nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2011‒06‒11
nine papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Does Portfolio Optimization Pay? By Günter Franke; Ferdinand Graf
  2. Classical Subjective Expected Utility By Simone Cerreia-Vioglio; Fabio Maccheroni; Massimo Marinacci; Luigi Montrucchio
  3. Loss aversion, social comparison and physical abilities at younge age By Nakamoto, Yasuhiro; Sato, Masayuki
  4. Painful Regret and Elation at the Track By Adi Schnytzer; Barbara Luppi
  5. Social Exchange and Risk and Ambiguity Preferences By John Engle; Jim Engle-Warnick; Sonia Laszlo
  6. Industrialization and technological progress with many countries under a non-homothetic preference. By Keita, Kamei
  7. Uncovered Interest Parity and the Risk Premium By Li, Dandan; Ghoshray, Atanu; Morley, Bruce
  8. Risk Spillovers and Hedging: Why Do Firms Invest Too Much in Systemic Risk? By Willems, Bert; Morbee, J.
  9. On finite-time ruin probabilities with reinsurance cycles influenced by large claims By Mathieu Bargès; Stéphane Loisel; Xavier Venel

  1. By: Günter Franke (Department of Economics, University of Konstanz, Germany); Ferdinand Graf (Department of Economics, University of Konstanz, Germany)
    Abstract: All HARA-utility investors with the same exponent invest in a single risky fund and the risk-free asset. In a continuous time-model stock proportions are proportional to the inverse local relative risk aversion of the investor (1/γ-rule). This paper analyses the conditions under which the optimal buy and holdportfolio of a HARA-investor can be approximated by the optimal portfolio of an investor with some low level of constant relative risk aversion using the 1/γ-rule. It turns out that the approximation works very well in markets without approximate arbitrage opportunities. In markets with high equity premiums this approximation may be of low quality.
    Keywords: HARA-utility, portfolio choice, certainty equivalent, approximated choice
    JEL: G10 G11 D81
    Date: 2010–12–21
  2. By: Simone Cerreia-Vioglio; Fabio Maccheroni; Massimo Marinacci; Luigi Montrucchio
    Abstract: We consider decision makers that know that payo¤ relevant observations are generated by a process that belongs to a given class M, as postulated in Wald [33]. We incorporate this Waldean piece of objective information within an otherwise subjective setting a la Savage [30] and show that this leads to a two-stages subjective expected utility model that accounts for both state and model uncertainty.
    Date: 2011
  3. By: Nakamoto, Yasuhiro; Sato, Masayuki
    Abstract: We examine how physical abilities affect individuals' preferences. In particular, by incorporating social comparison into prospect theory, we directly estimate the degree of loss aversion from social comparison, a concept we term `ALJ' (\textit{Avoiding Loss relative to the Joneses}). Our main findings are as follows: (i) the participants who choose the physical education as the best subject exhibit a greater degree of ALJ than others; (ii) physical fitness influences the degree of ALJ; (iii) gender influences social comparison preferences; (iv) participants with a greater degree of ALJ do not respond to voluntary questionnaire; (v) the form of participants' ALJ is affected by the voluntary behavior of their parents. A comparison of ALJ with loss aversion in the original prospect theory reveals that they have different characteristics.
    Keywords: Loss aversion; Risk aversion; Social Comparison; Physical fitness; Voluntary participation
    JEL: D12 C90 C93
    Date: 2011–06–01
  4. By: Adi Schnytzer (Bar-Ilan University); Barbara Luppi (University of Modena and Reggio Emilia)
    Abstract: We present an empirical study of loss aversion in the Hong Kong horse betting market. We provide evidence of the presence of loss aversion in a context of complete absence of the favourite-longshot bias. This would suggest that, since loss aversion is a psychological bias, the favourite-longshot bias may not necessarily be caused by psychological issues and may be due, for instance, to informational asymmetry. We investigate different types of bettors and their attitude towards loss aversion. Our data set enables us to distinguish approximately among insiders, unsophisticated outsiders and sophisticated outsiders. The results show clearly that even sophisticated bettors are beset by loss aversion, while even unsophisticated outsiders display no favourite-longshot bias. Thus, our paper provides evidence that loss aversion may be an attitude innate rather than learned, regardless of the level of sophistication in designing economic behaviour or the extent of information asymmetry. Chen et al (2006) show that capuchin monkeys display biases when faced with gambles, including loss aversion, and provide evidence that loss aversion extends beyond humans. The present work supports the idea that loss aversion may be a more universal bias, arising regardless of experience and culture and demonstrates that loss aversion is displayed even by those bettors regarded in the market as “smart money”. Further, we find that more sophisticated and experienced bettors display a higher level of loss aversion. This result is consistent with the findings of Haigh and List (2005), who show that professional traders in financial markets exhibit more loss aversion than do students.
