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on Utility Models and Prospect Theory |
| By: | David Dillenberger (Department of Economics, University of Pennsylvania); Uzi Segal (Department of Economics, Boston College) |
| Abstract: | Machina (2009, 2012) lists a number of situations where standard models of ambiguity aversion are unable to capture plausible features of ambiguity attitudes. Most of these problems arise in choice over prospects involving three or more outcomes. We show that the recursive non-expected utility model of Segal (1987) is rich enough to accommodate all these situations. |
| Keywords: | Ambiguity, Ellsberg paradox, Choquet expected utility, recursive non-expected utility |
| JEL: | D81 |
| Date: | 2012–05–20 |
| URL: | http://d.repec.org/n?u=RePEc:pen:papers:12-021&r=upt |
| By: | Drichoutis, Andreas; Lusk, Jayson |
| Abstract: | Despite the fact that conceptual models of individual decision making under risk are deterministic, attempts to econometrically estimate risk preferences require some assumption about the stochastic nature of choice. Unfortunately, the consequences of making different assumptions are, at present, unclear. In this paper, we compare two popular error specifications (Luce vs. Fechner), with and without accounting for contextual utility, for two different conceptual models (expected utility and rank-dependent expected utility) using in- and out-of-sample selection criteria. We find drastically different inferences about structural risk preferences across the competing specifications. Overall, a mixture model combining the two conceptual models assuming Fechner error and contextual utility provides the best fit of the data both in- and out-of-sample. |
| Keywords: | error specification; expected utility theory; experiment; probability weighting; rank dependent utility; risk |
| JEL: | D81 C25 C91 |
| Date: | 2012–05–19 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:38951&r=upt |
| 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 |
| URL: | http://d.repec.org/n?u=RePEc:tse:wpaper:25815&r=upt |
| By: | T M Niguez; Ivan Paya; D Peel; J Perote |
| Abstract: | Economic growth models under uncertainty and rational agents with CRRA utility have been shown to provide quite fragile explanations of consumers.choice as equlib- rium comsumption paths (expected utility) are drastically dependant on distributional assumptions. We show that assuming a SNP distribution for random consumption provides stability to general equilibrium models as expected utility exists for any value of the marginal rate of substitution over time. |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:lan:wpaper:2451&r=upt |
| By: | Ozlem Ozdemir (Middle East Technical University, Department of Business Administration, Ankara, Turkey); Andrea Morone (Università degli Studi di Bari, Aldo Moro Dipartimento di Studi Aziendali e Giusprivatistici, Bari, Italy And Universitat Jaune I Departament d'Economia, Castellon, SpainAuthor-Name: David Skuse) |
| Abstract: | This experimental study investigates insurance decisions in low-probability, high-loss risk situations. Results indicate that subjects consider the probability of loss (loss size) when they make buying decisions (paying decisions). Most individuals are risk averse with no specific threshold probability. |
| Keywords: | Black swan, Risk, Insurance, Low probability, High loss, Experiment |
| JEL: | C91 D81 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:jau:wpaper:2012/12&r=upt |
| By: | Greco, Salvatore; Rindone , Fabio |
| Abstract: | Cumulative Prospect Theory of Tversky and Kahneman (1992) is the modern version of Prospect Theory (Kahneman and Tversky (1979)) and is nowadays considered a valid alternative to the classical Expected Utility Theory. Cumulative Prospect theory implies Gain-Loss Separability, i.e. the separate evaluation of losses and gains within a mixed gamble. Recently, some authors have questioned this assumption of the theory, proposing new paradoxes where the Gain-Loss Separability is violated. We present a generalization of Cumulative Prospect Theory which does not imply Gain-Loss Separability and is able to explain the cited paradoxes. On the other hand, the new model, which we call the bipolar Cumulative Prospect Theory, genuinely generalizes the original Prospect Theory of Kahneman and Tversky (1979), preserving the main features of the theory. We present also a characterization of the bipolar Choquet Integral with respect to a bi-capacity in a discrete setting. |
| Keywords: | Cumulative Prospect Theory; Gains-Loss Separability; bi- Weighting Function; Bipolar Choquet Integral |
