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on Utility Models and Prospect Theory |
| By: | Johanna Etner (CERSES - Centre de recherche sens, ethique, société - CNRS : UMR8137 - Université Paris Descartes - Paris V); Meglena Jeleva (GAINS - Université du Maine); Jean-Marc Tallon (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) |
| Abstract: | We review recent advances in the field of decision making under uncertainty or ambiguity. |
| Keywords: | Ambiguity, ambiguity aversion, uncertainty, decision. |
| Date: | 2009–10 |
| URL: | http://d.repec.org/n?u=RePEc:hal:cesptp:halshs-00429573_v1&r=upt |
| By: | Jianying Qiu (Department of Economics, University of Innsbruck); Eva-Maria Steiger (Stratigic Interaction Group, Max Planck Institute of Economics, Jena) |
| Abstract: | Economics and management science share the tradition of ordering risk aversion by ï¬tting the best expected utility (EU) model with a certain utility function to individual data, and then using the utility curvature for each individual as the sole index of risk attitude. (Cumulative) Prospect theory (CPT) has demonstrated various empirical deï¬ciencies of EU and introduced the weighting of probabilities as an additional component to capture risk attitude. However, if utility curvature and probability weighting were strongly correlated, the utility curvature in EU alone, while not properly describing risky behavior in general, would still capture most of the variance regarding degrees of risk aversion. This study shows, however, that such a strong correlation does not exist. Though, most individuals exhibit concave utility and convex probability weighting, the two components show no correlation. Thus neglecting one component entails a loss. |
| Keywords: | risk attitudes, cumulative prospect theory, experimental study |
| JEL: | C91 D81 |
| Date: | 2009–11–02 |
| URL: | http://d.repec.org/n?u=RePEc:jrp:jrpwrp:2009-088&r=upt |
| By: | Gill, David (University of Southampton); Prowse, Victoria L. (University of Oxford) |
| 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: | 2009–10 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp4536&r=upt |
| By: | Lefèbvre, Mathieu (CREPP, Université de Liège); Vieider, Ferdinand M. (CNRS, GATE); Villeval, Marie Claire (CNRS, GATE) |
| Abstract: | Most studies on the role of incentives on risk attitude report data obtained from within-subject experimental investigations. This may however raise an issue of sequentiality of effects as later choices may be influenced by earlier ones. This paper reports instead between-subject results on the effect of monetary stakes on risk attitudes for small probability prospects in a laboratory experiment. Under low stakes, we find the typical risk seeking behavior for small probabilities predicted by the prospect theory. But under high stakes, we provide some evidence that risk seeking behavior is dramatically reduced. This could suggest that utility is not consistently concave over the outcome space, but rather contains a convex section for very small amounts. |
| Keywords: | risk attitude, incentives, decision, experiment |
| JEL: | C91 D81 D89 |
| Date: | 2009–11 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp4545&r=upt |
| By: | Dietrich Franz; List Christian (METEOR) |
| Abstract: | According to standard rational choice theory, as commonly used in political science and economics, an agent''s fundamental preferences are exogenously fixed, and any preference change over decision options is due to Bayesian information learning. Although elegant and parsimonious, this model fails to account for preference change driven by experiences or psychological changes distinct from information learning. We develop a model of non-informational preference change.Alternatives are modelled as points in some multidimensional space, only some of whose dimensions play a role in shaping the agent''s preferences.Any change in these `motivationally salient'' dimensions can change the agent''s preferences. How it does so is described by a new representation theorem. Our model not only captures a wide range of frequently observed phenomena, but also generalizes some standard representations of preferences in political science and economics. |
| Keywords: | mathematical economics; |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:umamet:2009015&r=upt |
| By: | Eric T. Swanson |
| Abstract: | In dynamic stochastic general equilibrium (DSGE) models, the househol's labor margin as well as consumption margin affects Arrow-Pratt risk aversion. This paper derives simple, closed-form expressions for risk aversion that take into account the household's labor margin. Ignoring the labor margin can lead to wildly inaccurate measures of the household's true attitudes toward risk. We show that risk premia on assets computed using the stochastic discount factor are proportional to Arrow-Pratt risk aversion, so that measuring risk aversion correctly is crucial for understanding asset prices. Closed-form expressions for risk aversion in DSGE models with generalized recursive preferences and internal and external habits are also derived.> In dynamic stochastic general equilibrium (DSGE) models, the househol's labor margin as well as consumption margin affects Arrow-Pratt risk aversion. This paper derives simple, closed-form expressions for risk aversion that take into account the household's labor margin. Ignoring the labor margin can lead to wildly inaccurate measures of the household's true attitudes toward risk. We show that risk premia on assets computed using the stochastic discount factor are proportional to Arrow-Pratt risk aversion, so that measuring risk aversion correctly is crucial for understanding asset prices. Closed-form expressions for risk aversion in DSGE models with generalized recursive preferences and internal and external habits are also derived. |
