|
on Utility Models and Prospect Theory |
| By: | Traeger, Christian P. |
| Abstract: | The paper introduces a new notion of risk aversion that is independent of the good under observation and its measure scale. The representational framework builds on a time consistent combination of additive separability on certain consumption paths and the von Neumann & Morgenstern (1944) assumptions. In the one-commodity special case, the new notion of risk aversion closely relates to a disentanglement of standard risk aversion and intertemporal substitutability. |
| Keywords: | uncertainty, expected utility, recursive utility, risk aversion, intertemporal substitutability, certainty additivity, temporal lotteries, gauge-freedom, intertemporal risk aversion |
| Date: | 2010–05–01 |
| URL: | http://d.repec.org/n?u=RePEc:cdl:agrebk:1326477&r=upt |
| By: | Traeger, Christian P. |
| Abstract: | The paper extends a dynamic version of the classical von Neumann-Morgenstern setting to incorporate a degree of con�dence in or subjectivity of probabilistic beliefs. It provides a simple axiomatic characterization of a new preference representation that addresses ambiguity from a simple perspective, employing only basic tools from risk analysis. Conceptually, the paper renders the concept of smooth ambiguity aversion more precise and extends it to a more general notion of aversion to the subjectivity of belief. The representation maintains the normatively desirable axioms of the standard setting including the von Neumann-Morgenstern axioms and time consistency. |
| Keywords: | ambiguity, subjective beliefs, expected utility, intertemporal substitutability, intertemporal risk aversion, recursive utility, uncertainty, climate change |
| Date: | 2010–05–01 |
| URL: | http://d.repec.org/n?u=RePEc:cdl:agrebk:1326487&r=upt |
| By: | Crost, Benjamin; Traeger, Christian P. |
| Abstract: | We analyze the impact of uncertainty on optimal mitigation policies derived from the integrated assessment of climate change. For this purpose, we construct a close relative of the DICE model in a recursive dynamic programming framework. First, our framework can capture persistent uncertainty and we compare it to the simpler and more frequently employed analysis of ex-ante uncertainty. Second, our framework makes it possible to disentangle effects deriving from risk, from risk aversion, and from a decision maker’s aversion to intertemporal substitution. We analyze uncertainty over climate sensitivity as well as over damages. |
| Keywords: | climate change, uncertainty, integrated assessment, risk aversion, intertemporal substitution, recursive utility, dynamic programming |
| Date: | 2010–06–01 |
| URL: | http://d.repec.org/n?u=RePEc:cdl:agrebk:1354288&r=upt |
| By: | Glenn W. Harrison; Sebastian Moritz; Richard Pibernik |
| Abstract: | We study the risk attitudes of an important segment of the economy: managers. We conduct artefactual field experiments with 130 managers from 12 industrial companies. Our analysis is particularly careful to evaluate alternative models of decision-making under risk. In general, we find that the managers in our sample are moderately risk averse. Assuming a standard EUT model they exhibit similar risk attitudes as other sample populations. However, we find some differences within our sample. Superiors exhibit a higher level of risk aversion than team members that work for them in their department. Comparing purchasing managers with a random sample of non-purchasing managers from different corporate functions such as controlling, sales, engineering and so on, we cannot conclude that they differ from each other. We show that alternative theories of risky behavior provide complementary information on the risk attitude of industrial managers. While an expected utility theory model only characterizes managers as globally risk averse, we learn from a prospect theory model that the managers in our sample are only risk averse for a certain range of payoffs. For other payoffs, they even exhibit risk-seeking behavior. The reference point that determines which outcomes are to be viewed as losses and which as gains is not that induced by the task frame. We show that subjects had implicit expectations about their earning in the experiment, and used these expectations to evaluate the lotteries presented to them. Remarkably, the managers in our sample did not weigh probabilities and they did not exhibit a hypothetical bias in their decisions. |
| Date: | 2010–09 |
| URL: | http://d.repec.org/n?u=RePEc:exc:wpaper:2010-11&r=upt |
| By: | Steffen Andersen; John Fountain; Glenn W. Harrison; E. Elisabet Rutström |
| Abstract: | Subjective probabilities play a role in many economic decisions. There is a large theoretical literature on the elicitation of subjective probabilities, and an equally large empirical literature. However, there is a gulf between the two. The theoretical literature proposes a range of procedures that can be used to recover subjective probabilities, but stresses the need to make strong auxiliary assumptions or "calibrating adjustments" to elicited reports in order to recover the latent probability. With some notable exceptions, the empirical literature seems intent on either making those strong assumptions or ignoring the need for calibration. We illustrate how the joint estimation of risk attitudes and subjective probabilities using structural maximum likelihood methods can provide the calibration adjustments that theory calls for. This allows the observer to make inferences about the latent subjective probability, calibrating for virtually any well-specified model of choice under uncertainty. We demonstrate our procedures with experiments in which we elicit subjective probabilities. We calibrate the estimates of subjective beliefs assuming that choices are made consistently with expected utility theory or rank-dependent utility theory. Inferred subjective probabilities are significantly different when calibrated according to either theory, thus showing the importance of undertaking such exercises. Our findings also have implications for the interpretation of probabilities inferred from prediction markets. |
