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on Utility Models and Prospect Theory |
| By: | Coates, Dennis (Dept of Economics, UMBC); Humphreys, Brad (University of Alberta, Department of Economics); Zhou, Li (University of Alberta, Department of Economics) |
| Abstract: | We develop a consumer choice model of live attendance at a sporting event with reference-dependent preferences. The predictions of the model motivate the “uncertainty of outcome hypothesis” (UOH) as well as fan’s desire to see upsets and to simply see the home team win games, depending on the importance of the reference-dependent preferences and loss aversion. A critical review of previous empirical tests of the UOH reveals significant support for models with reference-dependent preferences, but less support for the UOH. New empirical evidence from Major League Baseball supports the loss aversion version of the model. |
| Keywords: | uncertainty of outcome hypothesis; attendance demand; prospect theory |
| JEL: | D12 L83 |
| Date: | 2012–04–03 |
| URL: | http://d.repec.org/n?u=RePEc:ris:albaec:2012_007&r=upt |
| By: | Mogens Fosgerau; Daniel L. McFadden; Michel Bierlaire |
| Abstract: | This paper considers discrete choice, with choice probabilities coming from maximization of preferences from a random utility field perturbed by additive location shifters (ARUM). Any ARUM can be characterized by a choice-probability generating function (CPGF) whose gradient gives the choice probabilities, and every CPGF is consistent with an ARUM. We relate CPGF to multivariate extreme value distributions, and review and extend methods for constructing CPGF for applications. |
| JEL: | C25 D11 |
| Date: | 2012–04 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:17970&r=upt |
| By: | Lucio Sarno (Faculty of Finance, Cass Business School, City University London, UK; Centre for Economic Policy Research (CEPR), UK; The Rimini Centre for Economic Analysis (RCEA), Italy); Paul Schneider (Finance Group, Warwick Business School, University of Warwick, UK); Christian Wagner (Institute for Finance, Banking and Insurance, Vienna University of Economics and Business, Austria) |
| Abstract: | We study the properties of foreign exchange risk premiums that can explain the forward bias puzzle, defined as the tendency of high-interest rate currencies to appreciate rather than depreciate. These risk premiums arise endogenously from the no-arbitrage condition relating the term structure of interest rates and exchange rates. Estimating affine (multi-currency) term structure models reveals a noticeable tradeoff between matching depreciation rates and accuracy in pricing bonds. Risk premiums implied by our global affine model generate unbiased predictions for currency excess returns and are closely related to global risk aversion, the business cycle, and traditional exchange rate fundamentals. |
| Keywords: | term structure; exchange rates; forward bias; predictability |
| JEL: | F31 E43 G10 |
| Date: | 2012–03 |
| URL: | http://d.repec.org/n?u=RePEc:rim:rimwps:10_12&r=upt |
| By: | Jan Heufer |
| Abstract: | This paper shows how revealed preference relations, observed under general budget sets, can be extended using closure operators which impose certain assumptions on preferences. Common extensions are based on the assumption that preferences are convex and/or monotonic, but we also consider satiated single-peaked preferences. For the obtained extended relations, the paper provides necessary and sufficient conditions for the existence of continuous complete extensions of the revealed preference relation. These results lead to a nonparametric analysis of revealed preference data which allows to recover all that can be said about a decision maker's preferences. The approach makes explicit what additional assumptions are imposed on the revealed preference relation. For example, Varian's (1982) "revealed preferred set" imposes monotonicity and convexity. The approach focuses strictly on what is observable. In particular, it does not assume that we observe all bundles on a budget among which the decision maker is indifferent. |
| Keywords: | Consistency of binary relations; continuous extension; decision theory; demand theory; GARP; nonparametric analysis; revealed preference |
| JEL: | C12 C14 C91 D00 |
| Date: | 2012–03 |
| URL: | http://d.repec.org/n?u=RePEc:rwi:repape:0324&r=upt |
| By: | Christina Nikitopoulos-Sklibosios (Finance Discipline Group, UTS Business School, University of Technology, Sydney; Finance Discipline Group, UTS Business School, University of Technology, Sydney) |
| Abstract: | According to the expectations hypothesis, the forward rate is equal to the expected future short rate, an argument that is not supported by most empirical studies that demonstrate the existence of term premiums. An alternative arbitrage-free term structure model for reviewing the expectations hypothesis is presented and tractable expressions for time-varying term premiums are obtained. The model is constructed under the real-world probability measure and depends on two stochastic factors: the short rate and the market price of risk. The model suggests that for short maturities the short rate contribution determines the term premiums, while for longer maturities, the contribution of the market price of risk dominates. |
| Keywords: | expectations hypothesis; time-varying term premiums; real-world probability measure; market price of risk |
| JEL: | G13 |
| Date: | 2012–03–01 |
| URL: | http://d.repec.org/n?u=RePEc:uts:rpaper:305&r=upt |
| By: | Jean-Philippe Boussemart (IESEG School of Management (LEM-CNRS) and University Lille 3); David Crainich (CNRS-LEM (UMR 8179) and IESEG School of Management); Hervé Leleu (CNRS-LEM (UMR 8179) and IESEG School of Management) |
