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on Utility Models and Prospect Theory |
| By: | Sebastian Ebert |
| Abstract: | It is often said that prudence and temperance play key roles in aversion to negative skewness and kurtosis, respectively. This paper puts a new perspective on these relationships and presents a characterization of higher-order risk preferences in terms of statistical moments. An implication is, for example, that prudence implies preference for distributions with higher skewness as defined by all odd moments. Moreover, we show that this preference is robust towards variation in kurtosis as defined by all even moments. We thus speak of the kurtosis robustness feature of prudence. Further, we show that all higher-order risk preferences of odd order imply skewness preference, but for different distributions than prudence. Similar results are presented for temperance and higher-order risk preferences of even order that can be related to kurtosis aversion and have a skewness robustness feature. |
| Keywords: | decision making under risk, higher-order risk preferences, kurtosis aversion, moments, prudence, skewness preference, temperance |
| JEL: | D81 |
| Date: | 2010–09 |
| URL: | http://d.repec.org/n?u=RePEc:bon:bonedp:bgse17_2010&r=upt |
| By: | Drichoutis, Andreas; Nayga, Rodolfo |
| Abstract: | We test whether induced mood states have an effect on elicited risk and time preferences. Risk preferences between subjects in the control, positive mood, and negative mood treatments are neither economically nor statistically significant. However, we find that subjects induced into a positive mood exhibit higher discount rates and that subjects under negative mood do not differ significantly with a control group. Results also suggest that irrespective of mood state, introducing a cognitively demanding task before risk preference elicitation increases risk aversion and females are less risk averse when in all-female sessions than when in mixed-gender sessions. |
| Keywords: | discount rates; risk aversion; lab experiment; mood; affect |
| JEL: | D81 D00 C91 |
| Date: | 2010–10 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:25731&r=upt |
| By: | Richard Watt (University of Canterbury); Francisco J. Vazquez |
| Abstract: | Traditionally, downside risk aversion is the study of the placement of a pure risk (a secondary risk) on either the upside or the downside of a primary two-state risk. When the decision maker prefers to have the secondary risk placed on the upside rather than the downside of the primary lottery, he is said to display downside risk aversion. The literature on the intensity of downside risk aversion has been clear on the point that greater prudence is not equivalent to greater downside risk aversion, although the two concepts are linked. In the present paper we present a new, and we argue equally natural, concept of the downside risk aversion of a decision maker, namely the fraction of a zero mean risk that the decision maker would optimally place on the upside. We then consider how this measure can be used to identify the intensity of downside risk aversion. Specifically, we show that greater downside risk aversion in our model can be accurately measured by a relationship that is very similar to, although somewhat stronger than, greater prudence. |
| Keywords: | risk aversion; prudence; downside risk |
| JEL: | D8 |
| Date: | 2010–05–14 |
| URL: | http://d.repec.org/n?u=RePEc:cbt:econwp:10/61&r=upt |
| By: | Martin Dufwenberg (University of Arizona); Simon Gaechter (University of Nottingham); Heike Hennig-Schmidt (University of Bonn) |
| Abstract: | Psychological game theory can provide rational-choice-based framing effects; frames influence beliefs, beliefs influence motivations. We explain this theoretically and explore empirical relevance experimentally. In a 2?2 design of one-shot public good games we show that frames affect subject’s first- and second-order beliefs, and contributions. From a psychological gametheoretic framework we derive two mutually compatible hypotheses about guilt aversion and reciprocity under which contributions are related to second- and first-order beliefs, respectively. Our results are consistent with either. |
| Keywords: | framing; psychological game theory; guilt aversion; reciprocity; public good games; voluntary cooperation |
| JEL: | C91 C72 D64 Z13 |
| Date: | 2010–09 |
| URL: | http://d.repec.org/n?u=RePEc:cdx:dpaper:2010-16&r=upt |
| By: | Sergio Sousa (University of Nottingham) |
| Abstract: | Using hypothetical lottery choices to measure risk preferences, Frederick (2005) finds that higher cognitive ability is associated with less risk aversion. This paper documents, however, that when using an incentive compatible measure of risk preference, attitudes towards risk are not associated to cognitive ability as measured by Frederick’s (2005) three-item cognitive reflection test. This is a new finding that adds weight to the claim that lack of proper financial incentives can sometimes be a source of bias. In addition, we show that this lack of association between risk preferences and cognitive ability is robust to using a broader measure of cognitive ability that takes into account both verbal and non-verbal reasoning skills. Our results suggest the possibility that whether cognitive ability relates to attitudes towards risk is sensitive to instruments used to measure both of them. |
