|
on Utility Models and Prospect Theory |
| By: | André De Palma (ENS Cachan - Ecole Normale Supérieure de Cachan - École normale supérieure de Cachan - ENS Cachan, Department of Economics, Ecole Polytechnique - CNRS : UMR7176 - Polytechnique - X); Nathalie Picard (Department of Economics, Ecole Polytechnique - CNRS : UMR7176 - Polytechnique - X, THEMA - Théorie économique, modélisation et applications - CNRS : UMR8184 - Université de Cergy Pontoise); Jean-Luc Prigent (THEMA - Théorie économique, modélisation et applications - CNRS : UMR8184 - Université de Cergy Pontoise) |
| Abstract: | This paper presents a methodology to determine the preferences of an individual facing risk in the framework of (non)-expected utility theory. When individual preference satisfies a given invariance property, his utility function is solution of a functional equation associated to a specific transformation. Conversely, there exist transformations characterizing any given utility function and its invariance property. More precisely, invariance with respect to two transformations uniquely determines the individual utility function. We provide examples of such transformations for CARA or CRRA utility, but also with any other utility specification and discuss the example of DARA and IRRA specifications. |
| Keywords: | Utility theory; risk aversion, elicitation of preferences. |
| Date: | 2010–09–15 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-00517726_v1&r=upt |
| By: | Massimo Guidolin; Francesca Rinaldi |
| Abstract: | A growing body of empirical evidence suggests that investors’ behavior is not well described by the traditional paradigm of (subjective) expected utility maximization under rational expectations. A literature has arisen that models agents whose choices are consistent with models that are less restrictive than the standard subjective expected utility framework. In this paper we conduct a survey of the existing literature that has explored the implications of decision-making under ambiguity for financial market outcomes, such as portfolio choice and equilibrium asset prices. We conclude that the ambiguity literature has led to a number of significant advances in our ability to rationalize empirical features of asset returns and portfolio decisions, such as the empirical failure of the two-fund separation theorem in portfolio decisions, the modest exposure to risky securities observed for a majority of investors, the home equity preference in international portfolio diversification, the excess volatility of asset returns, the equity premium and the risk-free rate puzzles, and the occurrence of trading break-downs. |
| Keywords: | Capital assets pricing model ; Investments |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedlwp:2010-028&r=upt |
| By: | Pivato, Marcus |
| Abstract: | We develop a model of social choice over lotteries, where people's psychological characteristics are mutable, their preferences may be incomplete, and approximate interpersonal comparisons of well-being are possible. Formally, we suppose individual preferences are described by a von~Neumann-Morgenstern (vNM) preference order on a space of lotteries over psychophysical states; the social planner must construct a vNM preference order on lotteries over social states. First we consider a model when the individual vNM preference order is incomplete (so not all interpersonal comparisons are possible). Then we consider a model where the individual vNM preference order is complete, but unknown to the planner, and thus modeled by a random variable. In both cases, we obtain characterizations of a utilitarian social welfare function. |
| Keywords: | interpersonal comparisons; social welfare; social choice; utility; utilitarian; von Neumann-Morgenstern; risk |
| JEL: | D70 D63 D81 |
| Date: | 2010–09–20 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:25222&r=upt |
| By: | Klaus Nowotny (WIFO) |
| Abstract: | This paper analyzes the effect of individual risk aversion and time preference on cross-border commuting and migration intentions. Both the theoretical and empirical results show that the probability of being willing to migrate decreases with risk aversion, the rate of time preference, and the maximum number of periods an individual can work abroad. The probability of being willing to commute also decreases with risk aversion, but at a smaller rate compared to the willingness to migrate, while it is (largely) unaffected by intertemporal consumption preferences. The analysis helps to shed more light on the role of time preference and risk aversion as determinants of mobility decisions, which is especially important for integrating regions where both migration and commuting are possible, as in the enlarged European Union. |
| Date: | 2010–09–10 |
| URL: | http://d.repec.org/n?u=RePEc:wfo:wpaper:y:2010:i:379&r=upt |
| By: | Bonroy, O.; Lemarié, S.; Tropéano, J.P. |
| Abstract: | The existing literature in expert-customer relationship concludes that when: i) consumers are homogenous, ii) consumers are committed with an an expert once this one made a recommendation, and iii) the type of treatment provided is verifiable, an expert finds optimal to serve efficiently his customers. This work shows that the previous result may not occur when consumers are not risk-neutral. Our result, that holds in a monopoly setting and under Bertrand competition, suggests that risk averse consumers have more likely to be mistreated by experts. |
| Keywords: | CREDENCE GOODS;EXPERT SERVICES;RISK AVERSION |
| JEL: | D40 D82 L15 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:gbl:wpaper:201005&r=upt |
