nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2011‒10‒15
fifteen papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Expected Utility or Prospect Theory Maximizers? Results from a Structural Model based on Field-experiment Data By Bocqueho, Geraldine; Jacquet, Florence; Reynaud, Arnaud
  2. Eliciting Risk Preferences: A Field Experiment on a Sample of French Farmers By Bougherara, Douadia; Gassmann, Xavier; Piet, Laurent
  3. Within-subject Intra- and Inter-method consistency of two experimental risk attitude elicitation By Uwe Dulleck; Jacob Fell; Jonas Fooken
  4. Impatience, Anticipatory Feelings and Uncertainty: A Dynamic Experiment on Time Preferences By M. Casari; D. Dragone
  5. Risk Preferences and Voluntary Agri-environmental Schemes: Does Risk Aversion Explain the Uptake of the Rural Environment Protection Scheme? By Vollenweider, Xavier; Falco, Salvatore Di; O'Donoghue, Cathal
  6. The Real Exchange Rate, Real Interest Rates, and the Risk Premium By Charles Engel
  7. The Implications of Risk and Uncertainty Aversion in Public Goods Games By Veronika Nemes; Lata Gangadharan
  8. Decision-making under uncertainty and demand for insurance: An empirical study By Cristina Ottaviani; Daniela Vandone
  9. Combining risk perception and risk attitude: A comprehensive individual risk behavior model By van Winsen, Frankwin; Wauters, Erwin; Lauwers, Ludwig H.; de Mey, Yann; Van Passel, Steven; Vancauteren, Mark
  10. Idiosyncratic Risk and Higher-Order Cumulants By Lundtofte , Frederik; Wilhelmsson, Anders
  11. Integrating risk and uncertainty in PMP models By Petsakos, Athanasios; Rozakis, Stelios
  12. Long Horizons, High Risk Aversion, and Endogeneous Spreads By Paolo Guasoni; Johannes Muhle-Karbe
  13. Loss-Based Risk Measures By Rama Cont; Romain Deguest; Xuedong He
  14. Usefulness of Adaptive and Rational Expectations in Economics By Gregory C. Chow
  15. Agent Behavior under Risky and Uncertain Conditions. An Empirical Verification of Irving Fisherâs Notion of Time Preference By Balgah, Roland Azibo; Buchenrieder, Gertrud

  1. By: Bocqueho, Geraldine; Jacquet, Florence; Reynaud, Arnaud
    Abstract: We elicit risk preferences of French farmers in a field experimental setting under expected utility theory and cumulative prospect theory. We use two different estimation methods, namely the interval approach and the estimation of a random preference model. On average, farmers are risk averse and loss averse. They also exhibit an inverse S-shaped probability weighting function, meaning that they tend to overweight small probabilities and underweight high probabilities. We infer from our results that CPT explains farmersâ behaviour better than EUT in the context of our experiment. We also investigate how preferences correlate with individual socio-demographic characteristics. We find that education and agricultural innovation are negatively linked with risk aversion. Our results also show that age, education, household size and the level of secured income tend to lower farmersâ loss aversion. Finally, older farmers and farmers with large farms distort probabilities less than the others. These findings contribute to the literature which compares expected utility with competing decision theories. They also give important insights into farmersâ behaviour towards risk, which is critical for relevant public policy design.
    Keywords: risk preferences, field experiment, experimental economics, prospect theory, Risk and Uncertainty, C91, D81, J16, Q12,
    Date: 2011
  2. By: Bougherara, Douadia; Gassmann, Xavier; Piet, Laurent
    Abstract: We designed a field experiment involving real payments to elicit farmersâ risk preferences. Farmers are a very interesting sample to study since risk has always played an important role in agricultural producersâ decisions. Besides, European farmers may face more risky situations in the future. In this context, it is very important for any economic analysis focusing on agriculture to correctly assess farmersâ behaviour in the face of different sources of risk. We test for two descriptions of farmersâ behaviour: expected utility and cumulative prospect theory. We use two elicitation methods based on the procedures of Holt and Laury (2002) and Tanaka et al. (2010) on a sample of 30 French farmers. The experiment consists in asking subjects to make series of choices between two lotteries with varying probabilities and outcomes. We estimate parameters describing farmersâ risk preferences derived from structural models. We find farmers are slightly risk averse in the expected utility framework. In the cumulative prospect theory frame, we find farmers display either loss aversion or probability weighting, tending to overweight small probabilities and to underweight high probabilities. In our study, expected utility is not a good description of farmersâ behaviour towards risk.
    Keywords: Risk Attitudes, Field Experiment, Farming, Risk and Uncertainty, C93, D81, Q10,
    Date: 2011
  3. By: Uwe Dulleck (QUT); Jacob Fell (The commonwealth Grants Commission); Jonas Fooken (QUT)
    Abstract: We compare the consistency of choices in two methods to used elicit risk preferences on an aggregate as well as on an individual level. We asked subjects to choose twice from a list of nine decision between two lotteries, as introduced by Holt and Laury (2002, 2005) alternating with nine decisions using the budget approach introduced by Andreoni and Harbaugh (2009). We nd that while on an aggregate (subject pool) level the results are (roughly) consistent, on an individual (within-subject) level, behavior is far from consistent. Within each method as well as across methods we observe low correlations. This again questions the reliability of experimental risk elicitation measures and the ability to use results from such methods to control for the risk aversion of subjects when explaining effects in other experimental games.