    Date: 2011–03
  5. By: John Engle; Jim Engle-Warnick; Sonia Laszlo
    Abstract: We present an experiment in which we test for the effect of participating in a social exchange exercise on revealed risk and ambiguity preferences. In our experiments, subjects make choices over lotteries that reveal their risk and ambiguity preferences. They then participate with a small group in an unstructured on-line chat. After the chat, they reconsider their choices in the risk and ambiguity instruments. In a control session, different subjects view, but do not participate in, past chats. Through a content analysis we investigate the role of chat content and chat participation on changes in revealed preferences. We compare our results to the “Discovered Preferences Hypothesis” (Plott, 1996) and “Fact-Free Learning” (Aragones, Gilboa, Postlewaite, and Schmeidler, 2005). <P>Nous présentons une expérience en laboratoire dans laquelle nous testons l'effet de participer à un exercice d'échange social sur l'aversion au risque et à l'ambiguïté. Dans notre expérience, les participants jouent à une loterie où ils révèlent leurs préférences face au risque et à l'ambiguïté. Ils participent ensuite à une discussion de groupe déstructurée dans une salle de causette. Après la discussion, les participants peuvent reconsidérer leurs choix dans les instruments de risque et d'ambiguïté. Cependant, dans une session contrôle, d'autres participants observent, sans y participer, une discussion d'une session antérieure. Une analyse de contenu nous informe sur le rôle du contenu de la discussion et de la participation elle-même sur le changement des préférences révélées. Nous comparons nos résultats aux hypothèses de « Discovered Preferences » (Plott, 1996) et de « Fact-Free Learning » (Aragones, Gilboa, Postlewaite, and Schmeidler, 2005).
    Keywords: Risk and ambiguity preference measurement instruments, experimental economics, development economics, participatory development; social learning., Instruments de mesure de la préférence vis-à-vis le risque et l'ambiguïté, économie expérimentale, développement économique, développement participatif, apprentissage social
    Date: 2011–05–01
  6. By: Keita, Kamei
    Abstract: This paper examines industrialization in each country by using a model with a continuum of countries. Our model is mainly based on Yanagawa’s (1996) model. However, unlike Yanagawa’s model, our model adopts the Stone-Geary utility function of a non-homothetic preference. The main results are as follows. First, we find that an increase in agricultural productivity leads to industrialization under the nonhomothetic preference, whereas it leads to deindustrialization under the homothetic preference. Second, the widening disparity of manufacturing productivity among countries leads to an increase in the number of agricultural countries in the world, even if it is under the non-homothetic preference.
    Keywords: Industrialization; multi-countries; Stone-Geary utility function
    JEL: O1 Q17 O14
    Date: 2011–02–10
  7. By: Li, Dandan; Ghoshray, Atanu; Morley, Bruce
    Abstract: The aim of this study is to analyze the potential risk premium inherent in the uncovered interest parity (UIP) condition. In this approach the GARCH class models, including Component GARCH are used to measure the time-varying risk premium and the results show that it is significant in most countries studied in this analysis. This suggests that risk is an important part of modeling exchange rates and needs to be considered in both empirical and theoretical models. In general, the results suggest emerging countries work better in terms of UIP and the risk premium than developed countries.
    Date: 2011
  8. By: Willems, Bert; Morbee, J. (Tilburg University, Center for Economic Research)
    Abstract: In this paper we show that free entry decisions may be socially inefficient, even in a perfectly competitive homogeneous goods market with non-lumpy investments. In our model, inefficient entry decisions are the result of risk-aversion of incumbent producers and consumers, combined with incomplete financial markets which limit risk-sharing between market actors. Investments in productive assets affect the distribution of equilibrium prices and quantities, and create risk spillovers. From a societal perspective, entrants underinvest in technologies that would reduce systemic sector risk, and may overinvest in risk-increasing technologies. The inefficiency is shown to disappear when a complete financial market of tradable risk-sharing instruments is available, although the introduction of any individual tradable instrument may actually decrease efficiency. We therefore believe that sectors without well-developed financial markets will benefit from sector-specific regulation of investment decisions.
    Keywords: investments in productive assets;hedging;systemic risk;risk spillovers
    JEL: L51 L97 H23 G11
    Date: 2011
  9. By: Mathieu Bargès (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429, Ecole d'Actuariat - Université Laval); Stéphane Loisel (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429); Xavier Venel (SAF - Laboratoire de Sciences Actuarielle et Financière - Université Claude Bernard - Lyon I : EA2429, C&O - Equipe combinatoire et optimisation - Université Pierre et Marie Curie - Paris VI - CNRS : FRE3232, IMJ - Institut de Mathématiques de Jussieu - CNRS : UMR7586 - Université Pierre et Marie Curie - Paris VI - Université Paris-Diderot - Paris VII)
    Abstract: Market cycles play a great role in reinsurance. Cycle transitions are not independent from the claim arrival process : a large claim or a high number of claims may accelerate cycle transitions. To take this into account, a semi-Markovian risk model is proposed and analyzed. A refined Erlangization method is developed to compute the finite-time ruin probability of a reinsurance company. As this model needs the claim amounts to be Phase-type distributed, we explain how to fit mixtures of Erlang distributions to long-tailed distributions. Numerical applications and comparisons to results obtained from simulation methods are given. The impact of dependency between claim amounts and phase changes is studied.
    Date: 2011

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