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on Utility Models and Prospect Theory |
| By: | Paolo Crosetto (Max Planck Institute of Economics, Jena); Antonio Filippin (University of Milan, Department of Economics, and Institute for the Study of Labor (IZA), Bonn) |
| Abstract: | This paper presents the Bomb Risk Elicitation Task (BRET), an intuitive procedure aimed at measuring risk attitudes. Subjects decide how many boxes to collect out of 100, one of which containing a bomb. Earnings increase linearly with the number of boxes accumulated but are zero if the bomb is also collected. The BRET requires minimal numeracy skills, avoids truncation of the data, allows to precisely es- timate both risk aversion and risk seeking, and is not affected by the degree of loss aversion or by violations of the Reduction Axiom. We validate the task and test its robustness in a large-scale experiment. Choices react significantly to the stakes and to the size of the choice set. Our experiment rationalizes the gender gap that often characterizes choices under uncertainty by means of a higher loss rather than risk aversion. |
| Keywords: | Risk Aversion, Loss Aversion, Elicitation method |
| JEL: | C81 C91 D81 |
| Date: | 2012–07–04 |
| URL: | http://d.repec.org/n?u=RePEc:jrp:jrpwrp:2012-035&r=upt |
| By: | Jonathan Benchimol (Economics Department - ESSEC Business School, CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon Sorbonne) |
| Abstract: | We propose a New Keynesian Dynamic Stochastic General Equilibrium (DSGE) model where a risk aversion shock enters a separable utility function. We analyze five periods, each one lasting twenty years, to follow over time the dynamics of several parameters (such as the risk aversion parameter), the Taylor rule coefficients and the role of this risk aversion shock on output and real money balances in the Eurozone. Our analysis suggests that risk aversion was a more important component of output and real money balance dynamics between 2006 and 2011 than it had been between 1971 and 2006, at least in the short run. |
| Keywords: | Risk aversion; Output; Money; Euro area; New Keynesian DSGE models; Bayesian estimation; |
| Date: | 2012–06–28 |
| URL: | http://d.repec.org/n?u=RePEc:hal:cesptp:hal-00713669&r=upt |
| By: | Alexander Ludwig (CMR, University of Cologne; Albertus-Magnus-Platz; 50923 Koln; Germany); Alexander Zimper (Department of Economics, University of Pretoria) |
| Abstract: | We combine new developments in decision theory with a standard consumption-based asset-pricing framework. In our model the efficient market hypothesis is violated if and only if agents' beliefs express ambiguity about the stochastic process driving economic fundamentals. Asset price fluctuations result because agents with ambiguous beliefs are prone to a confirmatory bias in the interpretation of new information. We demonstrate that our approach gives rise to price-patterns of "underreaction" and "overreaction" to news about dividend payments. Although these empirical phenomena have received significant attention in the behavioral finance literature, we argue that our decision-theoretic underpinning of psychological attitudes has a less ad hoc flavor than existing approaches. |
| Keywords: | Choquet Expected Utility Theory, Portfolio Choice, Asset Pricing Puzzles |
| Date: | 2012–06 |
| URL: | http://d.repec.org/n?u=RePEc:pre:wpaper:201223&r=upt |
| By: | Koijen, Ralph; Lustig, Hanno; van Nieuwerburgh, Stijn |
| Abstract: | Value stocks have higher exposure to innovations in the nominal bond risk premium than growth stocks. Since the nominal bond risk premium measures cyclical variation in the market’s assessment of future output growth, this results in a value risk premium provided that good news about future output lowers the marginal utility of wealth today. In support of this mechanism, we provide new historical evidence that low return realizations on value minus growth, typically at the start of recessions when nominal bond risk premia are low and declining, are associated with lower future dividend growth rates on value minus growth and with lower future output growth. Motivated by this connection between the time series of nominal bond returns and the cross-section of equity returns, we propose a parsimonious three-factor model that jointly prices the cross-section of returns on portfolios of stocks sorted on book-to-market dimension, the cross-section of government bonds sorted by maturity, and time series variation in expected bond returns. Finally, a structural dynamic asset pricing model with the business cycle as a central state variable is quantitatively consistent with the observed value, equity, and nominal bond risk premia. |
| Keywords: | bond risk premium; cross-section of stock returns |
| JEL: | E21 E43 G00 G12 |
| Date: | 2012–07 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9024&r=upt |
| By: | Taras Bodnar; Nestor Parolya; Wolfgang Schmid |
| Abstract: | In the paper, we consider three quadratic optimization problems which are frequently applied in portfolio theory, i.e, the Markowitz mean-variance problem as well as the problems based on the mean-variance utility function and the quadratic utility.Conditions are derived under which the solutions of these three optimization procedures coincide and are lying on the efficient frontier, the set of mean-variance optimal portfolios. It is shown that the solutions of the Markowitz optimization problem and the quadratic utility problem are not always mean-variance efficient. The conditions for the mean-variance efficiency of the solutions depend on the unknown parameters of the asset returns. We deal with the problem of parameter uncertainty in detail and derive the probabilities that the estimated solutions of the Markowitz problem and the quadratic utility problem are mean-variance efficient. Because these probabilities deviate from one the above mentioned quadratic optimization problems are not stochastically equivalent. The obtained results are illustrated by an empirical study. |
| Date: | 2012–07 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1207.1029&r=upt |
| By: | Yuriy Kitsul; Jonathan H. Wright |
| Abstract: | Recently a market in options based on CPI inflation (inflation caps and floors) has emerged in the US. This paper uses quotes on these derivatives to construct probability densities for inflation. We study how these pdfs respond to news announcements, and find that the implied odds of deflation are sensitive to certain macroeconomic news releases. We compare the option-implied probability densities with those obtained by time series methods, and use this information to construct empirical pricing kernels. The options-implied densities assign considerably more mass to extreme inflation outcomes (either deflation or high inflation) than do their time series counterparts. This yields a U-shaped empirical pricing kernel, with investors having high marginal utility in states of the world characterized by either deflation or high inflation. |
| Date: | 2012–07 |
| URL: | http://d.repec.org/n?u=RePEc:jhu:papers:600&r=upt |
| By: | Marb´an, Sebasti´an (Maastricht University) |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:ner:maastr:urn:nbn:nl:ui:27-29508&r=upt |
| By: | Taras Bodnar; Nestor Parolya; Wolfgang Schmid |
| Abstract: | In this paper we derive the exact solution of the multi-period portfolio choice problem for an exponential utility function under return predictability. It is assumed that the asset returns depend on predictable variables and that the joint random process of the asset returns and the predictable variables follow a vector autoregressive process. We prove that the optimal portfolio weights depend on the covariance matrices of the next two periods and the conditional mean vector of the next period. The case without predictable variables and the case of independent asset returns are partial cases of our solution. Furthermore, we provide an empirical study where the cumulative empirical distribution function of the investor's wealth is calculated using the exact solution. It is compared with the investment strategy obtained under the additional assumption that the asset returns are independently distributed. |
| Date: | 2012–07 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1207.1037&r=upt |