    Keywords: risk preferences, laboratory experiment, elicitation methods, subject heterogeneity
    JEL: C91 D81
    Date: 2011–10–05
  4. By: M. Casari; D. Dragone
    Abstract: We study intertemporal choices through an experiment that elicits a subject's plan and then tracks its implementation over time. There are two main results. When facing a costly task to be completed under a deadline, two thirds of subjects prefer anticipating it rather than postponing it. Choice reversals are common although present-biased preferences alone cannot explain them. This evidence is compatible with models based on anticipatory feelings and stochastic utility.
    JEL: C91 D01 D80 D90
    Date: 2011–07
  5. By: Vollenweider, Xavier; Falco, Salvatore Di; O'Donoghue, Cathal
    Keywords: Environmental Economics and Policy, Risk and Uncertainty,
    Date: 2011
  6. By: Charles Engel (University of Wisconsin and Hong Kong Institute for Monetary Research)
    Abstract: The well-known uncovered interest parity puzzle arises from the empirical regularity that, among developed country pairs, the high interest rate country tends to have high expected returns on its short term assets. At the same time, another strand of the literature has documented that high real interest rate countries tend to have currencies that are strong in real terms - indeed, stronger than can be accounted for by the path of expected real interest differentials under uncovered interest parity. These two strands - one concerning short-run expected changes and the other concerning the level of the real exchange rate - have apparently contradictory implications for the relationship of the foreign exchange risk premium and interest-rate differentials. This paper documents the puzzle, and shows that existing models appear unable to account for both empirical findings. The features of a model that might reconcile the findings are discussed.
    Date: 2011–09
  7. By: Veronika Nemes (Centre for Energy and Environmental Markets, The University of New South Wales and Victorian Government Department of Sustainability and Environment.); Lata Gangadharan (Department of Economics, Monash University)
    Abstract: In this paper we examine how individuals behave in situations of risk and uncertainty in public and private goods context. We find that subjects are willing to pay a much higher amount to find out information relating to the probabilities of providing the private good than information relating to the public good even if this information has greater consequences for the individual in he public goods context. We find strong support for the free-rider hypothesis and extend it to cases when risk and uncertainty are present. We find that subjects treat risks and uncertainties associated with the provision of private good and public good differently.
    Date: 2011–06
  8. By: Cristina Ottaviani (Università degli Studi di Roma - La Sapienza); Daniela Vandone (University of Milan)
    Abstract: In this study we empirically estimated the role played by attitudes toward risk in insurance decision-making. To this end, we used the Iowa Gambling Task coupled with skin conductance recording, a validated experimental task of decision making under ambiguity which provides two dimensions of risk taking: the performance at the risk, as a measure of risk propensity, and the functioning of the somatic marker, as a measure of risk perception, that is the ability of the individual to “feel” the risk, independently of his/her risk attitude. The sample was made by 445 households and demographic-socio economical profiles were also obtained. Aside from confirming the role played by socio-economic explanatory variables, such as income level and marital status, on insurance purchase, results from the probit model showed the relevance of psychophysiological data: the likelihood of insurance demand is higher for people who are more risk seeking (worse performance at the task) but are adaptively able to feel the risk (anticipatory skin conductance responses to disadvantageous decks). Results are discussed in light of the need of interdisciplinary research.
    Keywords: insurance demand, decision making, ambiguity, risk taking, Iowa gambling task,
    Date: 2011–02–23
  9. By: van Winsen, Frankwin; Wauters, Erwin; Lauwers, Ludwig H.; de Mey, Yann; Van Passel, Steven; Vancauteren, Mark
    Abstract: Although risk management in farming is a well-documented subject in scientific literature, this same literature is usually used only by other scientist and is not aiding individual farmers in their management. Risk perception and risk attitude are well described determinants of risk behaviour but rarely combined in an integrated approach for risk behaviour research. Furthermore in most literature risk attitude is taken as a given stable personality trait on which the optimal behaviour should be based. We argue that risk attitude can be manageable in order to derive optimal risk behaviour. Based on these findings we develop a comprehensive theoretical basic model on farmers risk behaviour. Furthermore a participatory approach involving the stakeholder, the farmer, to build on this model is presented. This presented model has as final purpose of guiding research on establishing risk management tools applicable by farmers.
    Keywords: risk management, risk perception, risk attitude, risk behaviour, Risk and Uncertainty,
    Date: 2011–09–02
  10. By: Lundtofte , Frederik (Department of Economics, Lund University); Wilhelmsson, Anders (Department of Business Administration, Lund University)
    Abstract: We show that, when allowing for general distributions of dividend growth in a Lucas economy with multiple "trees," idiosyncratic volatility will affect expected returns in ways that are not captured by the log linear approximation. We derive an exact expression for the risk premia for general distributions. Assuming growth rates are Normal Inverse Gaussian (NIG) and fitting the distribution to the data used in Mehra and Prescott (1985), the coefficient of relative risk aversion required to match the equity premium is more than halved compared to the finding in their article.
