nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2012‒09‒16
ten papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Contests between players with mean-variance preferences By Alex Robson
  2. Stereotypes and Risk Attitudes: Evidence from the Lab and the Field By Andrea Leuermann; Benjamin Roth
  3. Essential Data, Budget Sets and Rationalization By Francoise Forges; Vincent Iehlé
  4. Does Good Advice Come Cheap?: On the Assessment of Risk Preferences in the Lab and in the Field By Andrea Leuermann; Benjamin Roth
  5. Self and other regarding motives in decision making under uncertainty. By Cettolin, Elena
  6. A Long-Run Risks Explanation of Predictability Puzzles in Bond and Currency Markets By Ravi Bansal; Ivan Shaliastovich
  7. Ranking opportunity sets, indirect utility and indifferences By Tom POTTOMS; Luc LAUWERS
  8. Pairwise Mutual Knowledge and Correlated Rationalizability By Tsakas Elias
  9. Macroeconomic implications of time-varying risk premia By François Gourio
  10. Investment decision making under deep uncertainty -- application to climate change By Hallegatte, Stephane; Shah, Ankur; Lempert, Robert; Brown, Casey; Gill, Stuart

  1. By: Alex Robson
    Keywords: Contests, risk aversion, expected utility
    JEL: D72 D81 C72
    Date: 2012–07
  2. By: Andrea Leuermann; Benjamin Roth
    Abstract: Recent studies have found correlations between risk attitudes and several sociodemographic characteristics. In this paper, we deploy an artefactual field experiment and study whether subjects - non-professionals and -financial professionals - are aware of these correlations. This is largely confirmed by our results for all subject groups. We show that the subjects attach informational value to sociodemographic information when assessing others' risk attitudes. This provides external validity to the correlations found between risk preferences and sociodemographics. A person's self-assessment of risk attitudes is the most helpful device for the subjects' assessments of others, although experienced professionals make use of it to a minor extent than all other subjects.
    Keywords: Risk preferences, financial advice, artefactual field experiment, behavioral finance
    JEL: C91 D81
    Date: 2012
  3. By: Francoise Forges (LEDa - Laboratoire d'Economie de Dauphine - Université Paris IX - Paris Dauphine, CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - CNRS : UMR7534 - Université Paris IX - Paris Dauphine); Vincent Iehlé (LEDa - Laboratoire d'Economie de Dauphine - Université Paris IX - Paris Dauphine, CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - CNRS : UMR7534 - Université Paris IX - Paris Dauphine)
    Abstract: According to a minimalist version of Afriat's theorem, a consumer behaves as a utility maximizer if and only if a feasibility matrix associated with his choices is cyclically consistent. An essential experiment consists of observed consumption bundles (x_1,..., x_n) and a feasibility matrix \alpha. Starting with a standard experiment, in which the economist has access to precise budget sets, we show that the necessary and sufficient condition for the existence of a utility function rationalizing the experiment, namely, the cyclical consistency of the associated feasibility matrix, is equivalent to the existence, for any budget sets compatible with the deduced essential experiment, of a utility function rationalizing them (and typically depending on them). In other words, the conclusion of the standard rationalizability test, in which the economist takes budget sets for granted, does not depend on the full specification of the underlying budget sets but only on the essential data that these budget sets generate. Starting with an essential experiment (x_1,..., x_n; alpha) only, we show that the cyclical consistency of alpha, together with a further consistency condition involving both (x_1,..., x_n) and alpha, guarantees the existence of a budget representation and that the essential experiment is rationalizable almost robustly, in the sense that there exists a single utility function which rationalizes at once almost all budget sets which are compatible with (x_1,..., x_n; alpha). The conditions are also trivially necessary.
    Keywords: Afriat's theorem, budget sets, cyclical consistency, rational choice, revealed preference
    Date: 2012–07–05
  4. By: Andrea Leuermann; Benjamin Roth
    Abstract: Advice is important for decision making, especially in the financial sector. We investigate how individuals assess risk preferences of others given sociodemographic information or pictures. Both non-professionals and financial professionals participate in this artefactual field experiment. Subjects mainly rely on the other's self-assessment of risk preferences and on gender when forming the belief about someone else's risk preferences. On average, subjects consider themselves to be more risk-tolerant than the person they evaluate. Subjects use their own risk attitude as a reference point for predicting others' risk preferences. This false consensus effect is less pronounced for young professionals than for senior and non-professionals. Furthermore, financial professionals predict risk preferences more accurately compared to non-professionals.