| JEL: | D81 C60 |
| Date: | 2011–08 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:38957&r=upt |
| By: | Michele Berardi |
| Abstract: | Stylized facts about statistical properties for short horizon returns in financial markets have been identified in the literature, but a common cause for their manifestation has yet to be found. We show that a simple asset pricing model with representative agent and rational expectations is able to generate time series of returns that replicate such stylized facts if the risk aversion coefficient is allowed to change endogenously over time in response to unexpected excess returns. The same model, under constant risk aversion, would instead generate returns that are essentially Gaussian. We conclude that an endogenous time-varying risk aversion represents a very parsimonious way to make the model match real data on key statistical properties, and therefore deserves careful consideration from economists and practitioners alike. |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:man:cgbcrp:168&r=upt |
| By: | Ömer Özak (Southern Methodist University) |
| Abstract: | I study how boundedly rational agents can learn the solution to an infinite horizon optimal consumption problem under uncertainty and liquidity constraints. I present conditions for the existence of an optimal linear consumption rule and characterize it. Additionally, I use an empirically plausible theory of learning to generate a class of adaptive learning algorithms that converges to the optimal rule. This provides an adaptive and boundedly rational foundation to neoclassical consumption theory. |
| Keywords: | Adaptive learning models, bounded rationality, dynamic programming, consumption function, behavioral economics, liquidity constraint, Markov process |
| JEL: | C6 D8 D9 E21 |
| Date: | 2012–05 |
| URL: | http://d.repec.org/n?u=RePEc:smu:ecowpa:1204&r=upt |
| By: | Brahim Brahimi |
| Abstract: | We discuss a new notion of risk measures that preserve the property of coherence called Copula Conditional Tail Expectation (CCTE). This measure describes the expected amount of risk that can be experienced given that a potential bivariate risk exceeds a bivariate threshold value, and provides an important measure for right-tail risk. Our goal is to propose an alternative risk measure which takes into account the fluctuations of losses and possible correlations between random variables. |
| Date: | 2012–05 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1205.4345&r=upt |
| By: | Malakhov, Sergey |
| Abstract: | The paper argues that when a consumer searches for a lower price, a satisficing decision procedure equalizes marginal costs of search with its marginal benefit. The consumer can maximize the utility of his consumption-leisure choice with regard to the equality of marginal values of search. Therefore, the satisficing decision procedure results in the optimizing consumer behavior. |
| Keywords: | satisficing; optimizing;consumption; leisure; search; reserve for purchases |
| JEL: | D11 D83 |
| Date: | 2012–05–22 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:38964&r=upt |
| By: | Zeckhauser, Richard Jay; Tran, Ngoc-Khanh |
| Abstract: | Movements in asset prices are a major risk confronting individuals. This paper establishes new asset pricing results when agents differ in risk preference, time preference and/or expectations. It shows that risk tolerance is a critical concept driving savings decisions, consumption allocations, prices and return volatilities. Surprisingly, due to the equilibrium risk sharing, the precautionary savings motive in the aggregate can vastly exceed that of even the most prudent actual agent in the economy. Consequently, a low real interest rate, resulting from large aggregate savings, can prevail with reasonable risk aversions for all agents. One downside of a large aggregate savings motive is that savings rates become extremely sensitive to output fluctuation. Thus, the same mechanism that produces realistically low interest rates tends to make them unrealistically volatile. A powerful isomorphism allows differences in time preference and expectations to be swept away in the analysis, yielding an equivalent economy whose agents differ merely in risk aversion. These results hold great potential to simplify the analysis of heterogeneous-agent economies, as we demonstrate in quantifying how asset prices move and bounding their volatilities. All results are obtained in closed form for any number of agents possessing additively separable preferences in an endowment economy. |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:hrv:hksfac:5027955&r=upt |