    Keywords: diosyncratic risk; idiosyncratic volatility; risk premia; cumulants; NIG distribution
    JEL: C13 G12
    Date: 2011–09–30
  11. By: Petsakos, Athanasios; Rozakis, Stelios
    Abstract: Positive Mathematical Programming (PMP) is one of the most commonly used methods of calibrating activity linear programming (LP) models in agriculture. PMP applications published thus far focus on the estimation of a farmâs nonlinear cost or profit function and rely on the recovery of unobserved or implicit information that can explain the initial modelâs inability to calibrate. In this paper we use the PMP procedure to calibrate an expected utility model under the assumption that this implicit information can reveal a farmerâs profit expectations and risk attitude. The perfect calibration shows that PMP can be applied not only to LP models, but also to models that incorporate risk and this provides an interesting alternative to the traditional PMP methodology.
    Keywords: E-V analysis, expected utility, farm model, Positive Mathematical Programming, risk., Risk and Uncertainty,
    Date: 2011
  12. By: Paolo Guasoni; Johannes Muhle-Karbe
    Abstract: For an investor with constant absolute risk aversion and a long horizon, who trades in a market with constant investment opportunities and small proportional transaction costs, we obtain explicitly the optimal investment policy, its implied welfare, liquidity premium, and trading volume. We identify these quantities as the limits of their isoelastic counterparts for high levels of risk aversion. The results are robust with respect to finite horizons, and extend to multiple uncorrelated risky assets. In this setting, we study a Stackelberg equilibrium, led by a risk-neutral, monopolistic market maker who sets the spread as to maximize profits. The resulting endogenous spread depends on investment opportunities only, and is of the order of a few percentage points for realistic parameter values.
    Date: 2011–10
  13. By: Rama Cont (LPMA - Laboratoire de Probabilités et Modèles Aléatoires - CNRS : UMR7599 - Université Pierre et Marie Curie - Paris VI - Université Paris Diderot - Paris 7, Center for Financial Engineering, Columbia University - Columbia University); Romain Deguest (EDHEC RIsk Institute - École des hautes études commerciales du Nord (EDHEC)); Xuedong He (Center for Financial Engineering, Columbia University - Columbia University)
    Abstract: Starting from the requirement that risk measures of financial portfolios should be based on their losses, not their gains, we define the notion of loss-based risk measure and study the properties of this class of risk measures. We characterize loss-based risk measures by a representation theorem and give examples of such risk measures. We then discuss the statistical robustness of estimators of loss-based risk measures: we provide a general criterion for qualitative robustness of risk estimators and compare this criterion with sensitivity analysis of estimators based on influence functions. Finally, we provide examples of statistically robust estimators for loss-based risk measures.
    Keywords: risk measure, coherent risk measure, Fenchel-Legendre transform, Choquet capacity
    Date: 2011
  14. By: Gregory C. Chow (Princeton University)
    Abstract: This paper provides a statistical reason and strong econometric evidence for supporting the adaptive expectations hypothesis in economics. It points out why the rational expectations hypothesis was embraced by the economics profession without sufficient evidence. Finally it will summarize the conditions under which these two competing hypotheses can be used effectively.
    Keywords: macroeconomics, adaptive expectations, rational expectations
    JEL: E00
    Date: 2011–09
  15. By: Balgah, Roland Azibo; Buchenrieder, Gertrud
    Abstract: Irving Fisher's theory on time preference in the 1930s arguably influenced the analysis of agents' current behavior with respect to future outcomes. By suggesting linear discount rates implying rational and self-interested motives of agents, Fisher substantiated neoclassical economic thinking. However, Fisher's notion of time preference, the choice between present and future enjoyment that actually integrates a psychological discounting component has not received similar attention in the scholarly literature. This paper aims at closing this gap. It empirically examines agent behavior under uncertain conditions culminating from natural shocks, and differentiates the psychic from the physical component. To empirically test Fisher's notion of time preference, we analyze disaster households from the 1986 Lake Nyos natural shock in rural Cameroon. We look at differences in incomes for impatient households, who illegally moved back to the disaster area and more patient and stationary households in official resettlement camps. Results show that, contrary to Fisher's contention, wealth is positively correlated with impatience. Households in the disaster zone display higher incomes than stationary ones. This finding assumes that differences in incomes existed before the movement. The results lead us to conclude that Irving Fisher's theory is only partially relevant in explaining agent behavior under conditions of risk and uncertainty. Partiality is attributed by the finding that impatience was rather positively correlated with income, with the exception of social capital. The results lead us to conclude that Irving Fisher's theory is only partially relevant in explaining agent behavior under conditions of risk and uncertainty.
    Keywords: Risks, uncertainty, agent behavior, Fisher, time preference, Cameroon, Risk and Uncertainty,
    Date: 2011

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