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on Utility Models and Prospect Theory |
| By: | Bahaji, Hamza |
| Abstract: | This paper examines the incentives from stock options for loss-averse employees subject to probability weighting. Employing the certainty equivalence principle, I built on insights from Cumulative Prospect Theory (CPT) to derive a continuous time model to value options from the perspective of a representative employee. Consistent with a growing body of empirical and experimental studies, the model predicts that the employee may overestimate the value of his options in-excess of their risk-neutral value. This is nevertheless in stark contrast with a common finding of standard models based on the Expected Utility Theory (EUT) framework that options value to a riskaverse undiversified employee is strictly lower than the value to risk-neutral outside investors. In particular, I proved that loss aversion and probability weighting have countervailing effects on the option subjective value. In addition, for typical setting of preferences parameters around the experimental estimates, and assuming the company is allowed to adjust existing compensation when making new stock option grants, the model predicts that incentives are maximized for strike prices set around the stock price at inception. This finding is consistent with companies’ actual compensation practices that standard EUT-based models have difficulties accommodating their existence. |
| Keywords: | Stock options; Cumulative Prospect Theory; Incentives; Subjective value; |
| JEL: | J33 J44 G13 G32 M12 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:ner:dauphi:urn:hdl:123456789/8915&r=upt |
| By: | Matthew Polisson (Institute for Fiscal Studies and University of Leicester); John Quah |
| Abstract: | <p>We show that an agent maximizing some utility function on a discrete (as opposed to continuous) consumption space will obey the generalized axiom of revealed preference (GARP) so long as the agent obeys cost efficiency. Cost efficiency will hold if there is some good, outside the set of goods being studied by the modeler, that can be consumed by the agent in continuous quantities. An application of Afriat's Theorem then guarantees that there is a strictly increasing utility function on the discrete consumption space that rationalizes price and demand observations in that space.</p> |
| Date: | 2012–03 |
| URL: | http://d.repec.org/n?u=RePEc:ifs:ifsewp:12/03&r=upt |
| By: | Schurer, Stefanie; Yong, Jongsay |
| Abstract: | Fixed effects models are the gold standard in empirical well-being research, however, their applicability is limited to controlling for intercept heterogeneity and identifying effects of time-varying variables. This paper investigates the usefulness of random coefficient models in controlling for heterogeneity in well-being and the marginal utility of income, and explores whether these forms of heterogeneity depend on the Big-Five personality traits. Using unique Australian longitudinal data that have personality measures available in two time periods we show that a Mundlak-adjusted random coefficient model yields almost identical results as the fixed effects model, making it a powerful modelling alternative when interest lies in multiple forms of heterogeneity. Big-Five personality explains 10 percent of the variation in intercept heterogeneity and 6-7 percent of the variation in the marginal utility of income. For women, we suggest that the marginal utility of income is significantly linked to personality, implying important gender-differences in the expected effectiveness of financial incentives to influence behaviour. |
| Keywords: | Subjective well-being, Marginal utility of income, Heterogeneity, Personality, Random coefficient models, |
| Date: | 2012–02–24 |
| URL: | http://d.repec.org/n?u=RePEc:vuw:vuwecf:2040&r=upt |
| By: | Pollmann, Daniel (ROA, Maastricht University); Dohmen, Thomas (ROA, Maastricht University); Palm, Franz C. (Maastricht University) |
| Abstract: | We present a semiparametric method to estimate group-level dispersion, which is particularly effective in the presence of censored data. We apply this procedure to obtain measures of occupation-specific wage dispersion using top-coded administrative wage data from the German IAB Employment Sample (IABS). We then relate these robust measures of earnings risk to the risk attitudes of individuals working in these occupations. We find that willingness to take risk is positively correlated with the wage dispersion of an individual's occupation. |
| Keywords: | dispersion estimation, earnings risk, censoring, quantile regression, occupational choice, sorting, risk preferences, SOEP, IABS |
| JEL: | C14 C21 C24 J24 J31 D01 D81 |
| Date: | 2012–03 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp6447&r=upt |
| By: | Hübler, Olaf (University of Hannover) |
| Abstract: | This paper examines the question of whether risk aversion of prime-age workers is negatively correlated with human height to a statistically significant degree. A variety of estimation methods, tests and specifications yield robust results that permit one to answer this question in the affirmative. Hausman-Taylor panel estimates, however, reveal that height effects disappear if personality traits and skills, parents' behaviour, and interactions between environment and individual abilities appear simultaneously. Height is a good proxy for these influences if they are not observable. Not only one factor but a combination of several traits and interaction effects can describe the time-invariant individual effect in a panel model of risk attitude. |
| Keywords: | height, risk preference |
| JEL: | D90 J13 J24 |
| Date: | 2012–03 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp6441&r=upt |
| By: | Rachmilevitch, Shiran (Department of Economics, University of Haifa) |
| Abstract: | Bargaining theory has a conceptual dichotomy at its core: according to one view, the utilities in the bargaining problem are meaningless numbers (v-N.M utilities), while according to another view they do have concrete meaning (willingness to pay). The former position is assumed by the Nash and Kalai-Smorodinsky solutions, and the latter is assumed by the egalitarian, utilitarian, and equal-loss solutions. In this paper I describe a certain form of equivalence between the set consisting of the former solutions and the set consisting of the latter. This equivalence is the result of an attempt to bridge the gap between the aforementioned views; utilizing this equivalence, I derive a new axiomatization of the Nash solution. |
| Keywords: | Bargaining; interpersonal utility comparisons; Nash solution |
| JEL: | D63 D71 |
| Date: | 2012–02–06 |
| URL: | http://d.repec.org/n?u=RePEc:haf:huedwp:wp201201&r=upt |