| Keywords: | cognitive ability, risk preferences, financial incentives, cognitive reflection test |
| JEL: | C91 D01 D80 D00 |
| Date: | 2010–10 |
| URL: | http://d.repec.org/n?u=RePEc:cdx:dpaper:2010-17&r=upt |
| By: | Maria De Paola (Dipartimento di Economia e Statistica, Università della Calabria) |
| Abstract: | This paper studies the relationship between risk attitudes and individual characteristics focusing on the intergenerational transmission of risk preferences. We use a data set on a sample of Italian students allowing us to build different measures of risk aversion, based respectively on a survey asking students about their willing to invest in a risky asset and about their preferences for job security and on the results of an entry test using explicit penalty points in the case of incorrect answers. Consistently with findings emerging form the existing literature, we find that risk aversion is positively related to age, being female and family income and negatively related to individual ability. As far as intergenerational transmission of preferences is concerned, from our analysis it emerges that students whose fathers are entrepreneurs have a higher propensity to take risks, while students whose fathers are employed in the public sector are more risk averse. Only fathers matter for their children risk attitudes. These results are robust to different measures of risk aversion and to different specifications of our model. |
| Keywords: | risk aversion, college choice, education. |
| JEL: | I21 Z13 J24 |
| Date: | 2010–10 |
| URL: | http://d.repec.org/n?u=RePEc:clb:wpaper:201016&r=upt |
| By: | Yann Rébillé (LEMNA - Laboratoire d'économie et de management de Nantes Atlantique - Université de Nantes : EA4272) |
| Abstract: | We consider a decision maker facing uncertainty which behaves as a subjective expected utility maximizer. The value of information is traditionnaly captured as a greater expected utility the decision maker can achieve by selecting a best strategy as information arrives. We deal with the limit process of being better informed and introduce an information density function depending soley on the states that gives an exact least upper bound to being more informed. This information density function is given by a Radon-Nikodym's type theorem for set functions and is explicitely computed for the countable case. |
| Keywords: | Decision making under uncertainty; value of information; expected utility; capacity; Radon-Nikodyn derivative |
| Date: | 2010–10–14 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-00526251_v1&r=upt |
| By: | Valeria Faralla; Francesca Benuzzi; Paolo Nichelli; Nicola Dimitri |
| Abstract: | According to recent evidence (Frederick, Loewenstein, & O’Donoghue, 2002), the traditional Discounted Utility model (Samuelson, 1937) has a limited ability to describe realistic models of behaviour and indeed there are several documented empirical regularities that seem to contradict this statement both in certainty and uncertainty conditions. This study focused on one of the best documented anomalies: sign effect or gain-loss asymmetry (Frederick et al., 2002; Loewenstein & Prelec, 1992; Read, 2004). Specifically, the study investigated the intertemporal preference for symmetric monetary rewards and punishments in certain conditions, and the no wealth effects hypothesis (Dimitri, 2007) by asking subjects to choose between two positive or two negative euro amounts available at different points in time. The experimental design applied here followed the same behavioural pattern of the neuroeconomics’ study on monetary rewards realized by McClure et al. (2004). The results confirmed a gain-loss asymmetry at least for medium and large euro amount and suggested new directions of research. |
| Keywords: | intertemporal preferences; gains; losses; certainty; sign effect . |
| JEL: | D90 D91 |
| Date: | 2010–06 |
| URL: | http://d.repec.org/n?u=RePEc:usi:labsit:029&r=upt |
| By: | Langlais, Eric |
| Abstract: | We study the characteristics of optimal levels of care and distribution of risk in a extended unilateral accident model, where 1/ parties are Rank Dependant Expected Utility maximizers, which allows us to capture two important behavioral characteristics in risk, both pessimism (probability transformation) and risk aversion; 2/ there exists an aggregate/uninsurable risk in case of accident ; 3/ tortfeasors have the opportunity to invest in damages reduction activities having a monetary cost of effort. Important results show that the optimal care is larger than under the risk neutral/small risks case, it depends on the aggregate wealth of society but does not depend on wealth distribution. We then examine whether ordinary liability rules, with or without insurance, can be used to implement the first-best outcome. |
