nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2011‒02‒05
nine papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Probabilistic Sophistication, Second Order Stochastic Dominance, and Uncertainty Aversion By Simone Cerreia-Vioglio; Fabio Maccheroni; Massimo Marinacci; Luigi Montrucchio
  2. Disappointment Models : an axiomatic approach By Thierry Chauveau; Nicolas Nalpas
  3. On the utility representation of asymmetric single-peaked preferences* By Francisco Martinez Mora; M. Socorro Puy
  4. Awareness-Dependent Subjective Expected Utility By Burkhard, Schipper
  5. Estimating risk attitudes in conventional and artefactual lab experiments By Drichoutis, Andreas; Koundouri, Phoebe
  6. Affective decision making: a theory of optimism bias By Anat Bracha; Donald J. Brown
  7. On the stability of the CRRA utility under high degrees of uncertainty By David Peel; Ivan Paya; Trino-Manuel Niguez; Javier Perote
  8. Collective risk aversion By Elyès Jouini; Clotilde Napp; Diego Nocetti
  9. Asset Allocation with Aversion to Parameter Uncertainty: A Minimax Regression Approach By Sessi Topkavi

  1. By: Simone Cerreia-Vioglio; Fabio Maccheroni; Massimo Marinacci; Luigi Montrucchio
    Abstract: We study the interplay of probabilistic sophistication, second order stochastic dominance, and uncertainty aversion, three fundamental notions in choice under uncertainty. In particular, our main result, Theorem 2, characterizes uncertainty averse preferences that satisfy second order stochastic dominance, as well as uncertainty averse preferences that are probabilistically sophisticated.
    Keywords: Probabilistic Sophistication; Second Order Stochastic Dominance; Uncertainty Aversion; Unambiguous Events; Subjective Expected Utility
    JEL: D81
    Date: 2010
  2. By: Thierry Chauveau (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I); Nicolas Nalpas (Toulouse Business School - ESC Toulouse)
    Abstract: In this paper, a fully choice-based theory of disappointment is developed. It encompasses, as particular cases, EU theory, Gul's theory of disappointment (1991) and the models of Loomes and Sugden (1986). According to the new theory, the risk premium of a random prospect is the sum of two premiums : a concavity premium that is nothing but the usual Arrow-Pratt premium and a second premium that may be identified to expected disappointment. The corresponding representing functional belongs to the class of lottery-dependent utility models (Becker and Sarin 1987) since disappointment is the deficit between the utility of the realized outcome and its expected value. However, unlike the lottery-dependent approach, the theory is choice-based and its axioms are experimentally testable.
    Keywords: Axiomatisation, aversion pour la déception, revenu aléatoire, prime de risque, utilité espérée.
    Date: 2010–12
  3. By: Francisco Martinez Mora; M. Socorro Puy
    Abstract: We introduce two natural types of asymmetric single-peaked preferences, which we name biased-above and biased-below, depending on whether the asymmetry (or preference-bias) favors alternatives above or below the peak. We a rich family of utility functions, the generalized distance-metric utility functions, that can represent preferences biased-above or biased-below, besides accommodating any degree of asymmetry. We also identify restrictions on differentiable utility representations that guarantee the underlying preferences to be biased-above or below, and allow to compare degrees of asymmetry. Finally, we consider a specific application -agents preferences over government size- to illustrate the role of factors such as risk aversion and tax distortions in shaping asymmetric preferences.
    Keywords: Single-peaked preferences; asymmetric preferences; quadratic preferences; risk aversion; prudence
    JEL: D72 H31 H5
    Date: 2011–01
  4. By: Burkhard, Schipper (University of California Davis)
    Abstract: We develop awareness-dependent subjective expected utility by taking unawareness structures introduced in Heifetz, Meier, and Schipper (2006, 2008, 2009) as primitives in the Anscombe-Aumann approach to subjective expected utility. We observe that a decision maker is unaware of an event if and only if her choices reveal that the event is "null" and the negation of the event is "null". Moreover, we characterize "impersonal" expected utility that is behaviorally indistinguishable from awareness-dependent subject expected utility and assigns probability zero to some subsets of states that are not necessarily events. We discuss in what sense probability zero can model unawareness.
    JEL: C70 C72 D80 D81
    Date: 2010–12
  5. By: Drichoutis, Andreas; Koundouri, Phoebe
    Abstract: We elicit and compare risk preferences from student subjects and subjects drawn from the general population, using the multiple price list method devised by Holt and and Laury (2002). We find evidence suggesting that students have lower relative risk aversion than others.
