nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2009‒09‒19
eight papers chosen by
Alexander Harin
Modern University for the Humanities

  1. An experimental methodology testing for prudence and third-order preferences By Sebastian Ebert; Daniel Wiesen
  2. A Structural Analysis of Disappointment Aversion in a Real Effort Competition By David Gill; Victoria Prowse
  3. Risk Aversion and Clientele Effects By Douglas W. Blackburn; William N. Goetzmann; Andrey D. Ukhov
  4. Preference for Skew in Lotteries: Evidence from the Laboratory By Santos-Pinto, Luís; Astebro, Thomas; Mata, José
  5. Nice guys with cold feet: The cost of responsible investing in the bond markets By Bastien Drut
  6. Possibility and permissibility By Kin Chung Lo
  7. Markets fo Heterogeneous Products: a Boundedly Rational Consumer Model By Marco Valente
  8. How to Extend a Model of Probabilistic Choice from Binary Choices to Choices among More Than Two Alternatives By Pavlo R. Blavatskyy

  1. By: Sebastian Ebert; Daniel Wiesen
    Abstract: We propose an experimental method to test individuals for prudence (i.e. downside risk aversion) outside the expected utility framework. Our method relies on a novel representation of compound lotteries which allows for a systematic parameterization that captures the full generality of prudence. Therefore, we develop a general technique for lottery calibration in experiments. Since we investigate a very subtle third-order property we test our method in the laboratory employing a factorial design. We find that it yields robust results and that prudence is observed on the aggregate as well as on the individual level. Further we show that preferences based on statistical moments, in particular skewness seeking, can at most approximately explain individuals' behavior in the experiment.
    Keywords: Decision making under uncertainty, risk preferences, prudence, downside risk, statistical moments, laboratory experiment
    JEL: D81 C91
    Date: 2009–09
  2. By: David Gill; Victoria Prowse
    Abstract: We develop a novel computerized real effort task, based on moving sliders across a screen, to test experimentally whether agents are disappointment averse when they compete in a real effort sequential-move tournament. Our theory predicts that a disappointment averse agent, who is loss averse around her endogenous expectations-based reference point, responds negatively to her rival’s effort. We find significant evidence for this discouragement effect, and use the Method of Simulated Moments to estimate the strength of disappointment aversion on average and the heterogeneity in disappointment aversion across the population.
    Keywords: Disappointment aversion, Loss aversion, Reference-dependent preferences, Reference point adjustment, Expectations, Tournament, Real effort experiment, Slider task
    JEL: C91
    Date: 2009
  3. By: Douglas W. Blackburn; William N. Goetzmann; Andrey D. Ukhov
    Abstract: We use traded options on growth and value indices to test for clientele differences in risk preferences. Value investors appear to have exhibited a higher average level of risk aversion than growth investors for two different time periods in the late 1990’s and early 2000’s. We construct a model of time-varying clientele preferences that allows investors with different levels of risk-aversion to switch between investment styles conditional upon the evolution of returns and risk. The model makes predictions about the autocorrelations structure of measured risk parameters and also about the autocorrelation and cross-autocorrelation of fund flows by style. Empirical tests of the model provide evidence consistent with the existence of style switchers—investors who move funds between growth and value securities. We construct trading strategies in the value and growth index options markets that effectively buy risk from one clientele and sell it to another. These strategies generated modest positive returns over the period of study.
    JEL: D01 G11 G12
    Date: 2009–09
  4. By: Santos-Pinto, Luís; Astebro, Thomas; Mata, José
    Abstract: Using a laboratory experiment we investigate how skew in uences choices under risk. We find that subjects make significantly riskier choices when the distribution of payoffs is positively skewed, these choices being driven in part by the shape of the utility function but also by subjective distortion of probabilities. A utility model with probability distortion calibrated on laboratory data is able to explain why most gamblers in public lotteries buy only a small number of tickets.
    Keywords: Risk; Skew; Gambling; Lab Experiment
    JEL: D81 C91
    Date: 2009–06–09
  5. By: Bastien Drut (Centre Emile Bernheim, Solvay Brussels School of Economics and Management, Université Libre de Bruxelles, Brussel, Credit Agricole Asset Management SGR and University of Paris Ouest, Paris.)
    Abstract: The aim of this paper is to measure the cost of investing responsibly for different risk aversion levels by taking the example of green sovereign bond portfolios. We show that for developed countries, the cost of being a nice guy is lower if you have cold feet while this is the contrary for emerging countries. It implies that managers of Socially Responsible Investment (SRI) funds should gauge investor’s risk aversion prior to evaluating the “SRI cost”, this cost being null in some cases.
    Keywords: Climate Change, Environmental Performance Index, Responsible Investing, Risk Aversion, Portfolio Selection, Socially Responsible Investment, Sovereign Bonds.
    JEL: G11 G15 Q59
    Date: 2009–09
  6. By: Kin Chung Lo (York University, Toronto)
    Abstract: We generalize permissibility (Brandenburger, 1992) to allow for any suitably defined model of preference and definition of possibility. We also prove that the generalized solution concept characterizes rationality, caution, and “common belief" of rationality and caution.
    JEL: C72 D81
    Date: 2009–09
  7. By: Marco Valente
    Abstract: The paper is based on the acknowledgement that properties of markets stemming from features of demand are too frequently overlooked in the economic literature, and a re-balancing is necessary to properly account for theoretical and empirical phenomena. We sustain that one of the most relevant reasons for the neglect of the role of demand is the lack of an adequate representation of consumers. This claim is particu- larly relevant for evolutionary economics since its critique to the mainstream approach stopped at the representation of firms. The standard utility maximization approach to consumers? theory is even less defensible than the related assumption of producers? rationality, given the lack of competitive pressure on consumers. As a contribution to this theoretical gap, the paper presents a model for consumer based on the assumption of bounded rationality and inspired to the literature on experimental psychology. The proposed model can be applied to multi-dimensional products/services and relies on intuitive and potentially observable parameters, allow- ing for a wide range of theoretical and empirical applications. Moreover, the intrinsic structure of the model provides a clear definition of preferences, meant as ex-ante decisional criteria, distinguished from post-hoc justification of any decisional result. Though structurally simple, the proposed model is very flexible and allows for a clear exploration of the impact of specific demand features on the produced results. Several experiments show that the model can be successfully applied both to generate standard results and to implement complex configurations such as those of generated by large markets with heterogeneous products. Among the results presented, the most relevant concerns the identification of two classes of market segmentation, generated by the identical suppliers and demand?s ex- ogenous factors, but different consumers? decisional mechanisms. The results produced are observationally equivalent, but are shown to have radically different properties, and are proposed as initial elements of a taxonomy for the classification demand classes, likely to explain common properties across different markets.
    Keywords: Evolutionary Economics, Consumer Theory, Bounded Rationality, Marketing and Preferences, Simulation Models, Market Structure
    JEL: C63 D11 D81 L10 L15 M30
    Date: 2009–09–08
  8. By: Pavlo R. Blavatskyy
    Abstract: This note presents an algorithm that extends a binary choice model to choice among multiple alternatives. Both neoclassical microeconomic theory and Luce choice model are consistent with the proposed algorithm. The algorithm is compatible with several empirical findings (asymmetric dominance and attraction effects) that cannot be explained within standard models.
    Keywords: Probabilistic choice, binary choice, multiple alternatives
    JEL: C44 D11 D70 D81
    Date: 2009–09

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