| Keywords: | K13 |
| JEL: | K13 D02 |
| Date: | 2010–09–30 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:25710&r=upt |
| By: | Elena Vigna |
| Abstract: | We consider the portfolio selection problem in the accumulation phase of a defined contribution (DC) pension scheme. We solve the mean-variance portfolio selection problem using the embedding technique pioneered by Zhou and Li (2000) and show that it is equivalent to a target-based optimization problem, consisting in the minimization of a quadratic loss function. We support the use of the target-based approach in DC pension funds for three reasons. Firstly, it transforms the difficult problem of selecting the individual's risk aversion coefficient into the easiest task of choosing an appropriate target. Secondly, it is intuitive, flexible and adaptable to the member's needs and preferences. Thirdly, it produces final portfolios that are efficient in the mean-variance setting. We address the issue of comparison between an efficient portfolio and a portfolio that is optimal according to the more general criterion of maximization of expected utility (EU). The two natural notions of Variance Inefficiency and Mean Inefficiency are introduced, which measure the distance of an optimal inefficient portfolio from an efficient one, focusing on their variance and on their expected value, respectively. As a particular case, we investigate the quite popular classes of CARA and CRRA utility functions. In these cases, we prove the intuitive but not trivial results that the mean-variance inefficiency decreases with the risk aversion of the individual and increases with the time horizon and the Sharpe ratio of the risky asset. Numerical investigations stress the impact of the time horizon on the extent of mean-variance inefficiency of CARA and CRRA utility functions. While at instantaneous level EU-optimality and efficiency coincide (see Merton (1971)), we find that for short durations they do not differ significantly. However, for longer durations - that are typical in pension funds - the extent of inefficiency turns out to be remarkable and should be taken into account by pension fund investment managers seeking appropriate rules for portfolio selection. Indeed, this result is a further element that supports the use of the target-based approach in DC pension schemes. |
| Keywords: | Mean-variance approach; efficient frontier; expected utility maximization; defined contribution pension scheme; portfolio selection; risk aversion; Sharpe ratio |
| JEL: | C61 D81 G11 G23 |
| Date: | 2010 |
| URL: | http://d.repec.org/n?u=RePEc:cca:wpaper:154&r=upt |
| By: | Frédéric Roy-Vigneault; Daniel Rondeau; Maurice Doyon; Christian A. Vossler |
| Abstract: | This paper explores methodological issues surrounding the use of discrete choice experiments to elicit values for public goods. We develop an explicit game-theoretic model of individual decisions to a series of choice sets, providing general conditions under which surveys with repeated binary choices are incentive compatible. We complement the theory with a framed field experiment, with treatments that span the spectrum from incentive compatible, financially binding decisions to decisions with no direct financial consequences. The results suggest truthful preference revelation is possible in surveys, provided that respondents view their decisions as having more than a weak chance of influencing policy. <P>Cette étude s’intéresse à des aspects méthodologiques associés à l’utilisation d’expériences avec choix discrets pour évaluer des biens publics. Nous avons développé un modèle explicite de jeux théoriques pour des décisions individuelles à des séries de choix, avec conditions générales sous lesquelles un questionnaire avec des choix binaires répétés incite la révélation des valeurs. Ce développement théorique est suivi d’expériences terrains avec traitements qui couvrent le spectre des incitatifs de la révélation des valeurs, passant de la décision avec mise en place réelle du projet et paiements réels de la part des participants, à celle sans aucune conséquence financière directe et avec projets hypothétiques. Les résultats indiquent qu’il est possible d’obtenir une révélation des valeurs réelles en situation hypothétique, si les participants pensent que leurs décisions ont un potentiel d’impact significatif sur une éventuelle politique. |
| Keywords: | discrete choice experiment, framed field experiment, mechanism design theory, stated preferences, consequentiality , expériences avec choix discrets; expérience terrain; préférences révélées; conséquences, biais hypothétique |
| JEL: | C93 D72 D82 H41 Q51 |
| Date: | 2010–10–01 |
| URL: | http://d.repec.org/n?u=RePEc:cir:cirwor:2010s-43&r=upt |
| By: | Antonella Campana (Dept. SEGeS, University of Molise); Paola Ferretti (Dept. of Applied Mathematics and Advanced School of Economics, University Ca'Foscari of Venice) |
