|
on Utility Models and Prospect Theory |
| By: | Andrea Repetto (Escuela de Gobierno, Universidad Adolfo Ibáñez) |
| Date: | 2012–09 |
| URL: | http://d.repec.org/n?u=RePEc:uai:wpaper:wp_024&r=upt |
| By: | Chan, Raymond H.; Clark, Ephraim; Wong, Wing-Keung |
| Abstract: | This paper studies some properties of stochastic dominance (SD) for risk-averse and risk-seeking investors, especially for the third order SD (TSD). We call the former ascending stochastic dominance (ASD) and the latter descending stochastic dominance(DSD). We first discuss the basic property of ASD and DSD linking the ASD and DSD of the first three orders to expected-utility maximization for risk-averse and risk-seeking investors. Thereafter, we prove that a hierarchy exists in both ASD and DSD relationships and that the higher orders of ASD and DSD cannot be replaced by the lower orders of ASD and DSD. Furthermore, we study conditions in which third order ASD preferences will be 'the opposite of' or 'the same as' their counterpart third order DSD preferences. In addition, we construct examples to illustrate all the properties developed in this paper. The theory developed in this paper provides investors with tools to identify first, second, and third order ASD and DSD prospects and thus they could make wiser choices on their investment decision. |
| Keywords: | Third order stochastic dominance; ascending stochastic dominance; descending stochastic dominance; expected-utility maximization; risk averters; risk seekers |
| JEL: | D81 G11 C02 |
| Date: | 2012–11–16 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:42676&r=upt |
| By: | Bettina Klose; Paul Schweinzer |
| Abstract: | We develop the idea of using mean-variance preferences for the analysis of the first-price, all-pay auction. On the bidding side, we characterise the optimal strategy in symmetric all-pay auctions under mean-variance preferences for general distributions of valuations and any number of bidders. We find that, in contrast to winner-pay auction formats, only hightype bidders increase their bids relative to the risk-neutral case while low types minimise variance exposure by bidding low. Introducing asymmetric variance aversions across bidders into a Uniform valuations, two-player framework, we show that a more variance-averse type bids always higher than her less variance-averse counterpart. Taking mean-variance bidding behaviour as given, we show that an expected revenue maximising seller may want to optimally limit the number of participants. Although expected revenue for risk-neutral bidders typically dominates revenue under mean-variance bidding, if the seller himself takes account of the variance of revenue, he may find it preferable to attract bidders endowed with mean-variance preferences. |
| Keywords: | Auctions, contests, mean-variance preferences |
| JEL: | C7 D7 D81 |
| Date: | 2012–11 |
| URL: | http://d.repec.org/n?u=RePEc:zur:econwp:097&r=upt |
| By: | Edoardo Gaffeo (University of Trento); Ivan Petrella (Birkbeck, University of London); Damjan Pfajfar (University of Tilburg); Emiliano Santoro (Catholic University of Milan and University of Copenhagen) |
| Abstract: | There is widespread evidence that monetary policy exerts asymmetric effects on output over contractions and expansions in economic activity, while price responses display no sizeable asymmetry. To rationalize these facts we develop a dynamic general equilibrium model where households' utility depends on consumption deviations from a reference level below which loss aversion is displayed. In line with the prospect theory pioneered by Kahneman and Tversky (1979), losses in consumption loom larger than gains. State-dependent degrees of real rigidity and elasticity of intertemporal substitution in consumption generate competing effects on output and infl?ation. The resulting state-dependent trade-off between output and infl?ation stabilization recommends stronger policy activism towards in?flation during expansions |
| Keywords: | Asymmetry, Monetary Policy, Business Cycle, Prospect Theory |
| JEL: | E32 E42 E52 D03 D11 |
| Date: | 2012–07–16 |
| URL: | http://d.repec.org/n?u=RePEc:kud:kuiedp:1221&r=upt |
| By: | Tahir Choulli; Jun Deng; Junfeng Ma |
| Abstract: | The fundamental theorem of utility maximization (called FTUM hereafter) says that the utility maximization admits solution if and only if there exists an equivalent martingale measure. This theorem is true for discrete market models (where the number of scenarios is finite), and remains valid for general discrete-time market models when the utility is smooth enough. However, this theorem fails in continuous-time framework even with nice utility function, where there might exist arbitrage opportunities and optimal portfolio. This paper addresses the question how far we can weaken the non-arbitrage condition as well as the utility maximization problem to preserve their complete and strong relationship described by the FTUM. As application of our version of the FTUM, we establish equivalence between the No-Unbounded-Profit-with-Bounded-Risk condition, the existence of num\'eraire portfolio, and the existence of solution to the utility maximization under equivalent probability measure. The latter fact can be interpreted as a sort of weak form of market's viability, while this equivalence is established with a much less technical approach. Furthermore, the obtained equivalent probability can be chosen as close to the real-world probability measure as we want. |
| Date: | 2012–11 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1211.4598&r=upt |
| By: | Cary Frydman; Nicholas Barberis; Colin Camerer; Peter Bossaerts; Antonio Rangel |
| Abstract: | We use measures of neural activity provided by functional magnetic resonance imaging (fMRI) to test the "realization utility" theory of investor behavior, which posits that people derive utility directly from the act of realizing gains and losses. Subjects traded stocks in an experimental market while we measured their brain activity. We find that all subjects exhibit a strong disposition effect in their trading, even though it is suboptimal. Consistent with the realization utility explanation for this behavior, we find that activity in the ventromedial prefrontal cortex, an area known to encode the value of options during choices, correlates with the capital gains of potential trades; that the neural measures of realization utility correlate across subjects with their individual tendency to exhibit a disposition effect; and that activity in the ventral striatum, an area known to encode information about changes in the present value of experienced utility, exhibits a positive response when subjects realize capital gains. These results provide support for the realization utility model and, more generally, demonstrate how neural data can be helpful in testing models of investor behavior. |
| JEL: | G11 |
| Date: | 2012–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:18562&r=upt |
| By: | William Coleman |
| Abstract: | In a well-known paper Friedman and Savage (1948) advocated a utility function in which the marginal utility of wealth is increasing in wealth above some critical level of wealth. In order to win a reception for this novel conception of the utility function Friedman and Savage took some pains in the first part of their paper to try to shake the grip that the 'law of diminishing marginal utility ' had on the mind of their fellow economists. To that end they criticised a classic 'elemental argument' in favour marginal utility being diminishing in wealth. Friedman and Savage's attempt to reconcile the rich man's avoidance of pain with increasing marginal utility is inadequate. We find that the 'elemental argument' that concludes in favour of diminishing marginal utility - on the basis of a comparison of rich and poor - is valid. |
| Date: | 2012–11 |
| URL: | http://d.repec.org/n?u=RePEc:auu:dpaper:676&r=upt |