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on Utility Models and Prospect Theory |
| By: | Richard S.J. Tol (Economic and Social Research Institute) |
| Abstract: | I define the rate of inequity aversion, distinguishing between the pure rate and the consumption rate. I measure the rate of aversion to inequality in consumption as expressed in the development aid given by rich countries to poor ones between 1965 and 2005. There is an ambiguous relationship between the pure rate of inequity aversion and the consumption rate, driven by the rate of risk aversion. However, for a reasonable choice of the rate of risk aversion, rich countries are shown to be inequity averse, and increasingly so over time. The social cost of carbon is very sensitive to equity weighting and assumptions about the rate of risk and inequity aversion. Estimates for the consumption rate of inequity aversion for recent data suggest that the equity-weighted social cost of carbon is less than 50% larger than the unweighted estimate. |
| Keywords: | Inequity aversion, risk aversion, income distribution, development aid, climate change, social cost of carbon |
| JEL: | D31 D63 Q54 |
| Date: | 2009–11 |
| URL: | http://d.repec.org/n?u=RePEc:sgc:wpaper:178&r=upt |
| By: | Adam, Klaus; Marcet, Albert |
| Abstract: | We present a decision theoretic framework with agents that are learning about the behavior of market determined variables. Agents are 'internally rational', i.e., maximize discounted expected utility under uncertainty given consistent beliefs about the future, but may not be 'externally rational', i.e., may not know the true stochastic process for market determined variables (asset prices) and fundamentals (dividends). We apply this approach to a simple asset pricing model with heterogeneity and incomplete markets. We show how knowledge about dividends and optimal behavior alone fail to fully inform agents about equilibrium prices, so that learning about price behavior, as in Adam, Marcet and Nicolini (2008), is fully consistent with internal rationality. We also show that equilibrium prices depend on expectations of the discounted price and dividend in the next period only, rather than on the expected discounted sum of future dividends. Discounted sums emerge only after making very strong assumptions about agents' knowledge and prove extremely sensitive to the details about agents' prior beliefs about the dividend process. |
| Keywords: | learning; rationality |
| JEL: | D83 D84 G12 G14 |
| Date: | 2009–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7498&r=upt |
| By: | Gil S. Epstein (Bar-Ilan University); Ira N. Gang (Rutgers University) |
| Abstract: | In this paper we try to understand the phenomena whereby a large proportion of the population evades tax payments. We present a model which incorporates elements from the theory of information cascades with the standard model of tax evasion and analyze the connection between the decision of a potential tax evader, the number of tax evaders and the number caught in previous periods. General conditions exist under which any expected utility maximizing potential tax evaders will decide to emulate other tax evaders. |
| Keywords: | Tax evasion, Information Cascades, Uncertainty |
| JEL: | H26 H31 D82 |
| Date: | 2009–04–27 |
| URL: | http://d.repec.org/n?u=RePEc:rut:rutres:200902&r=upt |
| By: | Volker Krätschmer; John Schoenmakers |
| Abstract: | In this paper we consider the optimal stopping problem for general dynamic monetary utility functionals. Sufficient conditions for the Bellman principle and the existence of optimal stopping times are provided. Particular attention is payed to representations which allow for a numerical treatment in real situations. To this aim, generalizations of standard evaluation methods like policy iteration, dual and consumption based approaches are developed in the context of general dynamic monetary utility functionals. As a result, it turns out that the possibility of a particular generalization depends on specific properties of the utility functional under consideration. |
| Keywords: | monetary utility functionals, optimal stopping, duality, policy iteration |
| JEL: | C61 C63 G12 G13 |
| Date: | 2009–11 |
| URL: | http://d.repec.org/n?u=RePEc:hum:wpaper:sfb649dp2009-055&r=upt |
| By: | DeClippel, Geoffroy; Eliaz, Kfir |
| Abstract: | This paper proposes a model of boundedly rational choice that explains the well known attraction and compromise effects. Choices in our model are interpreted as a cooperative solution to a bargaining problem among an individual’s conflicting dual selves. We axiomatically characterize a unique bargaining solution that captures both effects when the selves’ preferences are known. We then provide a revealed preference foundation to our solution, and characterize the extent to which these two underlying preference relations can be uniquely identified. |
| Keywords: | Attraction Effect; Bounded Rationality; Compromise Effect; Cooperative Bargaining; Fallback Bargaining; Reason-based-choice |
| JEL: | C71 C78 D11 |
| Date: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7414&r=upt |
| By: | Kris De Jaegher; Robert van Rooij |
| Abstract: | This paper brings together several approaches to vagueness, and ends by suggesting a new approach. The common thread in these approaches is the crucial role played by context. Using a single example where there is a conflict of interest between speaker and listener, we start by treating game-theoretic rationales for vagueness, and for the related concepts of generality and ambiguity. We argue that the most plausible application of these models to vagueness in natural language is one where the listener only imperfectly observes the context in which the speaker makes her utterances. We next look at a rationale for vagueness when there is no conflict between speaker and listener, and which is an application of Horn's rule. Further, we tackle the Sorites paradox. This paradox apparently violates standard axioms of rational behaviour. Yet, once it is taken into account that vague language is used in an appropriate context, these axioms are no longer violated. We end with a behavioural approach to vagueness, where context directly enters agents. preferences. In an application of prospect theory, agents think in terms of gains and losses with respect to a reference point. Vague predicates now allow agents to express their subjective valuations, without necessarily specifying the context. |
