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on Utility Models and Prospect Theory |
| By: | Thierry Chauveau (Centre d'Economie de la Sorbonne) |
| Abstract: | If an investor does care for utilities –and not for monetary outcomes– stochastic dominances should be expresed in terms of utility units ("utils"). If so, any "rational" investor may be characterized by an elementary function u(.) which is such that the random variables u (w) –where w is a random prospect– never violate the second-order stochastic dominance property and that the partial weak order induced by stochastic dominance over utils is as "close" to the weak order of preferences as possible. Similarly "subjective" risk must be substituted for "objective" risk à la Rothschild and Stiglitz (1970). A weakened independence axiom may then be set over comparable prospects, i.e. those which exhibit the same expected utility. This leads to a fully choice-based theory of disappointment. The functional is lottery-dependent (Becker and Sarin 1987). When constant marginal utility is assumed, it is but the opposite to a convex measure of risk (Föllmer and Shied 2002). It may be viewed as a theoretical justification for choosing this measure of risk. |
| Keywords: | Disappointment, risk-aversion, subjective risk, risk premium, expected utility. |
| JEL: | D81 |
| Date: | 2012–10 |
| URL: | http://d.repec.org/n?u=RePEc:mse:cesdoc:12063&r=upt |
| By: | Ani Guerdijkova (THEMA, Université de Cergy-Pontoise); Emanuela Sciubba (Department of Economics, Mathematics & Statistics, Birkbeck) |
| Abstract: | We analyze a market populated by expected utility maximizers and smooth ambiguity-averse consumers. We study conditions under which ambiguity-averse consumers survive and affect prices in the limit. If ambiguity vanishes with time or if the economy exhibits no aggregate risk, ambiguity-averse consumers survive, but have no long-run impact on prices. In both scenarios, ambiguity-averse consumers are fully insured against ambiguity in equilibrium and, thus, behave as expected utility maximizers with correct beliefs. If ambiguity-averse consumers are not fully insured against ambiguity, they behave as expected utility maximizers with effectively wrong beliefs and an effective discount factor which might be higher or lower than their actual discount factor. Using this insight, we demonstrate that consumers with constant absolute ambiguity aversion vanish in expectations, whenever the economy faces aggregate risk. In contrast, consumers with constant relative (and thus, decreasing absolute) ambiguity aversion survive in expectation and with positive probability and have a non-trivial impact on prices in the limit. |
| Keywords: | ambiguity, ambiguity-aversion, survival |
| JEL: | D50 D81 |
| Date: | 2012–10 |
| URL: | http://d.repec.org/n?u=RePEc:bbk:bbkefp:1216&r=upt |
| By: | Ávalos, Eloy |
| Abstract: | In this paper we develop the theory of uncertainty in a context where the risks assumed by the individual are measurable and manageable. We primarily use the definition of lottery to formulate the axioms of the individual's preferences, and its representation through the utility function von Neumann - Morgenstern. We study the expected utility theorem and its properties, the paradoxes of choice under uncertainty and finally the measures of risk aversion with monetary lotteries. |
| Keywords: | Incertidumbr; riesgo; lotería simple; lotería compuesta; utilidad esperada; paradoja de San Petersburgo; paradoja de Allais; paradoja de Ellsberg; prima de riesgo; aversión al riesgo |
| JEL: | D81 D80 |
| Date: | 2011–05–29 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:42339&r=upt |
| By: | Fairley, Kim; Sanfey, Alan; Vyrastekova, Jana; Weitzel, Utz |
| Abstract: | Despite intensive research there is no clear evidence for a link between lottery risk preferences and risk involved in trusting others. We argue that this is partially due to a misalignment of the underlying sources of risk. Trusting is giving up control to a human source of risk while lottery risk has a mechanistic source. We propose a risky trust game that experimentally elicits social risk preferences that pertain to the same underlying human source. Our results show that transfers in the classic trust game are indeed best explained by social risk preferences and not by lottery risk preferences with an underlying mechanistic source. In addition, we argue that the type of uncertainty also plays a role. In the absence of objectively known probabilities of trustworthiness, trust also has an ambiguous component. We therefore decompose uncertainty in the trust game into social risk and an ambiguous component. Our results provide evidence that, when accounting for social risk, subjects who score high on ambiguity tolerance explain some of the remainder of trusting behavior. |
| Keywords: | Trust; trust game; decision making under uncertainty; risk; ambiguity; source of uncertainty |
| JEL: | C9 C7 D8 |
| Date: | 2012–10–29 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:42302&r=upt |
| By: | Stephens, Thomas A; Tyran, Jean-Robert |
