, social interactions. |
| JEL: | D71 D81 C62 |
| Date: | 2009–07 |
| URL: | http://d.repec.org/n?u=RePEc:vnm:wpaper:189&r=upt |