    Keywords: Risk preferences, financial advice, artefactual field experiment, behavioral finance
    JEL: C91 D81
    Date: 2012
  5. By: Cettolin, Elena (Maastricht University)
    Date: 2012
  6. By: Ravi Bansal; Ivan Shaliastovich
    Abstract: We show that bond risk-premia rise with uncertainty about expected inflation and fall with uncertainty about expected growth; the magnitude of return predictability using these two uncertainty measures is similar to that by multiple yields. Motivated by this evidence, we develop and estimate a long-run risks model with time-varying volatilities of expected growth and inflation. The model simultaneously accounts for bond return predictability and violations of uncovered interest parity in currency markets. We find that preference for early resolution of uncertainty, time-varying volatilities, and non-neutral effects of inflation on growth are important to account for these aspects of asset markets.
    JEL: E0 F0 F3 F31 G0 G1
    Date: 2012–09
    Abstract: We characterize a new quasi-ordering on the collection of opportunity (or choice) sets. This new rule combines two criteria: the individual preferences on the universal set of options and the number of maximal options in the opportunity set. This new rule is compared with the indirect utility approach, and is further refined towards the leximax rule defined by Bossert, Pattanaik, and Xu (Journal of Economic Theory, 63, 1994).
    Date: 2012–09
  8. By: Tsakas Elias (METEOR)
    Abstract: We provide epistemic conditions for correlated rationalizability, which are considerably weakerthan the ones by Zambrano (2008). More specifically, we simultaneously replace mutual knowledge ofrationality and mutual knowledge of the event that every player deems possible only strategyprofiles that belong to the support of her actual conjecture, with strictly weaker epistemicconditions of pairwise mutual knowledge of these events.Moreover, we show that our epistemic foundation for correlated rationalizability does not implymutual knowledge of rationality.
    Keywords: microeconomics ;
    Date: 2012
  9. By: François Gourio (Boston University, Department of Economics, 270 Bay State Road, Boston MA 02215, USA and NBER)
    Abstract: A large empirical literature suggests that risk premia on stocks or corporate bonds are large and countercyclical. This paper studies a simple real business cycle model with a small, exogenously time-varying risk of disaster, and shows that it can replicate several important facts documented in the literature. In the model, an increase in disaster risk leads to a decline of output, investment, stock prices, and interest rates, and an increase in the expected return on risky assets. The model matches well business cycle data and asset price data, and the countercyclicality of risk premia. I present an extension of the model with endogenous choice of leverage and endogenous default, and show that the model accounts well for the level and cyclicality of credit spreads, and in particular the relation between investment and credit spreads. JEL Classification: E32, E44, G12
    Keywords: Business cycles, investment, credit spreads, risk premia, rare events
    Date: 2012–08
  10. By: Hallegatte, Stephane; Shah, Ankur; Lempert, Robert; Brown, Casey; Gill, Stuart
    Abstract: While agreeing on the choice of an optimal investment decision is already difficult for any diverse group of actors, priorities, and world views, the presence of deep uncertainties further challenges the decision-making framework by questioning the robustness of all purportedly optimal solutions. This paper summarizes the additional uncertainty that is created by climate change, and reviews the tools that are available to project climate change (including downscaling techniques) and to assess and quantify the corresponding uncertainty. Assuming that climate change and other deep uncertainties cannot be eliminated over the short term (and probably even over the longer term), it then summarizes existing decision-making methodologies that are able to deal with climate-related uncertainty, namely cost-benefit analysis under uncertainty, cost-benefit analysis with real options, robust decision making, and climate informed decision analysis. It also provides examples of applications of these methodologies, highlighting their pros and cons and their domain of applicability. The paper concludes that it is impossible to define the"best"solution or to prescribe any particular methodology in general. Instead, a menu of methodologies is required, together with some indications on which strategies are most appropriate in which contexts. This analysis is based on a set of interviews with decision-makers, in particular World Bank project leaders, and on a literature review on decision-making under uncertainty. It aims at helping decision-makers identify which method is more appropriate in a given context, as a function of the project's lifetime, cost, and vulnerability.
    Keywords: Climate Change Economics,Climate Change Mitigation and Green House Gases,Science of Climate Change,Global Environment Facility,Water Supply and Sanitation Governance and Institutions
    Date: 2012–09–01

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