nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2011‒05‒30
nine papers chosen by
Alexander Harin
Modern University for the Humanities

  1. In search of characterization of the preference for safety under the Choquet model By Michèle Cohen; Isaac Meilijson
  2. Higher Order Risk Attitudes, Demographics, and Financial Decisions By Noussair, C.N.; Trautmann, S.T.; Kuilen, G. van de
  3. Ambiguity and the historical equity premium By Fabrice Collard; Sujoy Mukerji; Kevin Sheppard; Jean-Marc Tallon
  4. Variety Aversion and Information Overload: An Experimental Approach By Karen Kaiser
  5. Selection in asset market: the good, the bad, and the unknown By Giulio Bottazzi; Pietro Dindo
  6. Cultural Values, CEO Risk Aversion and Corporate Takeovers By Thorsten Lehnert; Bart Frijn; Aaron Gilbert; Alireza Tourani-Rad
  7. Attitudes to Risk and Roulette By Adi Schnytzer; Sara Westreich
  8. Axiomatic Foundations of Multiplier Preferences By Tomasz Strzalecki
  9. US market risk premium used in 2011 by professors, analysts and companies: A survey with 5.731 answers By Fernandez, Pablo; Aguirreamalloa, Javier; Corres, Luis

  1. By: Michèle Cohen (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris); Isaac Meilijson (School of Mathematical Sciences - Raymond and Beverly Sackler Faculty of Exact Sciences)
    Abstract: Victor prefers safety more than Ursula if whenever Ursula prefers some constant to some uncertain act, so does Victor. This paradigm, whose Expected Utility version takes the form of Arrow & Pratt's more risk averse concept, will be studied in the Choquet Uncertainty model, letting u and μ (v and ν) be Ursula's (Victor's) utility and capacity. A necessary and sufficient condition (A) on the pairs (u, μ) and (v, ν) will be presented for dichotomous weak increased uncertainty aversion, the preference by Victor of a constant over a dichotomous act whenever such is the preference of Ursula. This condition, pointwise inequality between a function defined in terms of v (u-1(⋅)) and another defined purely in terms of the capacities, preserves the flavor of the "more pessimism than greediness" characterization of monotone risk aversion by Chateauneuf, Cohen & Meilijson in the Rank-dependent Utility Model and its extension by Grant & Quiggin to the Choquet Utility Model. A sufficient condition (B) in terms of the capacities only, satisfied in particular if ν (⋅) = f (μ (⋅)) for some convex f, will be presented for more simplicity seeking, the preference by Victor over any act for some dichotomous act, that leaves Ursula indifferent. Condition A is thus a characterization of weak increased uncertainty aversion for convex f. An example will be exhibited disproving the more far reaching conjecture under which the dichotomous case implies the general case.
    Keywords: Choquet Utility, greediness, pessimism, Rank-dependent Utility, Risk aversion, uncertainty.
    Date: 2011–05
  2. By: Noussair, C.N.; Trautmann, S.T.; Kuilen, G. van de (Tilburg University, Center for Economic Research)
    Abstract: We conduct an experiment to study the prevalence of the higher order risk attitudes of prudence and temperance, in a large demographically representative sample, as well as in a sample of undergraduate students. Participants make pairwise choices between lotteries of the form proposed by Eeckhoudt and Schlesinger (2006). The choices in these lotteries isolate prudent from imprudent, and temperate from intemperate, behavior. We relate individuals’ risk aversion, prudence, and temperance levels to demographics and financial decisions. We observe that the majority of individuals’ decisions are consistent with risk aversion, prudence, and temperance, in both the student and the demographically representative sample. An individual’s level of prudence is predictive of his wealth, saving, and borrowing behavior outside of the experiment, while temperance predicts the riskiness of portfolio choices. Our findings suggest that the coefficient of relative prudence for a representative individual is approximately equal to two.
    Keywords: prudence;temperance;saving;portfolio choice;experiment
    JEL: C91 C93 D14 D81 E21
    Date: 2011
  3. By: Fabrice Collard (Department of Economics - University of Bern - University of Bern); Sujoy Mukerji (Department of Economics and University College - University of Oxford); Kevin Sheppard (Department of Economics and Oxford-Man Institute of Quantitative Finance - University of Oxford); Jean-Marc Tallon (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Panthéon-Sorbonne - Paris I, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)
    Abstract: This paper assesses the quantitative impact of ambiguity on the historically observed equity premium. We consider a Lucas-tree pure-exchange economy with a single agent where we introduce two key non-standard assumptions. First, the agent's beliefs about the dividend/consumption process is ambiguous. Second, the agent's preferences are sensitive to this ambiguity. We further extend the model to allow for uncertainty about the magnitude of the persistence of the latent state. The agent's beliefs are ambiguous due to the uncertainty about the conditional mean of the probability distribution on consumption and dividends in the next period. This results in an endogenously volatile and (counter-) cyclical equity premium. We calibrate the level of ambiguity aversion to match only the first moment of the risk-free rate in data, and ambiguity to match the uncertainty conditional on the historical growth path, and evaluate the model using moderate levels of risk aversion. We find that this simple modification of Lucas-tree model accounts for a large part of the historical equity premium, both in terms of its level and variation over time.
    Keywords: Equity premium, ambiguity.
    Date: 2011–05