    Keywords: Risk aversion; CRRA; expo-power; multiple price list
    JEL: D81 D01 C91
    Date: 2011–01
  6. By: Anat Bracha; Donald J. Brown
    Abstract: Optimism bias is inconsistent with the independence of decision weights and payoffs found in models of choice under risk, such as expected utility theory and prospect theory. Hence, to explain the evidence suggesting that agents are optimistically biased, we propose an alternative model of risky choice, affective decision making, where decision weights—which we label affective or perceived risk—are endogenized. Affective decision making (ADM) is a strategic model of choice under risk where we posit two cognitive processes—the "rational" and the "emotional" process. The two processes interact in a simultaneous-move intrapersonal potential game, and observed choice is the result of a pure Nash equilibrium strategy in this game. We show that regular ADM potential games have an odd number of locally unique pure strategy Nash equilibria, and demonstrate this finding for ADM in insurance markets. We prove that ADM potential games are refutable by axiomatizing the ADM potential maximizers.
    Keywords: Insurance
    Date: 2010
  7. By: David Peel; Ivan Paya; Trino-Manuel Niguez; Javier Perote
    Abstract: Economic growth models under uncertainty and rational agents with CRRA utility have been shown to provide quite fragile explanations of consumers.choice as equlib- rium comsumption paths (expected utility) are drastically dependant on distributional assumptions. We show that assuming a SNP distribution for random consumption provides stability to general equilibrium models as expected utility exists for any value of the marginal rate of substitution over time.
    Keywords: Bayesian learning; Rational expectations; Semi-nonparametric distribu- tions.
    Date: 2011
  8. By: Elyès Jouini (CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - CNRS : UMR7534 - Université Paris Dauphine - Paris IX); Clotilde Napp (CREST - Centre de Recherche en Économie et Statistique - INSEE - École Nationale de la Statistique et de l'Administration Économique, DRM - Dauphine Recherches en Management - CNRS : UMR7088 - Université Paris Dauphine - Paris IX); Diego Nocetti (CIMS - Courant Institute of Mathematical Science - New York University)
    Abstract: In this paper we analyse the risk attitude of a group of heterogenous agents and we develop a theory of comparative collective risk tolerance. In particular, we characterize how shifts in the distribution of individual levels of risk tolerance affect the representative agent's degree of risk tolerance. In the model with efficient risk – sharing and two agents (e.g. a household) with isoelastic preferences we show that an increase of the level of risk tolerance of one of the agents might have an ambiguous impact on the aggregate level of risk tolerance; the latter increases for some levels of aggregate wealth while it decreases for other levels of aggregate wealth. Specifically, there are two possible shapes for aggregate risk tolerance as a function of the risk tolerance level of one of the agents: increasing curve or increasing then decreasing curve. For more general populations we characterize the effect of first order like shifts (individual levels of risk tolerance more concentrated on high values) and second order like shifts (more dispersion on individual levels of risk tolerance) on the collective level of risk tolerance. We also evaluate how shifts in the distribution of individual levels of risk tolerance impact the collective level of risk tolerance in a framework with exogenous egalitarian sharing rules. Our results permit to better characterize differences in risk taking behavior between groups and individuals and among groups with different distribution of risk preferences.
    Keywords: heterogenous agents, collective risk, risk tolerance, isoelastic preferences, aggregate wealth, risk preferences
    Date: 2010–10–05
  9. By: Sessi Topkavi
    Abstract: This paper takes a minimax regression approach to incorporate aversion to parameter uncertainty into the mean-variance model. The uncertainty-averse minimax mean-variance portfolio is obtained by minimizing with respect to the unknown weights the upper bound of the usual quadratic risk function over a fuzzy ellipsoidal set. Beyond the existing approaches, our methodology offers three main advantages: first, the resulting optimal portfolio can be interpreted as a Bayesian mean-variance portfolio with the least favorable prior density, and this result allows for a comprehensive comparison with traditional uncertainty-neutral Bayesian mean-variance portfolios. Second, the minimax mean-variance portfolio has a shrinkage expression, but its performance does not necessarily lie within those of the two reference portfolios. Third, we provide closed form expressions for the standard errors of the minimax mean-variance portfolio weights and statistical significance of the optimal portfolio weights can be easily conducted. Empirical applications show that incorporating aversion to parameter uncertainty leads to more stable optimal portfolios that outperform traditional uncertainty-neutral Bayesian mean-variance portfolios.
    Keywords: Asset allocation, estimation error, aversion to uncertainty, min-imax regression, Bayesian mean-variance portfolios, least favorable prior
    Date: 2011

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