| Keywords: | Financial risk management ; Asset pricing |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedfwp:2009-26&r=upt |
| By: | Luc LAUWERS |
| Abstract: | Ordering infinite utility streams: maximal anonymity |
| Date: | 2009–05 |
| URL: | http://d.repec.org/n?u=RePEc:ete:ceswps:ces09.08&r=upt |
| By: | Oleg Badunenko; Nataliya Barasinska; Dorothea Schäfer |
| Abstract: | This study questions the popular stereotype that women are more risk averse than men in their financial investment decisions. The analysis is based on micro-level data from large-scale surveys of private households in five European countries. In our analysis of investment decisions, we directly account for individuals' self-perceived willingness to take financial risks. The empirical evidence we provide only weakly supports the gender differences argument. We find that women are less likely to invest in risky financial assets. However, when the probability of investing is controlled for, males and females are found to allocate equal shares of their wealth to risky assets. |
| Keywords: | Gender, risk aversion, financial behavior |
| JEL: | G11 J16 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:diw:diwwpp:dp928&r=upt |
| By: | Fernandez, Pablo (IESE Business School); Aguirreamalloa, Javier (IESE Business School); Liechtenstein, Heinrich (IESE Business School) |
| Abstract: | We argue that the equity premium puzzle may be explained by the fact that most market participants (equity investors, investment banks, analysts, companies¿) do not use standard theory (such as a standard representative consumer asset pricing model) for determining their Required Equity Premium, but rather, they use historical data and advices from textbooks and finance professors. Consequently, ex-ante equity premia have been high, market prices have been consistently undervalued, and the ex-post risk premia has been also high. Professors use in class and in their textbooks high equity premia (average around 6%, range from 3 to 10%), and investors use higher equity premia for valuing companies (average around 6%). The overall result is that equity prices have been, on average, undervalued in the last decades and, consequently, the measured ex-post equity premium is also high. As most investors use historical data and textbook prescriptions to estimate the required and the expected equity premium, the undervaluation and the high ex-post risk premium are self fulfilling prophecies. |
| Keywords: | equity premium puzzle; required equity premium; historical equity premium; |
| JEL: | G12 G31 M21 |
| Date: | 2009–09–07 |
| URL: | http://d.repec.org/n?u=RePEc:ebg:iesewp:d-0821&r=upt |
| By: | Llavador, Humberto (Universitat Pompeu Fabra); Roemer, John E. (Yale University); Silvestre, Joaquim (University of California, Davis) |
| Abstract: | Let there be a positive (exogenous) probability that, at each date, the human species will disappear. We postulate an Ethical Observer (EO) who maximizes intertemporal welfare under this uncertainty, with expected-utility preferences. Various social welfare criteria entail alternative von Neumann- Morgenstern utility functions for the EO: utilitarianism, Rawlsianism, and an extension of the latter that corrects for the size of population. Our analysis covers, first, a cake-eating economy, where the utilitarian and Rawlsian recommend the same allocation. Second, a productive economy with education and capital. There, however, the recommendations of the two Ethical Observers are in general different. But when the utilitarian program diverges, then it is optimal for the extended Rawlsian to ignore the uncertainty concerning the possible disappearance of the human species in the future. We conclude discussing the implications for intergenerational welfare maximization in the presence of global warming. |
| Date: | 2009–03 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:ucdeco:09-4&r=upt |
| By: | Irina Georgescu |
| Abstract: | The Arrow index of a fuzzy choice function C is a measure of the degree to which C satisfies the Fuzzy Arrow Axiom, a fuzzy version of the classical Arrow Axiom. The main result of this paper shows that A(C) characterizes the degree to which C is full rational. We also obtain a method for computing A(C). The Arrow index allows to rank the fuzzy choice functions with respect to their rationality. Thus, if for solving a decision problem several fuzzy choice functions are proposed, by the Arrow index the most rational one will be chosen. |
| Keywords: | Fuzzy choice function, revealed preference indicator, congruence indicator, similarity |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:diw:diwwpp:dp930&r=upt |