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on Utility Models and Prospect Theory |
| By: | Nengjiu Ju; Jianjun Miao |
| Abstract: | We propose a novel generalized recursive smooth ambiguity model which permits a three-way separation among risk aversion, ambiguity aversion, and intertemporal substitution. We apply this utility model to a consumption-based asset pricing model in which consumption and dividends follow hidden Markov regime-switching processes. Our calibrated model can match the mean equity premium, the mean risk-free rate, and the volatility of the equity premium observed in the data. In addition, our model can generate a variety of dynamic asset pricing phenomena, including the procyclical variation of price-dividend ratios, the countercyclical variation of equity premia and equity volatility, the leverage e?ect, and the mean reversion of excess returns. The key intuition is that an ambiguity averse agent behaves pessimistically by attaching more weight to the pricing kernel in bad times when his continuation values are low. |
| Keywords: | Ambiguity aversion, learning, asset pricing puzzles, model uncertainty, robustness, pessimism, regime switching |
| JEL: | D81 E44 G12 |
| Date: | 2010–11 |
| URL: | http://d.repec.org/n?u=RePEc:cuf:wpaper:438&r=upt |
| By: | Nabil I. Al-Najjar; Luciano De Castro |
| Abstract: | This note questions the behavioral content of second-order acts and their use in decision theoretic models. We show that there can be no verification mechanism to determine what the decision maker receives under a second-order act. This impossibility applies even in idealized repeated experiments where infinite data can be observed. |
| Date: | 2010–12–01 |
| URL: | http://d.repec.org/n?u=RePEc:nwu:cmsems:1532&r=upt |
| By: | Alain Chateauneuf; Luciano De Castro |
| Abstract: | What is the effect of ambiguity aversion on trade? Although in a Bewley's model ambiguity aversion always lead to less trade, in other models this is not always true. However, we show that if the endowments are unambiguous then more ambiguity aversion implies less trade, for a very general class of preferences. The reduction in trade caused by ambiguity aversion can be as severe as to lead to no-trade. In an economy with MEU decision makers, we show that if the aggregate endowment is unanimously unambiguous then every Pareto optima allocation is also unambiguous. We also characterize the situation in which every unanimously unambiguous allocation is Pareto optimal. Finally, we show how our results can be used to explain the home-bias effect. As a useful result for our methods, we also obtain an additivity theorem for CEU and MEU decision makers that does not require comonotonicity JEL Code: D51, D6, D8 |
| Keywords: | no-trade results, ambiguity aversion, Pareto optimality. |
| Date: | 2011–04–01 |
| URL: | http://d.repec.org/n?u=RePEc:nwu:cmsems:1535&r=upt |
| By: | Alain Chateauneuf; Luciano I. de Castro |
| Abstract: | What is the effect of ambiguity aversion on trade? Although in a Bewley's model ambiguity aversion always lead to less trade, in other models this is not always true. However, we show that if the endowments are unambiguous then more ambiguity aversion implies less trade, for a very general class of preferences. The reduction in trade caused by ambiguity aversion can be as severe as to lead to no-trade. In an economy with MEU decision makers, we show that if the aggregate endowment is unanimously unambiguous then every Pareto optima allocation is also unambiguous. We also characterize the situation in which every unanimously unambiguous allocation is Pareto optimal. Finally, we show how our results can be used to explain the home-bias effect. As a useful result for our methods, we also obtain an additivity theorem for CEU and MEU decision makers that does not require comonotonicity. |
| JEL: | D51 D6 D8 |
| Date: | 2011–04–01 |
| URL: | http://d.repec.org/n?u=RePEc:nwu:cmsems:1526&r=upt |
| By: | Luciano De Castro; Marialaura Pesce; Nicolas Yannelis |
| Abstract: | This paper introduces new core and Walrasian equilibrium notions for an asymmetric information economy with non-expected utility preferences. We prove existence and incentive compatibility results for the new notions we introduce. |
| Date: | 2011–03–07 |
| URL: | http://d.repec.org/n?u=RePEc:nwu:cmsems:1534&r=upt |
| By: | Agostino Capponi; Martin Larsson |
| Abstract: | We develop a finite horizon continuous time market model, where risk averse investors maximize utility from terminal wealth by dynamically investing in a risk-free money market account, a stock written on a default-free dividend process, and a defaultable bond, whose prices are determined via equilibrium. We analyze financial contagion arising endogenously between the stock and the defaultable bond via the interplay between equilibrium behavior of investors, risk preferences and cyclicality properties of the default intensity. We find that the equilibrium price of the stock experiences a jump at default, despite that the default event has no causal impact on the dividend process. We characterize the direction of the jump in terms of a relation between investor preferences and the cyclicality properties of the default intensity. We conduct similar analysis for the market price of risk and for the investor wealth process, and determine how heterogeneity of preferences affects the exposure to default carried by different investors. |
| Date: | 2011–08 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1108.1133&r=upt |
| By: | Paolo Dai Pra (Department of Pure and Applied Mathematics, Università di Padova); Fulvio Fontini ("M. Fanno" Department of Economics and Management, Università di Padova); Elena Sartori (Department of Management, Università Ca' Foscari Venezia); Marco Tolotti (Department of Management, Università Ca' Foscari Venezia) |
| Abstract: | In this paper we propose a simple binary mean field game, where N agents may decide whether to trade or not a share of a risky asset in a liquid market. The asset's returns are endogenously determined taking into account demand and transaction costs. Agents' utility depends on the aggregate demand, which is determined by all agents' observed and forecasted actions. Agents are boundedly rational in the sense that they can go wrong choosing their optimal strategy. The explicit dependence on past actions generates endogenous dynamics of the system. We, firstly, study under a rather general setting (risk attitudes, pricing rules and noises) the aggregate demand for the asset, the emerging returns and the structure of the equilibria of the asymptotic game. It is shown that multiple Nash equilibria may arise. Stability conditions are characterized, in particular boom and crash cycles are detected. Then we precisely analyze properties of equilibria under significant examples, performing comparative statics exercises and showing the stabilizing property of exogenous transaction costs. |
| Keywords: | Endogenous dynamics; Nash equilibria; Bounded rationality; Transaction costs; Mean field games; Random utility |
| JEL: | D81 C62 C72 |
| Date: | 2011–08 |
| URL: | http://d.repec.org/n?u=RePEc:vnm:wpdman:7&r=upt |