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on Utility Models and Prospect Theory |
| By: | Antoine Bommier (ETH Zurich, Switzerland); François Le Grand (EMLyon Business School) |
| Abstract: | We investigate whether the set of Kreps and Porteus (1978) preferences include classes of preferences that are stationary, monotonic and well-ordered in terms of risk aversion. We prove that the class of preferences introduced by Hansen and Sargent (1995) in their robustness analysis is the only one that fulfills these properties. The paper therefore suggests a shift from the traditional approach to studying the role of risk aversion in recursive problems. We also provide applications, in which we discuss the impact of risk aversion on asset pricing and risk sharing. |
| Keywords: | risk aversion; recursive utility; robustness; ordinal dominance; risk free rate; equity premium; risk sharing |
| JEL: | E2 E43 E44 |
| Date: | 2013–01 |
| URL: | http://d.repec.org/n?u=RePEc:eth:wpswif:13-172&r=upt |
| By: | Jeffrey V. Butler (EIEF); Luigi Guiso (EIEF); Tullio Jappelli (University of Naples "Federico II" and CSEF) |
| Abstract: | Prior research suggests that those who rely on intuition rather than effortful reasoning when making decisions are less averse to risk and ambiguity. The evidence is largely correlational, however, leaving open the question of the direction of causality. In this paper, we present experimental evidence of causation running from reliance on intuition to risk and ambiguity preferences. We directly manipulate participants’ predilection to rely on intuition and find that enhancing reliance on intuition lowers the probability of being ambiguity averse by 30 percentage points and increases risk tolerance by about 30 percent in the experimental subpopulation where we would a priori expect the manipulation to be successful (males). |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:eie:wpaper:1301&r=upt |
| By: | Sheremeta, Roman |
| Abstract: | We provide an overview of experimental literature on contests and point out the two main phenomena observed in most contest experiments: (i) overbidding relative to the standard Nash equilibrium prediction and (ii) heterogeneous behavior of ex-ante symmetric contestants. Based on the sample of contest experiments that we review, the median overbidding rate is 72%. We provide different explanations for the overbidding phenomenon, including bounded rationality, utility of winning, other-regarding preferences, probability distortion, and the shape of the payoff function. We also provide explanations for heterogeneous behavior of contestants based on differences in preferences towards winning, inequality, risk and losses, and demographic differences. Furthermore, we suggest mechanisms that can reduce overbidding and induce more homogeneous behavior. Finally, we discuss directions for future research. |
| Keywords: | experiments; contests; overbidding; heterogeneous behavior |
| JEL: | C92 D74 D72 C91 C72 |
| Date: | 2013–01–25 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:44124&r=upt |
| By: | Laurence Carassus; Miklos Rasonyi |
| Abstract: | This paper investigates the problem of maximizing expected terminal utility in a (generically incomplete) discrete-time financial market model with finite time horizon. In contrast to the standard setting, a possibly non-concave utility function $U$ is considered, with domain of definition $\mathbb{R}$. Simple conditions are presented which guarantee the existence of an optimal strategy for the problem. In particular, the asymptotic elasticity of $U$ plays a decisive role: existence can be shown when it is strictly greater at $-\infty$ than at $+\infty$. |
| Date: | 2013–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1302.0134&r=upt |
| By: | Ghattassi, I. |
| Abstract: | Based on CAMPBELL and COCHRANE [1999] Consumption-Based Asset Pricing Model (C)CAPM with habit formation, this paper provides empirical evidence in favor of the importance of habit persistence in asset pricing. Using U.S data, we show that the surplus consumption ratio is a strong predictor of excess returns at long-horizons and that it captures a component of expected returns, not explained by the consumption-wealth ratio. Moreover, this paper shows that the (C)CAPM with habit formation performs far better than the standard (C)CAPM in accounting for the cross-sectional variations in average excess returns on the 25 FAMA-FRENCH portfolios sorted by size and book-to-market value. |
| Keywords: | Habit formation, Surplus consumption ratio, Expected returns, Time series predictability, Cross section returns. |
| JEL: | G21 E21 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:bfr:banfra:417&r=upt |