| Abstract: | With reference to risk adjusted premium principle, in this paper we study excess of loss reinsurance with reinstatements in the case in which the aggregate claims are generated by a discrete distribution. In particular, we focus our study on conditions ensuring feasibility of the initial premium, for example with reference to the limit on the payment of each claim. Comonotonic exchangeability shows the way forward to a more general definition of the initial premium: some properties characterizing the proposed premium are presented. |
| Keywords: | Excess of loss reinsurance; reinstatements; distortion risk measures; initial premium; exchangeability. |
| JEL: | G22 |
| Date: | 2010–10 |
| URL: | http://d.repec.org/n?u=RePEc:vnm:wpaper:203&r=upt |
| By: | Brice Corgnet; Praveen Kujal; David Porter |
| Abstract: | We report experiments that examine trader reaction to ambiguity when dividend information is revealed sequentially. We find that experienced traders are better at internalizing ambiguity than inexperienced subjects. No significant differences are observed in the ambiguity versus control treatments regarding prices, price volatility and volumes for experienced subjects. However, relative to the control, prices are higher, volatility greater and trading unsophisticated for inexperienced subjects in the ambiguity treatment. Price changes are consistent with news revelation regardless of subject experience and the degree of ambiguity. Further, we do not find under or over price reactions to news. Regardless of experience, market reaction to news moves in line with fundamentals. |
| Keywords: | Experimental asset markets, Ambiguity, Market communications, Bounded rationality |
| JEL: | C92 G12 |
| Date: | 2010–10 |
| URL: | http://d.repec.org/n?u=RePEc:cte:werepe:ws1025&r=upt |
| By: | Alberto Feduzzi; Jochen Runde; Carlo Zappia |
| Abstract: | In the insurance literature it is often argued that private markets can provide insurance against ‘risk’ but not against ‘uncertainties’ in the sense of Knight (1921) or Keynes (1921). This claim is at odds with the standard economic model of risk exchange which, in assuming that decision-makers are always guided by precise point-valued subjective probabilities, predicts that all uncertainties can, in theory, be insured. Supporters of the standard model argue that the insuring of highly idiosyncratic risks by Lloyd’s of London proves that this is so even in practice. The purpose of this paper is to show that Bruno de Finetti, widely regarded as one of the three founding fathers of the subjective approach to probability assumed by the standard model, actually made a theoretical case for uncertainty within the subjectivist approach. We draw on empirical evidence from the practice of underwriters to show how this case may help explain the reluctance of insurers to cover highly uncertain contingencies. |
| Keywords: | uncertainty, insurance, probability, de Finetti. |
| JEL: | B23 D80 G22 |
| Date: | 2010–01 |
| URL: | http://d.repec.org/n?u=RePEc:usi:depfid:0310&r=upt |
| By: | Hanming Fang (Department of Economics, University of Pennsylvania); Yang Wang (Department of Economics, Lafayette College) |
| Abstract: | We extend the semi-parametric estimation method for dynamic discrete choice models using Hotz and Miller’s (1993) conditional choice probability (CCP) approach to the setting where individuals may have hyperbolic discounting time preferences and may be naive about their time inconsistency. We illustrate the proposed estimation method with an empirical application of adult women’s decisions to undertake mammography to evaluate the importance of present bias and naivety in the under-utilization of this preventive health care. Our results show evidence for both present bias and naivety. |
| Keywords: | Time Inconsistent Preferences, Intrapersonal Games, Dynamic Discrete Choices, Preventive Care |
| JEL: | C14 I1 |
| Date: | 2010–10–04 |
| URL: | http://d.repec.org/n?u=RePEc:pen:papers:10-033&r=upt |
| By: | R\'emi Lemoy; Eric Bertin; Pablo Jensen |
| Abstract: | In statistical physics, the conservation of particle number results in the equalization of the chemical potential throughout a system at equilibrium. In contrast, the homogeneity of utility in socio-economic models is usually thought to rely on the competition between individuals, leading to Nash equilibrium. We show that both views can be reconciled by introducing a notion of chemical potential in a wide class of socio-economic models, and by relating it in a direct way to the equilibrium value of the utility. This approach also allows the dependence of utility across the system to be determined when agents take decisions in a probabilistic way. Numerical simulations of a urban economic model also suggest that our result is valid beyond the initially considered class of solvable models. |
| Date: | 2010–10 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1010.3225&r=upt |