| Date: | 2010–09 |
| URL: | http://d.repec.org/n?u=RePEc:exc:wpaper:2010-08&r=upt |
| By: | Mohamed Belhaj (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - Université de la Méditerranée - Aix-Marseille II - Université Paul Cézanne - Aix-Marseille III - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - CNRS : UMR6579); Renaud Bourlès (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - Université de la Méditerranée - Aix-Marseille II - Université Paul Cézanne - Aix-Marseille III - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - CNRS : UMR6579); Frédéric Deroïan (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - Université de la Méditerranée - Aix-Marseille II - Université Paul Cézanne - Aix-Marseille III - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - CNRS : UMR6579) |
| Abstract: | We examine how moral hazard impacts risk-sharing when risk-taking can be part of the mechanism design. In a two-agent model with binary effort, we show that moral hazard always increases risk-taking (that is the amount of wealth invested in a risky project) whereas the effect on risk-sharing (the amount of wealth transferred between agents) is ambiguous. Risk-taking therefore appears as a useful incentive tool. In particular, in the case of preferences exhibiting Constant Absolute Risk Aversion (CARA), moral hazard has no impact on risk-sharing and risk-taking is the unique mechanism used to solve moral hazard. Thus, risk-taking appears to be the prevailing incentive tool. |
| Keywords: | Risk-Taking, Informal Insurance, Moral Hazard |
| Date: | 2010–08–31 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:halshs-00512779_v1&r=upt |
| By: | Felix Schlaepfer (Socioeconomic Institute, University of Zurich); Baruch Fischhoff (Department of Social and Decision Sciences, Department of Engineering and Public Policy, Carnegie Mellon University) |
| Abstract: | Traditionally, economists make a sharp distinction between stated and revealed preferences, viewing the latter as more fully meeting the assumptions of economic analysis. Here, we consider one form of empirical evidence regarding this belief: the consistency of choices in stated and revealed preference tasks. We show that both kinds of task can produce consistent choices, suggesting that both can measure underlying preferences, if necessary conditions are met. We propose that a necessary condition is that task be either familiar to those facing it or offer contextual cues that substitute for familiarity, such as prices in competitive markets or recommendations from trusted, knowledgeable sources. We show that how well decision makers achieve such understanding is often confounded with the method that researchers use. Considering task familiarity not only clarifies some of the conflicting evidence regarding revealed and stated preference methods, but raises potentially productive questions regarding the roles of social institutions in shaping preferences. |
| Keywords: | Consistency, contingent valuation, framing, public goods, revealed preferences, stated preferences, validity |
| JEL: | D01 Q51 |
| Date: | 2010–08 |
| URL: | http://d.repec.org/n?u=RePEc:soz:wpaper:1007&r=upt |
| By: | LI DONNI, P.; |
| Abstract: | We examined the relationship between unobserved risk preferences and four insurance purchase decisions: health Medigap insurance, long-term insurance, life insurance and annuity. Standard economic theory assumes that individuals take decision over a set of risky domains according to their own risk preferences which are stable across decision contexts. This assumption of context-invariant risk preference has caused debate in the literature concerning its validity. Using data from the Health and Retirement Study, we exploit latent class analysis to identify conditional on predicted and realized risk how heterogeneity in risk preferences affects multiple insurance demand. Our results provide evidence of the existence of domain general component of risk preferences, although non-preference factors - such as context specificity - play also an important role. JEL Classi_cation Numbers G11, Keywords |
| Keywords: | Risk Preferences; Multiple Demand for Insurance; Finite Mixture Model; Long-Term Care Insurance; Medigap; Annuity; Life Insurance; |
| JEL: | D82 G22 I11 |
| Date: | 2010–07 |
| URL: | http://d.repec.org/n?u=RePEc:yor:hectdg:10/17&r=upt |
| By: | Fry, J. M. |
| Abstract: | We develop a rational expectations model of financial bubbles and study ways in which a generic risk-return interplay is incorporated into prices. We retain the interpretation of the leading Johansen-Ledoit-Sornette model, namely, that the price must rise prior to a crash in order to compensate a representative investor for the level of risk. This is accompanied, in our stochastic model, by an illusion of certainty as described by a decreasing volatility function. As the volatility function goes to zero, crashes can be seen to represent a phase transition from stochastic to deterministic behaviour in prices. |
| Keywords: | financial crashes; super-exponential growth; illusion of certainty; housing-bubble |
| JEL: | C53 C00 E37 |
| Date: | 2010–09–03 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:24778&r=upt |
| By: | Ulrich Schmidt |
| Abstract: | This note presents an experimental study of the random lottery incentive mechanism. In the baseline treatment we observe risk behavior in a given choice problem. We show that by integrating a second, asymmetrically dominated choice problem in a random incentive mechanism risk behavior can be manipulated systematically. This implies that the isolation hypothesis is violated the random incentive mechanism does not elicit true preferences |
| Keywords: | Random incentive mechanism, isolation, asymmetrically dominated alternatives |
| JEL: | C91 D81 |
| Date: | 2010–08 |
| URL: | http://d.repec.org/n?u=RePEc:kie:kieliw:1646&r=upt |