nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2013‒01‒19
nine papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Harsanyi's aggregation theorem with incomplete preferences By Eric Danan; Thibault Gajdos; Jean-Marc Tallon
  2. On a dynamic adaptation of the Distribution Builder approach to investment decisions By Phillip Monin
  3. Are Risk Attitudes Fixed Factors or Fleeting Feelings? By Cho, In Soo
  4. Solomonic Separation: Risk Decisions as Productivity Indicators By Miller, Nolan; Wagner, Alexander F.; Zeckhauser, Richard J.
  5. Probability Weighting of Rare Events and Currency Returns By Chabi-Yo, Fousseni; Song, Zhaogang
  6. Preference for Randomization: Empirical and Experimental Evidence By Nadja Dwenger; Dorothea Kübler; Georg Weizsäcker;
  7. The Role of Family Risk Attitudes in Education and Intergenerational Mobility: An Empirical Analysis By Mathias Huebener
  8. Expectations of Returns and Expected Returns By Robin Greenwood; Andrei Shleifer
  9. Temporal stability of risk preference measures By Katerina Straznicka

  1. By: Eric Danan (THEMA - THéorie Economique, Modélisation et Applications - université de Cergy-Pontoise); Thibault Gajdos (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - Université de la Méditerranée - Aix-Marseille II - Université Paul Cézanne - Aix-Marseille III - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - CNRS : UMR7316); Jean-Marc Tallon (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon Sorbonne, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)
    Abstract: We provide a generalization of Harsanyi (1995)'s aggregation theorem to the case of incomplete preferences at the individual and social level. Individuals and society have possibly incomplete expected utility preferences that are represented by sets of expected utility functions. Under Pareto indifference, social preferences are represented through a set of aggregation rules that are utilitarian in a generalized sense. Strengthening Pareto indifference to Pareto preference provides a refinement of the representation.
    Keywords: Incomplete preferences; aggregation; expected multi-utility; utilitarianism
    Date: 2012–12
  2. By: Phillip Monin
    Abstract: Sharpe et al. proposed the idea of having an expected utility maximizer choose a probability distribution for future wealth as an input to her investment problem instead of a utility function. They developed a computer program, called The Distribution Builder, as one way to elicit such a distribution. In a single-period model, they then showed how this desired distribution for terminal wealth can be used to infer the investor's risk preferences. We adapt their idea, namely that a risk-averse investor can choose a desired distribution for future wealth as an alternative input attribute for investment decisions, to continuous time. In a variety of scenarios, we show how the investor's desired distribution combines with her initial wealth and market-related input to determine the feasibility of her distribution, her implied risk preferences, and her optimal policies throughout her investment horizon. We then provide several examples.
    Date: 2013–01
  3. By: Cho, In Soo
    Abstract: We investigate the stability of measured risk attitudes over time, using a 13-year longitudinal sample of individuals in the NLSY79. We find that an individual’s risk aversion changes systematically in response to personal economic circumstances.  Risk aversion increases with lengthening spells of employment and time out of labor force, and decreases with lengthening unemployment spells.  However, the most important result is that the majority of the variation in risk aversion is due to changes in measured individual tastes over time and not to variation across individuals.  These findings that measured risk preferences are endogenous and subject to substantial measurement errors suggest caution in interpreting coefficients in models relying on contemporaneous, one-time measures of risk preferences.  
    Keywords: risk aversion; stability; variance decomposition; within; measurement error; between; fixed effects
    JEL: C23 D81
    Date: 2013–01–10
  4. By: Miller, Nolan (University of IL); Wagner, Alexander F. (University of Zurich); Zeckhauser, Richard J. (Harvard University)
    Abstract: A principal provides budgets to agents (e.g., divisions of a firm or the principal's children) whose expenditures provide her benefits, either materially or because of altruism. Only agents know their potential to generate benefits. We prove that if the more "productive" agents are also more risk-tolerant (as holds in the sample of individuals we surveyed), the principal can screen agents and bolster target efficiency by offering a choice between a nonrandom budget and a two-outcome risky budget. When, at very low allocations, the ratio of the more risk-averse type's marginal utility to that of the other type is unbounded above (e.g., as with CRRA), the first-best is approached.--A biblical opening enlivens the analysis.
