nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2010‒06‒18
six papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Risk aversion and relationships in model-free. By Moez Abouda; Elyess Farhoud
  2. Embedding a Field Experiment in Contingent Valuation to Measure Context-Dependent Risk Preferences: Does Prospect Theory Explain Individual Responses for Wildfire Risk? By Kimberly Rollins; Mimako Kobayashi
  3. Epstein-Zin preferences and their use in macro-finance models: implications for optimal monetary policy By Matthieu Darracq Pariès; Alexis Loublier
  4. A comparison of responses to single and repeated discrete choice questions By McNair, Ben J.; Bennett, Jeff; Hensher, David A.
  5. Fairness und ihr Preis By Schneider, Andrea; Zimmermann, Klaus W.
  6. Variance Risk Premiums and Predictive Power of Alternative Forward Variances in the Corn Market By Zhiguang Wang; Scott W. Fausti; Bashir A. Qasmi

  1. By: Moez Abouda (Centre d'Economie de la Sorbonne et BESTMOD); Elyess Farhoud (Ecole Polytechnique de Tunisie et BESTMOD)
    Abstract: This paper belongs to the study of decision making under risk. We will be interested in modeling the behavior of decision makers (hereafter referred to as DM) when they are facing risky choices. We first introduce both the general framework of decision making problem under risk and the different models of choice under risk that are well recognized in the literature. Then, we review different concepts of some increase in risk and risk aversion that are valid independently of any representation. We will introduce two new forms of behaviors under risk namely weak weak risk aversion and anti-monotone risk aversion. Note that the latter is related to anti-comonotony (a concept investigated in Abouda, Aouani and Chateauneuf (2008)) and represents a halfway between monotone and weak risk aversion. Finally, we discuss the relationships -in model-free- among some of these behaviors.
    Keywords: Risk aversion, model-free concepts, relationships, anti-comonotone, SMRA, MRA, ARA, WWRA.
    JEL: D80 D81 G12
    Date: 2010–05
  2. By: Kimberly Rollins (Department of Resource Economics, University of Nevada, Reno); Mimako Kobayashi (Department of Resource Economics, University of Nevada, Reno)
    Abstract: This paper contributes towards the development of an empirical approach applicable to contingent valuation to accommodate non-expected utility risk preferences. Combining elicitation approaches used in field experiments with contingent valuation, we embed an experimental design that systematically varies probabilities and losses across a survey sample in a willingness to pay elicitation format. We apply the proposed elicitation and estimation approaches to estimate the risk preferences of a representative homeowner who faces probabilistic wildfire risks and an investment option that reduces losses due to wildfire. Based on prospect theory, we estimate parameters of probability weighting, risk preferences and use individual characteristics as covariates for these parameters and as utility shifters. We find that risk preferences are consistent with prospect theory. We find that probability weighting may offer an explanation for respondents’ observed under investment in measures to reduce losses due to wildfire.
    Keywords: Prospect theory; Contingent valuation; Field experiment, Wildfire risk
    JEL: Q51 C93 D81
    Date: 2010–05
  3. By: Matthieu Darracq Pariès (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Alexis Loublier
    Abstract: Epstein-Zin preferences have attracted significant attention within the macro-finance literature based on DSGE models as they allow to substantially increase risk aversion, and consequently generate non-trivial risk premia, without compromising the ability of standard models to achieve satisfactory macroeconomic data coherence. Such appealing features certainly hold for structural modelling frameworks where monetary policy is set according to Taylor-type rules or seeks to minimize an ad hoc loss function under commitment. However, Epstein-Zin preferences may have significant quantitative implications for both asset pricing and macroeconomic allocation under a welfare-based monetary policy conduct. Against this background, the paper focuses on the impact of such preferences on the Ramsey approach to monetary policy within a medium-scale model based on Smets and Wouters (2007) including a wide range of nominal and real frictions that have proven to be relevant for quantitative business cycle analysis. After setting an empirical benchmark that generates a mean value of 100 bp for the ten-year term premium, we show that Epstein-Zin preferences significantly affect the macroeconomic outcome when optimal policy is considered. The level and the dynamic pattern of risk premia are also markedly altered. We show that the effect of Epstein-Zin preferences is extremely sensitive to the presence of real rigidities in the form of quasi-kinked demands. We also analyse how this effect can be linked to a combined effect of capital accumulation and wage rigidities. JEL Classification: E44, E52, E61, G12.
    Keywords: Optimal monetary policy, macroeconometric equivalence, non time-separable preferences, term premium.
    Date: 2010–06
  4. By: McNair, Ben J.; Bennett, Jeff; Hensher, David A.
    Abstract: According to neoclassical economic theory, a stated preference elicitation format comprising a single binary choice between the status quo and one alternative is incentive compatible under certain conditions. Formats typically used in choice experiments comprising a sequence of discrete choice questions do not hold this property. In this paper, the effect on stated preferences of expanding the number of binary choice tasks per respondent from one to four is tested using a split sample treatment in an attribute-based survey relating to the undergrounding of overhead electricity and telecommunications wires. We find evidence to suggest that presenting multiple choice tasks per respondent decreases estimates of expected willingness to pay. Preferences stated in the first of a sequence of choice tasks are not significantly different from those stated in the incentive compatible single binary choice task, but, in subsequent choice tasks, responses are influenced by cost levels observed in past questions. Three behavioural explanations can be advanced – weak strategic misrepresentation, reference point revision and cost-driven value learning. The evidence is contrary to the standard assumption of truthful response with stable preferences.
    Keywords: Choice experiment; willingness-to-pay; incentive compatibility; order effects; undergrounding
    JEL: L94 Q51
    Date: 2010–05
  5. By: Schneider, Andrea (Helmut Schmidt University, Hamburg); Zimmermann, Klaus W. (Helmut Schmidt University, Hamburg)
    Abstract: Based on the premise that fairness is different from equity and that it is primarily used in in-formal contexts we present an economic approach to fairness. Discussing the results of behav-ioral economics reveals the experience that people do not accept a monetary offer even if that collides with the rationale that more money means higher utility. The economic aspects of fairness are discussed in two ways: first, Varian´s idea of envy-free allocations in a general-equilibrium context are exposed briefly, and second, we concentrate on the implications of fairness defined via producer and consumer rents. This in-depth exposition focuses on private as well as public goods and concludes with a comparative analysis of fairness in the private and public spheres.
    Keywords: fairness; welfare; private goods; public goods
    JEL: D63 H41
    Date: 2010–06–07
  6. By: Zhiguang Wang (South Dakota State University Department of Economics); Scott W. Fausti (South Dakota State University Department of Economics); Bashir A. Qasmi (South Dakota State University Department of Economics)
    Abstract: We propose a fear index for corn using the variance swap rate synthesized from out-of-the-money call and put options as a measure of implied variance. Previous studies estimate implied variance based on Black (1976) model or forecast variance using the GARCH models. Our implied variance approach, based on variance swap rate, is model independent. We compute the daily 60-day variance risk premiums based on the difference between the realized variance and implied variance for the period from 1987 to 2009. We find negative and time-varying variance risk premiums in the corn market. Our results contrast with Egelkraut, Garcia, and Sherrick (2007), but are in line with the findings of Simon (2002). We conclude that our synthesized implied variance contains superior information about future realized variance relative to the implied variance estimates based on the Black (1976) model and the variance forecasted using the GARCH(1,1) model.
    Keywords: Variance Risk Premium, Variance Swap, Model-free Variance, Implied Variance, Realized Variance, Corn VIX
    JEL: Q13 Q14 G13 G14
    Date: 2010–05

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