| Abstract: | The paper addresses the decomposition of firms’ profit inefficiency (i.e. the difference between the observed profit and the maximal profit that could have been earned) in a context of output price uncertainty. More precisely, we separate this inefficiency into price expectation error, expected profit loss due to risk preference and technical inefficiency. Within this decomposition, the allocative inefficiency is explicitly defined as the result of price expectation error and risk attitude instead of being a residual (as in the traditional profit inefficiency decomposition). Our theoretical model is then implemented in a Data Envelopment Analysis framework which allows the separate estimation of each term of the decomposition. Besides, we offer an operational tool to reveal producers’ risk preferences and to measure their intensity. While the DEA approach is appealing since it imposes very few assumptions on the production set, its main drawback lies in the sensitivity of the measure to outliers. We therefore adapt our model to a robust approach. |
| Keywords: | Profit Inefficiency, Allocative Inefficiency, Technical Inefficiency, Risk Preference, Risk Aversion, Data Envelopment Analysis, Robust DEA |
| JEL: | D21 D81 |
| Date: | 2012–03 |
| URL: | http://d.repec.org/n?u=RePEc:ies:wpaper:e201204&r=upt |
| By: | Jianjun Miao (Department of Economics, Boston University); Bin Wei (Capital Markets Section, Federal Reserve Board); Hao Zhou (Capital Markets Section, Federal Reserve Board) |
| Abstract: | This paper offers an ambiguity-based interpretation of variance premium - the differ- ence between risk-neutral and objective expectations of market return variance - as a com- pounding effect of both belief distortion and variance differential regarding the uncertain economic regimes. Our approach endogenously generates variance premium without impos- ing exogenous stochastic volatility or jumps in consumption process. Such a framework can reasonably match the mean variance premium as well as the mean equity premium, equity volatility, and the mean risk-free rate in the data. We find that about 96 percent of the mean variance premium can be attributed to ambiguity aversion. Applying the model to historical consumption data, we find that variance premium mostly captures depressions, deep recessions, and financial panics, with a post war peak in 2009. |
| Keywords: | Ambiguity aversion, learning, variance premium, regime-shift, belief distortion |
| JEL: | G12 G13 D81 E44 |
| Date: | 2012–01 |
| URL: | http://d.repec.org/n?u=RePEc:bos:wpaper:wp2012-009&r=upt |
| By: | Volker Kr\"atschmer; Alexander Schied; Henryk Z\"ahle |
| Abstract: | When estimating the risk of a P&L from historical data or Monte Carlo simulation, the robustness of the estimate is important. We argue here that Hampel's classical notion of qualitative robustness is not suitable for risk measurement and we propose and analyze a refined notion of robustness that applies to tail-dependent law-invariant convex risk measures on Orlicz space. This concept of robustness captures the tradeoff between robustness and sensitivity and can be quantified by an index of qualitative robustness. By means of this index, we can compare various risk measures, such as distortion risk measures, in regard to their degree of robustness. Our analysis also yields results that are of independent interest such as continuity properties and consistency of estimators for risk measures, or a Skorohod representation theorem for {\psi}-weak convergence. |
| Date: | 2012–04 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1204.2458&r=upt |
| By: | Willemien Kets |
| Abstract: | The standard framework for analyzing games with incomplete information models players as if they form beliefs about their opponents' beliefs about their opponents' beliefs and so on, that is, as if players have an infinite depth of reasoning. This strong assumption has nontrivial implications, as is well-known. This paper therefore generalizes the type spaces of Harsanyi (1967-1968) to model that players can have a finite depth of reasoning. The innovation is that players can have a coarse perception of the higher-order beliefs of other players, thus formalizing the small-world idea of Savage (1954) in a type-space context. Unlike the case in other models of finite-order reasoning, players with a finite depth of reasoning can have nontrivial higher-order beliefs about certain events. Intuitively, some higher-order events are generated by events of lower orders, making it possible for players to reason about them, even if they have a finite depth of reasoning. |
| Date: | 2012–03–19 |
| URL: | http://d.repec.org/n?u=RePEc:nwu:cmsems:1547&r=upt |
| By: | Owens, David; Grossman , Zachary; Fackler , Ryan |
| Abstract: | We document a lower bound for thecontrol premium: agents' willingness to pay to control their own payoff. Participants choose between an asset that will pay only if they later answer a particular quiz question correctly and one that pays only if their partner answers a different question correctly. However, they first estimate the likelihood that each asset will pay off. Participants are 20% more likely to choose to control their payoff than a group of payoff-maximizers with accurate beliefs. While some of this deviation is explained by overconfidence, 34% of it can only be explained by the control premium. The average participant expresses a control premium equivalent to 8% to 15% of the expected asset-earnings. Our results show that even agents with accurate beliefs may incur costs to avoid delegating and suggest that to correctly infer beliefs from choices, one should account for the control premium. |
| Keywords: | Economics, experiment, principal-agent, overconfidence, control premium, desire for control, control, Delegation |
| Date: | 2012–03–14 |
| URL: | http://d.repec.org/n?u=RePEc:cdl:ucsbec:qt5bg845s1&r=upt |