| Keywords: | Vagueness, signalling games, decision theory, prospect theory |
| JEL: | D82 D83 |
| Date: | 2009–11 |
| URL: | http://d.repec.org/n?u=RePEc:use:tkiwps:0931&r=upt |
| By: | Backus, David; Chernov, Mikhail; Martin, Ian |
| Abstract: | We use prices of equity index options to quantify the impact of extreme events on asset returns. We define extreme events as departures from normality of the log of the pricing kernel and summarize their impact with high-order cumulants: skewness, kurtosis, and so on. We show that high-order cumulants are quantitatively important in both representative-agent models with disasters and in a statistical pricing model estimated from equity index options. Option prices thus provide independent confirmation of the impact of extreme events on asset returns, but they imply a more modest distribution of them. |
| Keywords: | cumulants; entropy; equity premium; implied volatility; pricing kernel; risk-neutral probabilities |
| JEL: | E44 G12 |
| Date: | 2009–08 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7416&r=upt |
| By: | Olga Bourachnikova (Laboratoire de Recherche en Gestion et Economie, EM Strasbourg, Université de Strasbourg); Nurmukhammad Yusupov (Audencia Nantes School of Management) |
| Abstract: | While symmetric measures of risk, such as variance, have been conven- tionally used in ?nance, downside risk measures are arguably more intuitive although computationally more complex to use. Opponents of symmetric risk measures suggest that investors use downside risk approach to invest- ment decisions. In this paper, using French stock market data, we empir- ically test whether the two approaches to portfolio optimization produce signi?cantly di¤erent outcomes. Our results suggest portfolio choice under downside risk and symmetric risk frameworks yield similar results. Our paper contributes to the ongoing debate on the relevance of symmetric vs. downside risk measures. |
| JEL: | G11 |
| Date: | 2009 |
| URL: | http://d.repec.org/n?u=RePEc:lar:wpaper:2009-13&r=upt |
| By: | Schuknecht, Ludger; von Hagen, Jürgen; Wolswijk, Guido |
| Abstract: | This note looks at US$ and DM/Euro denominated government bond spreads relative to US and German benchmark bonds before and after the start of the current financial crisis. The study finds, first, that bond yield spreads before and during the crisis can largely be explained on the basis of economic principles. Second, markets penalise fiscal imbalances much more strongly after the Lehman default in September 2008 than before. There is also a significant increase in the spread on non-benchmark bonds due to higher general risk aversion, and German bonds obtained a safe-haven investment status similar to that of the US which they did not have before the crisis. These findings underpin the need for achieving sound fiscal positions in good times and complying with the Stability and Growth Pact. |
| Keywords: | Bond Markets; Financial Crisis; Sovereign Risk Premiums |
| JEL: | G12 G15 |
| Date: | 2009–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:7499&r=upt |
| By: | Kenichiro Shiraya (Mizuho-DL Financial Technology Co.,Ltd.); Akihiko Takahashi (Faculty of Economics, University of Tokyo); Masashi Toda (Graduate School of Economics, University of Tokyo) |
| Abstract: | This paper proposes a new approximation method of pricing barrier and average options under stochastic volatility environment by applying an asymptotic expansion approach. In particular, a high-order expansion scheme for general multi-dimensional diffusion processes is effectively applied. Moreover, the paper combines a static hedging method with the asymptotic expansion method for pricing barrier options. Finally, numerical examples show that the fourth or fifth-order asymptotic expansion scheme provides sufficiently accurate approximations under the C-SABR and SABR models. |
| Date: | 2009–10 |
| URL: | http://d.repec.org/n?u=RePEc:tky:fseres:2009cf682&r=upt |
| By: | A. VAN KERCKHOVE; I. VERMEIR; M. GEUENS |
| Abstract: | Marketers often use salient stimuli to draw consumers’ attention to a specific brand in the hope that a selective focus on the own brand increases the sales of this brand. However, previous studies are inconsistent concerning the impact that selectively focusing on a specific brand has on final brand choice. To offer an explanation for these inconsistent results, this paper introduces decision involvement as a moderator of the relation between selective focus and attitude-decision consistency. Two studies indicate that selectively focusing on a not most preferred alternative indeed alters choice decisions, but only when decision involvement is low. Study 1 further shows that this interaction effect between selective focus and involvement takes place in the selection rather than the brand consideration stage. By introducing level of processing next to decision involvement, Study 2 shows that the interaction effect emerges even in limited processing conditions. The study also reconciles different explanations for the negative effect of selective focus on attitude-behavior consistency. Selectively focusing on a not preferred choice option when consumer are low involved and use limited processing seems to lead to inconsistent choices because of an increased accessibility of the focal option, whereas selective focus on a not preferred option when consumers are low involved and use deep processing lead to inconsistent choices because of attitude polarization. |
| Keywords: | Attitude-behavior relation, consideration set, decision involvement, accessibility |
| Date: | 2009–07 |
| URL: | http://d.repec.org/n?u=RePEc:rug:rugwps:09/602&r=upt |