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on Utility Models and Prospect Theory |
| By: | Ding, Xiaohao (Peking University); Hartog, Joop (University of Amsterdam); Sun, Yuze (Peking University) |
| Abstract: | We combine a survey and an experiment with real pay-out among Peking University students to measure and validate individual risk attitudes. The experiment involves choosing between a cash payment and playing a lottery. The survey questions ask for the reservation price of a hypothetical lottery and self-assessment of risk attitude on a 0-10 scale. We confirm familiar findings: risk aversion dominates, women are more risk averse than men, risk aversion decreases with increasing parental income, risk attitudes are domain-specific. Correlations between survey measures and experimental measures, are in the right direction, but not very high. The survey measures are valid indicators of experimentally measured risk attitude, but with substantial noise remaining. Heterogeneity in levels and structures of risk attitude is large. |
| Keywords: | risk attitude, survey question, experimental validation |
| JEL: | D12 |
| Date: | 2010–03 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp4807&r=upt |
| By: | BOMMIER, Antoine; ZUBER, StŽphane (UniversitŽ catholique de Louvain (UCL). Center for Operations Research and Econometrics (CORE)) |
| Keywords: | inequality aversion, Pareto principle, uncertainty, time consistency |
| JEL: | D6 D7 D81 D9 |
| Date: | 2009–02–01 |
| URL: | http://d.repec.org/n?u=RePEc:cor:louvco:2009009&r=upt |
| By: | Marcel Nutz |
| Abstract: | We consider the economic problem of optimal consumption and investment with power utility. We study the optimal strategy as the relative risk aversion tends to infinity or to one. The convergence of the optimal consumption is obtained for general semimartingale models while the convergence of the optimal trading strategy is obtained for continuous models. The limits are related to exponential and logarithmic utility. To derive these results, we combine approaches from optimal control, convex analysis and backward stochastic differential equations (BSDEs). |
| Date: | 2010–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1003.3582&r=upt |
| By: | Kaizoji, Taisei |
| Abstract: | Recent many empirical studies have argued that currency carry trade have been a driving force behind exchange rate movements, and have explained the latest financial crisis of 2007-2009 in terms of a sudden, massive reversal of carry trade positions. The aim of this paper is to provide one potential theoretical explanation for questions why currency carry trade becomes profitable, and why a sudden unwinding of carry trade is caused. We propose a new behavioral model of currency bubbles and crashes. We consider that investors trade two currencies: the domestic currency, and the foreign currency. Investors are divided into two groups, the rational investors and the carry traders. The rational investors maximize their expected utility of their wealth in the next period. Carry traders maximize their random utility of binary choice: investing the domestic currency or investing the foreign currency. We demonstrate that carry-traders’ herd behavior, which follows the behavior getting a majority, gives cause to a currency bubble, and their carry trading prolongs bubble. However, depreciation of funding currency slows down as the carry-trader’s behavior approaches to a stationary state, so that the return on carry trade predicted by carry traders begins to decrease in the second half of bubble. We demonstrate that decreasing the return on carry trade predicted by carry traders lead to currency crash. Our model also gives a plausible explanation on the forward premium puzzle. |
| Keywords: | Carry trade; forward premium puzzle; currency crisis; behavioral finance |
| JEL: | F31 |
| Date: | 2010–03–10 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:21432&r=upt |
| By: | DENUIT, Michel M. (UNIVERSITE CATHOLIQUE DE LOUVAIN,); EECKHOUDT, Louis (UniversitŽ catholique de Louvain (UCL). Center for Operations Research and Econometrics (CORE)); MENEGATTI, Mario |
| Keywords: | bivariate higher order increasing concave stochastic dominance, precautionary savings, background risk, dependence |
| Date: | 2009–02–01 |
| URL: | http://d.repec.org/n?u=RePEc:cor:louvco:2009007&r=upt |
| By: | Sarno, Lucio; Schneider, Paul; Wagner, Christian |
| Abstract: | We study the properties of foreign exchange risk premia that can explain the forward bias puzzle - the tendency of high-interest rate currencies to appreciate rather than depreciate. These risk premia arise endogenously from imposing the no-arbitrage condition on the relation between the term structure of interest rates and exchange rates, and they compensate for both currency risk and interest rate risk. In our empirical analysis, we estimate risk premia using an affine multi-currency term structure model and find that model-implied risk premia yield unbiased predictions for exchange rate excess returns. While interest rate risk affects the level of risk premia, the time-variation in excess returns is almost entirely driven by currency risk. Furthermore, risk premia are (i) closely related to global risk aversion, (ii) countercyclical to the state of the economy, and (iii) tightly linked to traditional exchange rate fundamentals. |
| Keywords: | term structure; exchange rates; forward bias; predictability |
| JEL: | E43 F31 G10 |
| Date: | 2010–01 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:21302&r=upt |
| By: | Dobbelaere, Sabien; Luttens, Roland Iwan; Peters, Bettina |
| Keywords: | investment under uncertainty, R&D, demand uncertainty, technical uncertainty, entry threat |
| JEL: | D21 D81 L12 O31 |
| Date: | 2009–05–01 |
| URL: | http://d.repec.org/n?u=RePEc:cor:louvco:2009036&r=upt |
| By: | Adam Clements (QUT); Annastiina Silvennoinen (QUT) |
| Abstract: | Volatility forecasts are important inputs into financial decisions such as portfolio allocation. While the forecasts are often used in such economic applications, the parameters of these models are traditionally estimated within a statistical framework. This leads to an inconsistency between the loss functions under which the model is estimated and under which it is applied. This paper examines the impact of the choice of loss function on model performance in a portfolio allocation setting. It is found that employing a utility based estimation criteria is preferred over likelihood estimation, however a simple mean squared error criteria performs in a similar manner. These finding have obvious implications for the manner in which volatility models are estimated when one wishes to inform the portfolio allocation decision. |
| Keywords: | Volatility, utility, portfolio allocation, realized volatility, MIDAS |
| JEL: | C22 G11 |
| Date: | 2010–03–10 |
| URL: | http://d.repec.org/n?u=RePEc:qut:auncer:2010_01&r=upt |
| By: | Bellemare, Charles (Université Laval); Sebald, Alexander (University of Copenhagen); Strobel, Martin (Maastricht University) |
| Abstract: | We estimate structural models of guilt aversion to measure the population level of willingness to pay (WTP) to avoid feeling guilt by letting down another player. We compare estimates of WTP under the assumption that higher-order beliefs are in equilibrium (i.e. consistent with the choice distribution) with models estimated using stated beliefs which relax the equilibrium requirement. We estimate WTP in the later case by allowing stated beliefs to be correlated with guilt aversion, thus controlling for a possible source of a consensus effect. All models are estimated using data from an experiment of proposal and response conducted with a large and representative sample of the Dutch population. Our range of estimates suggests that responders are willing to pay between 0.40 and 0.80 Euro to avoid letting down proposers by 1 Euro. Furthermore, we find that WTP estimated using stated beliefs is substantially overestimated (by a factor of two) when correlation between preferences and beliefs is not controlled for. Finally, we find no evidence that WTP is significantly related to the observable socio-economic characteristics of players. |
| Keywords: | guilt aversion, willingness to pay, equilibrium and stated beliefs models |
| JEL: | C93 D63 D84 |
| Date: | 2010–03 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp4803&r=upt |