nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2012‒05‒08
ten papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Are small groups Expected Utility? By Andrea Morone; Piergiuseppe Morone
  2. Sex Hormones and Choice under Risk By Schipper, Burkhard C.
  3. Optimal insurance design of ambiguous risks By Gollier, Christian
  4. Information asymmetry and equilibrium models in behavioral finance. By Del Vigna, Matteo
  5. Capital Asset Pricing Under Ambiguity By Yehuda Izhakian
  6. What Does it Take for a Specific Prospect Theory Type Household to Engage in Risky Investment? By Hlouskova, Jaroslava; Tsigaris, Panagiotis
  7. Envelope theorems for non-smooth and non-concave optimization By Andrew Clausen; Carlo Strub
  8. Risk aversion influence on insurance market By Raduna, Daniela Viviana; Roman, Mihai Daniel
  9. Does consultation improve decision making? By Alessia Isopi; Daniele Nosenzo; Chris Starmer
  10. Risk Attitudes and Private Business Equity By Frank M. Fossen

  1. By: Andrea Morone (Department of Economics, Universitat Jaume I; Department of Economics, University of Bari); Piergiuseppe Morone (Department of Economics, Universitat Jaume I; Department of Economics, University of Foggia)
    Abstract: In this paper we analyse the empirical performance of several preference functionals using individual and group data. Our investigation aims to address two fundamental questions that have, until now, not been addressed in literature. Specifically, we intend to assess if there exists a risky choice theory that statistically fits group decisions significantly better than alternative theories, and if there are significant differences between individual and group choices. Experimental findings reported in this paper provide answers to both questions showing that when risky choices are undertaken by small groups (dyads in our case), disappointment aversion outperforms several alternative preference functionals, including expected utility. Since expected utility typically emerged as the dominant model in individual risky choices, this finding suggests that differences between individual and group choices exist, showing that the preference aggregation process drives out EU.
    Keywords: group decision, expected utility, risk and uncertainty.
    JEL: C91 C92 D81 D70
    Date: 2012
  2. By: Schipper, Burkhard C. (University CA, Davis)
    Abstract: We correlate choice under risk in Holt-Laury lottery tasks for gains and losses with salivary testosterone, estradiol, progesterone, and cortisol, the use of hormonal contraceptives, menstrual cycle information as well as the digit ratio (2D:4D) in more than 200 subjects. Risk aversion is negatively correlated with testosterone and positively correlated with cortisol, a stress hormone, for gains only. In males, testosterone is negatively correlated with risk aversion for gains only. In females, cortisol is marginally significantly positively correlated with risk aversion for gains only. No other significant correlations between risk aversion and salivary hormones are observed. In females, testosterone and progesterone are positively correlated with reflection, i.e., risk aversion for gains and risk seeking for losses. Testosterone is negatively correlated with "consistency" of preferences in females, while estradiol is negatively correlated with "consistency" of preferences in males. No significant correlations between risk aversion and the menstrual cycle or the digit ratio are observed. Females on hormonal contraceptives are more likely to make "consistent" choices although this may be due to a selection effect. Risk aversion is positively correlated with being female for losses only. Yet, if we control for salivary hormones we are surprised to find a negative correlation between female and risk aversion for gains.
    JEL: C91 C92 D44 D81 D87
    Date: 2012–04
  3. By: Gollier, Christian
    Abstract: We examine the characteristics of the optimal insurance contract under linear transaction cost and an ambiguous distribution of losses. Under the standard expected utility model, we know from Arrow (1965) that it contains a straight deductible. In this paper, we assume that the policyholder is ambiguity-averse in the sense of Klibanoff, Marinacci and Mukerji (2005). The optimal contract depends upon the structure of the ambiguity. For example, if the set of possible priors can be ranked according to the monotone likelihood ratio order, the optimal contract contains a disappearing deductible. We also show that the policyholder’s ambiguity aversion can reduce the optimal insurance coverage.
    Keywords: Deductible, risk-sharing, ambiguity, monotone likelihood ratio order
    JEL: D81 G22
    Date: 2012–05
  4. By: Del Vigna, Matteo
    Abstract: Dans cette thèse nous abordons deux sujets récents de la finance comportementale qui concernent l’optimisation de portefeuille et l’existence d’équilibres dans les marchés financiers. On introduit d’abord des théories développées pour représenter les préférences des agents comportementals. Dans le deuxième chapitre, nous étudions l’optimisation de portefeuille en temps continue pour un agent initié qui suit la Cumulative Prospect Theory (CPT). Nous donnons une solution dans les cas d’information forte, incomplète et faible et nous faisons une comparaison avec un agent qui maximise son utilité espérée (UE). Dans le troisième chapitre, nous étudions des modèles d’équilibre statique dans un marché financier simple. Les agents ont préférences hétérogènes et ils interagissent entre eux. Nous donnons des conditions suffisantes pour l’existence dans le cas d’un agent UE influent, un agent CPT influent et un market maker complaisant. Enfin, le cas de plusieurs agents UE et CPT est considéré.