| Abstract: | Loss aversion is one of the most robust findings to have emerged from behavioral economics. Surprisingly little attention, however, has been devoted to nominal loss aversion, the interaction of loss aversion and money illusion. People tend to think of transactions in terms of their nominal (monetary) values. Real losses may therefore loom larger in people’s minds when they lose money than when real losses are hidden by purely nominal gains. Using a survey experiment with a large and heterogeneous sample, we show that evaluations of housing transactions are systematically biased by purely nominal gains versus losses. |
| Keywords: | bounded rationality; housing transactions; loss aversion; money illusion |
| JEL: | A10 C91 D00 |
| Date: | 2012–10 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:9198&r=upt |
| By: | Jang, Tae-Seok; Sacht, Stephen |
| Abstract: | In this paper we empirically examine a heterogeneous bounded rationality version of a hybrid New-Keynesian model. The model is estimated via the simulated method of moments using Euro Area data from 1975Q1 to 2009Q4. It is generally assumed that agents' beliefs display waves of optimism and pessimism - so called animal spirits - on future movements of the output and inflation gap. Our main empirical findings show that a bounded rationality model with cognitive limitation provides a reasonable fit to auto- and cross-covariances of the data. This result is mainly driven by a high degree of intrinsic persistence in the output and inflation gap due to the impact of animal spirits on economic dynamics. Further, over the whole time interval the agents had expected moderate deviations of the future output gap from its steady state value with low uncertainty. Finally, we find strong evidence for an autoregressive expectation formation process regarding the inflation gap. -- |
| Keywords: | Animal Spirits,Bounded Rationality,Discrete Choice Theory,Euro Area,New-Keynesian Model,Simulated Method of Moments |
| JEL: | C53 D83 E12 E32 |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:cauewp:201212&r=upt |
| By: | Szczygielski, Krzysztof; Komisarski, Andrzej |
| Abstract: | Random Utitly Models (RUMs) are a particularly convenient way of modelling product differentiation. In this paper we demonstrate that they can be used to examine the possibilities of creating quality measures from data on prices and sales volumes. We formulate conditions sufficient for the existence of quality measures in two broad families of RUMs: additive random utility models and pure vertical differentiation models. |
| Keywords: | quality measure; product differentiation; random utility models |
| JEL: | D43 L15 C60 |
| Date: | 2012–10–30 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:42261&r=upt |
| By: | Gilbert Colletaz (LEO - Laboratoire d'économie d'Orleans - CNRS : UMR6221 - Université d'Orléans); Christophe Hurlin (LEO - Laboratoire d'économie d'Orleans - CNRS : UMR6221 - Université d'Orléans); Christophe Pérignon (GREGH - Groupement de Recherche et d'Etudes en Gestion à HEC - GROUPE HEC - CNRS : UMR2959) |
| Abstract: | This paper presents a new method to validate risk models: the Risk Map. This method jointly accounts for the number and the magnitude of extreme losses and graphically summarizes all information about the performance of a risk model. It relies on the concept of a super exception, which is de.ned as a situation in which the loss exceeds both the standard Value-at-Risk (VaR) and a VaR de.ned at an extremely low coverage probability. We then formally test whether the sequences of exceptions and super exceptions are rejected by standard model validation tests. We show that the Risk Map can be used to validate market, credit, operational, or systemic risk estimates (VaR, stressed VaR, expected shortfall, and CoVaR) or to assess the performance of the margin system of a clearing house. |
| Keywords: | Financial Risk Management; Tail Risk; Basel III |
| Date: | 2012–10–28 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:halshs-00746273&r=upt |
| By: | Robert Chambers (University of Maryland); Margarita Genius (Department of Economics, University of Crete, Greece); Vangelis Tzouvelekas (Department of Economics, University of Crete, Greece) |
| Abstract: | In this article we rst develop a theoretically consistent supply-response model for producers with invariant preferences facing price risk, and then we empirically apply the model for a group of Cretan olive-oil producers. For doing so, we estimate a Generalized Leontief cost function and we use the price distribution historically faced by individual farmers to induce three dierent representations of price risk corresponding to the second, third and fourth lp norms. These risk measures are combined with the estimated cost-structure to provide three separate representations of the ecient frontier for the representative producer. Empirical results suggest that, regardless of risk measure used, all farmers curtail production in managing price risk. |
| Keywords: | price risk; invariant risk preferences; producer responses; Cretan olive-oil producers |
| JEL: | C33 C22 D81 Q11 |
| Date: | 2012–11–04 |
| URL: | http://d.repec.org/n?u=RePEc:crt:wpaper:1210&r=upt |