    JEL: D82
    Date: 2012–11
  5. By: Chabi-Yo, Fousseni (OH State University); Song, Zhaogang (Federal Reserve Board)
    Abstract: We show that the probability weighting of rare events, accounting for investors' attitudes toward extreme downside losses versus upside gains in non-expected utility models, provides a unified explanation for both time-series and cross-sectional variations of currency portfolio returns. We use a simple structural model to show the link between the probability weighting function and pricing kernel, and then estimate them by non-parametric methods using currency options data from 1996 to 2012. The estimates show that a domestic investor over-weights the likelihood of a substantial depreciation or appreciation of foreign currencies, consistent with experimental studies. A global probability weighting measure of left (right) tail events is highly significant in positively (negatively) predicting future currency returns over time series at both individual and portfolios levels. Furthermore, asset pricing tests show that differences in exposure to our global tail weighting measures, of high versus low interest rate currencies and of high versus low past return currencies, can explain the cross-sectional variation in average excess returns across both carry and momentum portfolios. Moreover, our global tail weighting measures remain significant after controlling for existing currency risk factors in the literature, and frequently drive their significance out, in both time-series and cross-sectional return predictability regressions.
    JEL: G12 G15
    Date: 2012–11
  6. By: Nadja Dwenger; Dorothea Kübler; Georg Weizsäcker;
    Abstract: We investigate violations of consequentialism in the form of the stochastic dominance property. The property is shared by many theories of choice and implies that the decision-maker prefers receiving the best outcome for sure over all lotteries that involve multiple outcomes. We run experiments to demonstrate that dominated randomization can be attractive. In treatments where decision-makers are asked to submit multiple decisions without knowing which one is relevant, many participants submit contradictory sets of decisions and thereby induce a dominated lottery between outcomes. Explicit choice of non-consequentialist randomization is observed in a separate treatment. A possible reason for the eect is the desire to avoid having to make the decision. A large data set on (high-stake) university applications in Germany shows patterns that are consistent with a preference for randomization.
    Keywords: Stochastic dominance violations, individual decision making, university choice, matching
    JEL: D03 D01
    Date: 2013–01
  7. By: Mathias Huebener
    Abstract: This paper analyses the role of family risk attitudes in intergenerational mobility in incomes and education. Based on 1984-2009 data of sons and fathers from the German Socio-Economic Panel Survey, there is evidence suggesting that sons with risk taking fathers have a significantly higher educational mobility and persistently higher income mobility than peers with risk averse fathers. They obtain significantly higher levels of education, which would be justified by modest evidence on higher returns to education. The relationship seems more complex for sons’ own risk attitudes. Risk taking sons experience higher educational mobility, but there is no difference in income mobility to risk averse sons. There are no considerable differences in the levels of education, but modest evidence suggesting lower returns to education for risk taking sons. The findings improve the understanding of the intergenerational transmission mechanism of economic status and show that family risk attitudes impact economic mobility. The study suggests an important intergenerational link between fathers’ risk attitudes and sons’ levels of education, which has not received much attention in the literature.
    Keywords: Risk preferences, intergenerational mobility, educational mobility, social mobility, returns to education, intergenerational income elasticity, educational choice under uncertainty, SOEP
    JEL: D1 D8 I24 J13 J24 J62
    Date: 2012
  8. By: Robin Greenwood; Andrei Shleifer
    Abstract: We analyze time-series of investor expectations of future stock market returns from six data sources between 1963 and 2011. The six measures of expectations are highly positively correlated with each other, as well as with past stock returns and with the level of the stock market. However, investor expectations are strongly negatively correlated with model-based expected returns. We reconcile the evidence by calibrating a simple behavioral model, in which fundamental traders require a premium to accommodate expectations shocks from extrapolative traders, but markets are not efficient.
    JEL: G12 G14
    Date: 2013–01
  9. By: Katerina Straznicka (Université de Lyon, Lyon, F-69007, France ; CNRS, GATE Lyon St Etienne,F-69130 Ecully, France)
    Abstract: We examine the temporal stability of risk preference measures obtained by different elicitation methods in a controlled laboratory experiment at two distinct times. Our results indicate remarkable temporal stability of risk measures at the aggregated level and temporal instability at the individual level. We control for the impact of, first, personality traits, and second, performance realized in a market game. When better market performers demonstrate more stable risk preferences, the impact of personality traits is marginal.
    Keywords: Time stability, Risk Preferences, Personality Theory, Experimental economics
    JEL: C9 D8 D9
    Date: 2012

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