  4. By: Karen Kaiser
    Abstract: This paper analyzes the effect of information overload on preference or aversion for variety. According to the model, a rational decision maker who suffers from information overload, faces a two-stage decision process, and is choosing from a set of unknown goods will find it optimal at some point to become variety averse. To test this hypothesis, an experiment is conducted, and its results, that subjects suffering from information overload use variety aversion as a strategy to deal with their cognitive limitations, are consistent with the model. Moreover, results suggest that subjects are, on the average, choosing the optimal number of goods. As the price of the goods increases, subjects become more variety averse. In addition, as they become more experienced, they prefer larger sets of goods.
    Keywords: Variety aversion, information overload, bounded rationality, decision making, laboratory experiment.
    JEL: C91 D81 D83
    Date: 2011–05
  5. By: Giulio Bottazzi; Pietro Dindo
    Abstract: We provide simple examples to illustrate how wealth-driven selection works in asset markets. Our examples deliver both good and bad news. The good news is that if individual assets demands are expressed as a fractions of wealth to be invested in each asset, e.g. because traders maximize an expected Constant Relative Risk Aversion utility with unitary coefficient, then market rewards the best informed agent. As a result asset prices eventually reflect this information and the market can be said informationally efficient. However, and this is the bad news, when asset demands are expressed as price dependent fractions, e.g. they are derived from the maximization of expected Constant Relative Risk Aversion utility with non unitary coefficients, anything can happen and the informational content of long-run prices strongly depend on the ecology of traders' preferences and beliefs. Our examples show that the key difference between the two cases lies in the local, i.e. price dependent, versus global nature of wealth-driven selection.
    Keywords: Keywords: Market Selection; Evolutionary Finance; Informational Efficiency; Asset Pricing
    JEL: D50 D80 G11 G12
    Date: 2011–05–17
  6. By: Thorsten Lehnert (Luxembourg School of Finance, University of Luxembourg); Bart Frijn (AUT University, NZ); Aaron Gilbert; Alireza Tourani-Rad
    Abstract: We explicitly examine the role of culture in corporate takeover decisions. Prior research suggests that the risk aversion of CEOs affects their takeover decisions. In this paper, we argue that managerial risk aversion at a national level is a cultural trait and affects the net synergies. CEOs of firms located in countries with higher level of risk aversion, measured by Hofstede’s (2001) uncertainty avoidance score, show less takeover activity, engage more in diversifying takeovers and require higher premiums on takeovers. Required net synergies are higher for smaller firms, relatively larger deals, and for firms that engage in more takeover activity.
    Keywords: Financial Decision Making; Risk Aversion; Synergies; Culture; Takeovers.
    JEL: D81 G34 M14
    Date: 2011
  7. By: Adi Schnytzer (Bar-Ilan University); Sara Westreich
    Abstract: We present an empirical framework for determining whether or not customers at the roulette wheel are risk averse or risk loving. Thus, we present a summary of the Aumann-Serrano (2007) risk index as generalized to allow for the presence of risk lovers by Schnytzer and Westreich (2010). We show that, for any gamble, whereas riskiness increases for gambles with positive expected return as the amount placed on a given gamble is increased, the opposite is the case for gambles with negative expected return. Since roulette involves binary gambles, we restrict our attention to such gambles exclusively and derive empirically testable hypotheses. In particular, we show that, all other things being equal, for gambles with a negative expected return, riskiness decreases as the size of the contingent payout increases. On the other hand, riskiness increases if the gamble has a positive expected return. We also prove that, for positive return gambles, riskiness increases, ceteris paribus, in the variance of the gamble while the reverse is true for gambles with negative expected returns. Finally, we apply these results to the specific gambles involved in American roulette and discuss how we might distinguish between casino visitors who are risk averse and those who are risk loving as well as those who may suffer from gambling addictions of one form or another.
    Date: 2011–03
  8. By: Tomasz Strzalecki
    Date: 2011–05–22
  9. By: Fernandez, Pablo (IESE Business School); Aguirreamalloa, Javier (IESE Business School); Corres, Luis (IESE Business School)
    Abstract: The average Market Risk Premium (MRP) used in 2011 by professors for the USA (5.7%) is higher than the one used by analysts (5.0%) and companies (5.6%). The standard deviation of the MRP used in 2011 by analysts (1.1%) is lower than the ones of companies (2.0%) and professors (1.6%). Most previous surveys have been interested in the Expected MRP, but this survey asks about the Required MRP. The paper also contains the references used to justify the MRP, comments from 58 persons that do not use MRP, and comments of 110 that do use MRP. The comments illustrate the various interpretations of the required MRP and its usefulness. Professors, analysts and companies that cite Ibbotson as their reference use MRP for USA between 2% and 14.5%, and the ones that cite Damodaran as their reference use MRP between 2% and 10.8%.
    Keywords: equity premium; required equity premium; expected equity premium; historical equity premium;
    JEL: G12 G31 M21
    Date: 2011–05–01

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