| By: | Kontek, Krzysztof |
| Abstract: | This paper presents a review of adaptation concepts at the evolutionary, environmental, neural, sensory, mental and mathematical levels, including Helson’s and Parducci’s theories of perception and category judgments. Two kinds of adaptation can be clearly distinguished. The first, known as level adaptation, refers to the shift of the neutral perception level to the average stimulus value. It results in a single reference point and stimuli changes represented in absolute terms. This concept is employed by Prospect Theory, which assumes that gains and losses are perceived as monetary amounts. The second kind of adaptation refers to the adjustment of perception sensitivity to stimuli range. It results in two reference points (minimum and maximum stimulus) and stimuli changes perceived in relative terms. Both range adaptation and range relativity are well documented phenomena and have even been confirmed by the creators of Prospect Theory. This makes room for another decision making theory based on the range relativity approach. As shown by Kontek (2009), such a theory would not require the concept of probability weighting to describe lottery experiments or behavioral paradoxes. |
| Keywords: | Adaptation-Level Theory; Range-Frequency Theory; Prospect Theory |
| JEL: | D81 C91 D87 |
| Date: | 2010–09–19 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:25169&r=upt |
| By: | Fabian Herweg |
| Abstract: | The so called flat-rate bias is a well documented phenomenon caused by consumers' desire to be insured against fluctuations in their billing amounts. This paper shows that expectation-based loss aversion provides a formal explanation for this bias. We solve for the optimal two-part tariff when contracting with loss-averse consumers who are uncertain about their demand. The optimal tariff is a flat rate if marginal cost of production is low compared to a consumer's degree of loss aversion and if there is enough variation in the consumer's demand. Moreover, if consumers differ with respect to the degree of loss aversion, firms' optimal menu of tariffs typically comprises a flat-rate contract. |
| Keywords: | Consumer Loss Aversion; Flat-Rate Tariffs; Nonlinear Pricing; Uncertain Demand |
| JEL: | D11 D43 L11 |
| Date: | 2010–07 |
| URL: | http://d.repec.org/n?u=RePEc:bon:bonedp:bgse14_2010&r=upt |
| By: | Steffen Andersen; John Fountain; Glenn W. Harrison; Arne Risa Hole; E. Elisabet Rutström |
| Abstract: | We propose a method for estimating subjective beliefs, viewed as a subjective probability distribution. The key insight is to characterize beliefs as a parameter to be estimated from observed choices in a well-defined experimental task, and to estimate that parameter as a random coefficient. The experimental task consists of a series of standard lottery choices in which the subject is assumed to use conventional risk attitudes to select one lottery or the other, and then a series of betting choices in which the subject is presented with a range of bookies offering odds on the outcome of some event that the subject has a belief over. Knowledge of the risk attitudes of subjects conditions the inferences about subjective beliefs. Maximum simulated likelihood methods are used to estimate a structural model in which subjects employ subjective beliefs to make bets. We present evidence that some subjective probabilities are indeed best characterized as probability distributions with non-zero variance. |
| Date: | 2010–09 |
| URL: | http://d.repec.org/n?u=RePEc:exc:wpaper:2010-14&r=upt |
| By: | Peter Moffatt (School of Economics, University of East Anglia) |
| Abstract: | The problem of recognising Giffen behaviour is approached from the standpoint of the Indirect Utility Function (IUF) from which the marshallian demands are easily obtained via Roy's identity. It is shown that, for the two-good situation, downward convergence of the contours of the IUF is necessary for giffenity, and suffcient if this downward convergence is strong enough, in a sense that is geometrically determined. A family of IUFs involving hyperbolic contours convex to the origin, and having this property of (locally) downward convergence is constructed. The marshallian demands are obtained, and the region of Giffen behaviour determined. For this family, such regions exist for each good, and are non-overlapping. Finally, it is shown by geometric construction that the family of Direct Utility Functions having the same pattern of hyperbolic contours also exhibits giffenity in corresponding subregions of the positive quadrant. |
| Date: | 2010–09–15 |
| URL: | http://d.repec.org/n?u=RePEc:uea:aepppr:2010_13&r=upt |
| By: | Peter Ove Christensen; Kasper Larsen |
| Abstract: | We examine a class of Brownian based models which produce tractable incomplete equilibria. The models are based on finitely many investors with heterogeneous exponential utilities over intermediate consumption who receive partially unspanned income. The investors can trade continuously on a finite time interval in a money market account as well as a risky security. Besides establishing the existence of an equilibrium, our main result shows that the resulting equilibrium can display a lower risk-free rate and a higher risk premium relative to the usual Pareto efficient equilibrium in complete markets. Consequently, our model can simultaneously help explaining the risk-free rate and equity premium puzzles. |
| Date: | 2010–09 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1009.3479&r=upt |