nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2012‒10‒13
five papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Eliciting ambiguity aversion in unknown and in compound lotteries: A KMM experimental approach By Noemi Pace; Giuseppe Attanasi; Christian Gollier; Aldo Montesano
  2. An Alternative Explanation for the Variation in Reported Estimates of Risk Aversion By Conniffe, Denis; O'Neill, Donal
  3. Risk aversion, risk premia, and the labor margin with generalized recursive preferences By Eric T. Swanson
  4. The Expectation-Based Loss-Averse Newsvendor By Herweg, Fabian
  5. Optimal Trading Strategies in a Limit Order Market with Imperfect Liquidity By Kovaleva, P.; Iori, G.

  1. By: Noemi Pace (Department of Economics, University Of Venice Cà Foscari); Giuseppe Attanasi (University of Strasbourg); Christian Gollier (Toulouse School of Economics); Aldo Montesano (Bocconi University, Milan)
    Abstract: We define coherent-ambiguity aversion within the Klibanoff, Marinacci and Mukerji (2005) smooth ambiguity model (henceforth KMM) as the combination of choice-ambiguity aversion and value-ambiguity aversion. We analyze theoretically five ambiguous decision tasks, where a subject faces two-stage lotteries with binomial, uniform or unknown second-order probabilities. We check our theoretical predictions through a 10-task laboratory experiment. In (unambiguous) tasks 1-5, we elicit risk aversion both through a portfolio choice method and through a BDM mechanism. In (ambiguous) tasks 6-10, we elicit choice-ambiguity aversion through the portfolio choice method and value-ambiguity aversion through the BDM mechanism. We find that more than 75% of classified subjects behave according to the KMM model in all tasks 6-10, independent of their degree of risk aversion. Further, the percentage of coherently-ambiguity-averse subjects is lower in the binomial than in the uniform and in the unknown treatment, with only the latter difference being significant. Finally, highly-risk-averse subjects are more prone to coherent-ambiguity.
    Keywords: coherent-ambiguity aversion, value-ambiguity aversion, choice-ambiguity aversion, smooth ambiguity model, binomial distribution, uniform distribution, unknown urn.
    JEL: D81 D83 C91
    Date: 2012
  2. By: Conniffe, Denis (National University of Ireland, Maynooth); O'Neill, Donal (National University of Ireland, Maynooth)
    Abstract: There is a large literature estimating Arrow-Pratt coefficients of absolute and relative risk aversion. A striking feature of this literature is the very wide variation in the reported estimates of the coefficients. While there are often legitimate reasons for these differences in the estimates, there is another source of variation that has not been considered to date. The Arrow-Pratt coefficients are properties of the utility functions, but a number of estimates are obtained by equating these to risk aversion measures defined in a mean-variance framework. This paper shows that while the legitimacy of the mean-variance approach may hold under general conditions the additional assumptions invoked when estimating the risk aversion parameter hold only in very restricted circumstances and that serious under or over estimation can easily arise as a result.
    Keywords: mean-variance estimation, variability in risk aversion estimation, location scale
    JEL: C91 D81 G11
    Date: 2012–09
  3. By: Eric T. Swanson
    Abstract: A flexible labor margin allows households to absorb shocks to asset values with changes in hours worked as well as changes in consumption. This ability to absorb shocks along either or both margins greatly alters the household’s attitudes toward risk, as shown by Swanson (2012). The present paper extends that work to the case of generalized recursive preferences, as in Epstein and Zin (1989) and Weil (1989), which are increasingly being used to bring macroeconomic models into closer agreement with basic asset pricing facts. Measures of risk aversion commonly used in the literature show no stable relationship to the equity premium in a standard RBC model, while the closed-form expressions derived in this paper match the equity premium closely. Thus, measuring risk aversion correctly is crucial for understanding asset prices in the model.
    Keywords: Households - Economic aspects ; Risk assessment
    Date: 2012
  4. By: Herweg, Fabian
    Abstract: We modify the classic single-period inventory management problem by assuming that the newsvendor is expectation-based loss averse according to Koszegi and Rabin (2006, 2007). Expectation-based loss aversion leads to an endogenous psychological cost of leftovers as well as stockouts. If there are no monetary stockout costs, then the loss-averse newsvendor orders a quantity lower than the quantity ordered by a profit-maximizing newsvendor. If there are positive monetary costs associated with stockouts, then the loss-averse newsvendor places suboptimal orders, which can be either too high or too low.
    Keywords: behavioral operations management; inventory decision; loss aversion; newsvendor
    Date: 2012–10
  5. By: Kovaleva, P.; Iori, G.
    Abstract: We study the optimal execution strategy of selling a security. In a continuous time diffusion framework, a risk-averse trader faces the choice of selling the security promptly or placing a limit order and hence delaying the transaction in order to sell at a more favorable price. We introduce a random delay parameter, which defers limit order execution and characterizes market liquidity. The distribution of expected time-to-fill of limit orders conforms to the empirically observed exponential distribution of trading times, and its variance decreases with liquidity. We obtain a closed-form solution and demonstrate that the presence of the lag factor linearizes the impact of other market parameters on the optimal limit price. Finally, two more stylized facts are rationalized in our model: the equilibrium bid-ask spread decreases with liquidity, but increases with agents risk aversion.
    Keywords: order submission; execution delay; first passage time; risk aversion; liquidity traders
    Date: 2012

This nep-upt issue is ©2012 by Alexander Harin. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.