    Abstract: In this thesis we explore two recent topics in behavioral finance, namely portfolio optimization by non-expected utility insiders and existence of equilibria in financial markets populated by heterogeneous agents. Firstly, we review a number of theories which have been used to model behavioral decision makers’ preferences. In the second chapter, we set and solve a portfolio optimization problem in continuous time for an insider trader following Cumulative Prospect Theory (CPT). We provide an analysis in the strong as well as partial and weak information cases and we perform a comparison with respect to an Expected Utility (EU) decision maker. In the third chapter, we study equilibrium models in a one-period stylized financial market where agents with different preference structures can interact. We give sufficient conditions for existence when a large EU, a large CPT investor and an accommodating market maker trade. At last, the case of many EU and many CPT agents is presented.
    Keywords: Finance comportementale; délit d'initié; information faible; aversion aux pertes; agents hétérogènes; Behavioral fi nance; insider trading; weak information; Cumulative Prospect Theory; loss aversion; heterogeneous agents;
    JEL: G11 D82 D81
    Date: 2012
  5. By: Yehuda Izhakian
    Date: 2012
  6. By: Hlouskova, Jaroslava (Department of Economics and Finance, Institute for Advanced Studies, Vienna, Austria, and Department of Economics, Thompson Rivers University, Kamloops, Canada); Tsigaris, Panagiotis (Department of Economics, Thompson Rivers University, Kamloops, Canada)
    Abstract: This research note examines the conditions which will induce a prospect theory type investor, whose reference level is set by ‘playing it safe’, to invest in a risky asset. The conditions indicate that this type of investor requires a large equity premium to invest in risky assets. However, once she does invest because of a large risk premium, she becomes aggressive and buys/sells till an externally imposed upper/lower bound is reached.
    Keywords: Prospect theory, loss aversion, reference level, non-investment in risky assets
    JEL: D1 D8 G1
    Date: 2012–05
  7. By: Andrew Clausen; Carlo Strub
    Abstract: We study general dynamic programming problems with continuous and discrete choices and general constraints. The value functions may have kinks arising (1) at indifference points between discrete choices and (2) at constraint boundaries. Nevertheless, we establish a general envelope theorem: first-order conditions are necessary at interior optimal choices. We only assume differentiability of the utility function with respect to the continuous choices. The continuous choice may be from any Banach space and the discrete choice from any non-empty set.
    Keywords: Envelope theorem, differentiability, dynamic programming, discrete choice, non-smooth analysis
    JEL: C61 E20
    Date: 2012–04
  8. By: Raduna, Daniela Viviana; Roman, Mihai Daniel
    Abstract: Human behavior, rational or irrational one, influences one of the most complex markets worldwide: the insurance market. In most situations, insurance markets are not competitive and risk neutral insurers negotiate under asymmetric information with actors who exhibit risk aversion. In this paper we develop a game theory model that analyzes the negotiation of an insurance contract under risk aversion conditions (in static and dynamic approach). Risk aversion influence was introduced in the model by intermediary of a discount factor (the in equivalent to players’ patience) instead of using a utility function. The main conclusion is that the customer prefers to agree on a contract of insurance in the first stage of negotiation than having to wait for another round of negotiations, during which they could register various losses.
    Keywords: contract negotiations; model; insurance; dynamic game; risk aversion; discount factor
    JEL: C78 D81 G22 C73
    Date: 2011–11–13
  9. By: Alessia Isopi (School of Economics, University of Nottingham); Daniele Nosenzo (School of Economics, University of Nottingham); Chris Starmer (School of Economics, University of Nottingham)
    Abstract: This paper reports an experiment designed to test whether prior consultation within a group affects subsequent individual decision making in tasks where demonstrability of correct solutions is low. In our experiment subjects considered two paintings created by two different artists and were asked to guess which artist made each painting. We observed answers given by individuals under two treatments: in one, subjects were allowed the opportunity to consult with other participants before making their private decisions; in the other there was no such opportunity. Our primary findings are that subjects in the first treatment evaluate the opportunity to consult positively but they perform significantly worse and earn significantly less.
    Keywords: Consultation; Decision making; Group decisions; Individual decisions
    JEL: C91 C92 D80
    Date: 2011–07
  10. By: Frank M. Fossen
    Abstract: Why do people engage in entrepreneurship and commit large parts of their personal wealth to their business, despite comparably low returns and high risk? This paper connects several streams of literature to shed some light on this puzzle and suggests possible future research avenues. Key insights from the literature are that entrepreneurs may operate in imperfect financial markets and that entrepreneurs are less risk-averse than the rest of the population. A focus of this paper is, therefore, on the role of heterogeneous risk attitudes in entrepreneurial decisions, specifically portfolio choice and the entry and exit decisions. Nonpecuniary benefits of entrepreneurship, such as being independent in the workplace, also contribute to an explanation of entrepreneurial behavior.
    Keywords: Entrepreneurship, risk aversion, portfolio choice
    JEL: J23 G11 L26
    Date: 2012

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