nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2012‒03‒08
seven papers chosen by
Alexander Harin
Modern University for the Humanities

  1. "The connection between distortion risk measures and ordered weighted averaging operators" By Jaume Belles-Sampera; José M. Merigó; Montserrat Guillén; Miguel Santolino
  2. Risk preferences over small stakes: Evidence from deductible choice By Janko Gorter; Paul Schilp
  3. Optimism, pessimism and financial bubbles By Bertrand Wigniolle
  4. Modeling Ambiguity in Expert Elicitation Surveys: Theory and Application to Solar Technology R&D By Stergios Athanassoglou; Valentina Bosetti
  5. Risk and Uncertainty Analysis with Networks of Decisions By Recke, Guido
  6. High-frequency market-making with inventory constraints and directional bets By Pietro Fodra; Mauricio Labadie
  7. A Three-Stage Experimental Test of Revealed Preference By Hammond, Peter; Traub, Stefan

  1. By: Jaume Belles-Sampera (Faculty of Economics, University of Barcelona); José M. Merigó (Faculty of Economics, University of Barcelona); Montserrat Guillén (Faculty of Economics, University of Barcelona); Miguel Santolino (Faculty of Economics, University of Barcelona)
    Abstract: Distortion risk measures summarize the risk of a loss distribution by means of a single value. In fuzzy systems, the Ordered Weighted Averaging (OWA) and Weighted Ordered Weighted Averaging (WOWA) operators are used to aggregate a large number of fuzzy rules into a single value. We show that these concepts can be derived from the Choquet integral, and then the mathematical relationship between distortion risk measures and the OWA and WOWA operators for discrete and nite random variables is presented. This connection oers a new interpretation of distortion risk measures and, in particular, Value-at-Risk and Tail Value-at-Risk can be understood from an aggregation operator perspective. The theoretical results are illustrated in an example and the degree of orness concept is discussed.
    Keywords: Fuzzy systems; Degree of orness; Risk quantification; Discrete random variable JEL classification:C02,C60
    Date: 2012–01
  2. By: Janko Gorter; Paul Schilp
    Abstract: This paper provides new field evidence on risk preferences over small stakes. Using unique population and survey data on deductible choice in Dutch universal health insurance, we find that risk preferences are a dominant factor in decision aking. In fact, our results indicate that risk preferences are both statistically and quantitatively more significant in explaining deductible choice behavior than risk type. This finding contrasts with classical expected utility theory, as it implies risk neutrality over small stakes. More recently developed reference-dependent utility models, however, can rationalize risk aversion over small stakes, on account of loss aversion and narrow framing.
    Keywords: consumer preferences; insurance; deductible; decision making; loss aversion
    JEL: D12 D81 G22
    Date: 2012–02
  3. By: Bertrand Wigniolle (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon Sorbonne, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)
    Abstract: This paper shows that it is possible to extend the scope of the existence of rational bubbles when uncertainty is introduced associated with rank-dependent expected utility. This RDU assumption can be viewed as a transformation of probabilities depending on the pessimism/optimism of the agent. The results show that pessimism favors the existence of deterministic bubbles, when optimism may promote the existence of stochastic bubbles. Moreover, under pessimism, the RDU assumption may generate multiple bubbly equilibria. The RDU assumption also leads to new conditions ensuring the (absence of) Pareto-optimality of the competitive equilibrium without bubbles. These conditions still govern the existence of bubbles.
    Keywords: Rational bubbles, RDU preferences.
    Date: 2012–02
  4. By: Stergios Athanassoglou (Fondazione Eni Enrico Mattei and Euro-Mediterranean Center for Climate Change); Valentina Bosetti (Fondazione Eni Enrico Mattei and Euro-Mediterranean Center for Climate Change)
    Abstract: Optimal R&D investment is defined by deep uncertainty that can only partially be addressed through historical data. Thus, expert judgments expressed as subjective probability distributions are seen as an alternative way of assessing the potential of new technologies. In this paper we propose a simple decision-theoretic framework that takes into account ambiguity over expert opinion and helps decision makers visualize the full range of R&D outcomes given a particular level of ambiguity. Our model is intuitive, captures decision makers' ambiguity attitudes, and enables simple sensitivity analysis across levels of ambiguity. We apply our framework to original data from a recent expert elicitation survey on solar technology. The analysis suggests that ambiguity plays an important role in assessing the potential of a breakthrough in solar technology given different R&D investments.
    Keywords: Ambiguity, Expert Elicitation, Convex Optimization, Solar Energy
    JEL: C61 D81
    Date: 2012–01
  5. By: Recke, Guido
    Abstract: In this paper an applied approach for analysing economic problems under risk and uncertainty based on networks of decisions (NODs) will be discussed. It can be shown that network of decision analysis can help to understand complex decision problems under risk and uncertainty in single case situations. A variety of decision criteria like expectation values and a special ANOVA can be used to get better knowledge about prediction and controllability of the decision problems.
    Keywords: networks of decisions, decision criteria, variance analysis, prediction, control, Risk and Uncertainty,
    Date: 2011–09
  6. By: Pietro Fodra (LPMA - Laboratoire de Probabilités et Modèles Aléatoires - CNRS : UMR7599 - Université Paris VI - Pierre et Marie Curie - Université Paris VII - Paris Diderot); Mauricio Labadie (Chercheur Indépendant - Aucune)
    Abstract: In this paper we extend the market-making models with inventory constraints of Avellaneda and Stoikov "High-frequency trading in a limit-order book", Quantitative Finance Vol.8 No.3 2008) and Lehalle, Gueant and Fernandez-Tapia ("Dealing with inventory risk", Preprint 2011) to the case of a rather general class mid-price processes, under either exponential or linear PnL utility functions, and with an inventory-risk-aversion parameter that penalises the marker-maker if she finishes her day with a non-zero inventory. This general, non-martingale framework allows a market-maker to make directional bets on market trends whilst keeping under control her inventory risk. In order to achieve this, the marker-maker places non-symmetric limit orders that favour market orders to hit her ask (resp. bid) quotes if she expects that prices will go up (resp. down). In the case of a mean-reverting mid-price, we show numerically that the market-maker can increase her PnL between 10% and 25% depending on her buget risk on inventory and PnL distribution (especially variance, skewness, kurtosis and VaR). Moreover, with this inventory-risk-aversion parameter the market-maker has not only direct control on her inventory risk but she also has indirect control on the moments of her PnL distribution. Therefore, this parameter can be seen as a fine-tuning of the marker-maker's risk-reward profile.
    Keywords: Quantitative Finance; high-frequency trading; market-making; limit-order book; inventory risk; optimisation; stochastic control; Hamilton-Jacobi-Bellman; PnL distribution
    Date: 2012–03–02
  7. By: Hammond, Peter (University of Warwick); Traub, Stefan (University of Bremen)
    Abstract: A powerful test of Varian's (1982) generalised axiom of revealed preference (GARP) with two goods requires the consumer's budget line to pass through two demand vectors revealed as chosen given other budget sets. In an experiment using this idea, each of 41 student subjects faced a series of 16 successive grouped portfolio selection problems. Each group of selection problems had up to three stages, where later budget sets depended on that subject's choices at earlier stages in the same group. Only 49% of subjects' choices were observed to satisfy GARP exactly, even by our relatively generous nonparametric test.
    Keywords: Rationality, revealed preference, uncertainty
    Date: 2012

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