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on Utility Models and Prospect Theory |
| By: | Kohei Daido (School of Economics, Kwansei Gakuin University); Kimiyuki Morita (Graduate School of Commerce and Management, Hitotsubashi University); Takeshi Murooka (Department of Economics, University of California-Berkeley); Hiromasa Ogawa (Graduate School of Economics, University of Tokyo) |
| Abstract: | We analyze a simple task-assignment model in which a principal assigns a task to one of two agents depending on the state. If the agents have standard concave utility, the principal assigns the task to an agent with the highest productivity in each state. In contrast, if the agents are loss averse, in order to alleviate their expected losses the principal may assign the task to a single agent in all states. Furthermore, the optimal contract may specify the same effort level across states. Our results imply that such simple contracts can be optimal even when employers can write contingent contracts at no cost. |
| Keywords: | task assignment, loss aversion, reference-dependent preferences |
| JEL: | D03 D86 M12 M52 |
| Date: | 2013–03 |
| URL: | http://d.repec.org/n?u=RePEc:kgu:wpaper:103&r=upt |
| By: | Cordoba, Juan Carlos; Ripoll, Marla |
| Abstract: | We document various limitations of the expected utility model for the study of health and longevity. The model assumes individuals are indifferent between early and late resolution of uncertainty. This assumption gives rise to predictions regarding the economic value of life that are inconsistent with relevant evidence. For example, poor individuals would price life below the present value of foregone income or even negatively. We show that a non-expected utility model disentangling intertemporal substitution from risk aversion can overcome these limitations. We illustrate the quantitative implications of our model for the economic value of life across countries and time. |
| Keywords: | life expectancy; value of statistical life; mortality risk aversion; Epstein-Zin-Weil pref- erences; Welfare; AIDS. |
| JEL: | I J |
| Date: | 2013–03–28 |
| URL: | http://d.repec.org/n?u=RePEc:isu:genres:36067&r=upt |
| By: | Trino-Manuel Niguez; Ivan Paya; D Peel; Javier Perote |
| Abstract: | This paper revisits the corner solution in classical portfolio choice theory in which risk-averse agents would all be optimally plungers rather than diversifiers. We examine the effect of higher-order moments of two-, three- and four-parameter density functions on the investor's decision to diversify in an expected utility framework. The empirical analysis provides estimates of four parametric and two semi-nonparametric densities for the S&P500 and concluded that allocation of all wealth in the risky asset would not have been optimal. |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:lan:wpaper:18297128&r=upt |
| By: | Geoffrey Heal; Antony Millner |
| Abstract: | Uncertainty is intrinsic to climate change: we know that the climate is changing, but not precisely how fast or in what ways. Nor do we understand fully the social and economic consequences of these changes, or the options that will be available for reducing climate change. Furthermore the uncertainty about these issues is not readily quantified and expressed in probabilistic terms: we are facing deep uncertainty or ambiguity rather than risk in the classical sense, rendering the classical expected utility framework of limited value. We review the sources of uncertainty about all aspects of climate change and resolve these into various components, commenting on their relative importance. Then we review decision-making frameworks that are appropriate in the absence of quantitative probabilistic information, including non-probabilistic approaches and those based on multiple priors, and discuss their application in climate change economics. |
| JEL: | D81 |
| Date: | 2013–03 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:18929&r=upt |
| By: | KARL-THEODOR EISELE (LaRGE Research Center, Université de Strasbourg); MICHAEL KUPPER |
| Abstract: | In this paper asymptotically stable risk assessments are studied. They are characterized by not being sensitive with respect to huge additional capital in the very far future. Under the additional hypothesis of being locally continuous from below, these risk assessments are exactly those which allow a robust representation with so-called local test probabilities having a support with finite time horizon. Time-consistent risk assessments can be constructed by composing a sequence of generators. We give several conditions for the generators such that the resulting risk assessments are indeed asymptotically stable. |
| Keywords: | asymptotic stability of risk assessments, construction by generators, local test probabilities, robust representation, time-consistency. |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:lar:wpaper:2013-04&r=upt |
| By: | G. Delprat; M.-L. Leroux; P.-C. Michaud |
| Abstract: | The standard model of intertemporal choice assumes risk neutrality toward the length of life: due to additivity, agents are not sensitive to a mean preserving spread in the length of life. Using a survey fielded in the RAND American Life Panel (ALP), this paper provides empirical evidence on possible deviation from risk neutrality with respect to longevity in the U.S. population. The questions we ask allow to find the distribution as well as to quantify the degree of risk aversion with respect to the length of life in the population. We find evidence that roughly 75% of respondents were not neutral with respect to longevity risk. Higher income households are more likely to be risk averse. We do not find evidence that the degree of risk aversion varies with age or education. |
| Keywords: | Intertemporal choice, Risk aversion toward the Length of Life, Stated-Preference |
| JEL: | D12 D91 I10 J26 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:lvl:lacicr:1304&r=upt |
| By: | Daniela Glätzle-Rützler; Matthias Sutter; Achim Zeileis |
| Abstract: | Myopic loss aversion (MLA) has been found to play a persistent role for investment behavior under risk. We study whether MLA is already present during adolescence. Quite surprisingly, we find no evidence of MLA in a sample of 755 adolescents. This finding is at odds with previous findings, and it might be explained by self-selection effects. In other dimensions, however, we are able to replicate stylized findings in our pool of adolescents, such that teams invest higher amounts than individuals and that women invest less than men. |
| Keywords: | myopic loss aversion, experiment, adolescents, team-decision making |
| JEL: | C91 D03 |
| Date: | 2013–03 |
| URL: | http://d.repec.org/n?u=RePEc:inn:wpaper:2013-07&r=upt |
| By: | Utteeyo Dasgupta (Franklin and Marshall College); Subha Mani (Fordham University) |
| Abstract: | In an artefactual field experiment, we introduce a novel allocation game to investigate the role of procedural altruism in household decision-making and study choices of married spouses. Subjects can distribute their earnings from the experiment either on food items (joint consumption good), or on gender specific personal clothing (private consumption good). Subjects’ consumption choices are observed under two treatments – earnings with effort, and earnings without effort. At the aggregate we find that subjects exhibit a strong preference for own private consumption good when assigned to the effort treatment. However, further scrutiny suggests that women’s choice for the joint consumption good in the household remains largely independent of the treatment. In contrast, men exhibit a strong preference for private consumption good in the effort treatment. |
| Keywords: | Procedural utility, Household decision making, Gender, Experiment |
| JEL: | C93 D1 Z1 |
| URL: | http://d.repec.org/n?u=RePEc:frd:wpaper:dp2013-01&r=upt |
| By: | Oliver Walker; Simon Dietz |
| Abstract: | Many insurance and reinsurance contracts are contingent on events such ashurricanes, terrorist attacks or political upheavals whose probabilities are not known with precision. There is a body of experimental evidence showing thathigher premiums are charged for these “ambiguous” contracts, which may in turn inhibit (re)insurance transactions, but little research analysing explicitlyhow and why premiums are loaded in this way. In this paper we model the effect of ambiguity on the capital requirement of a (re)insurer whose objectives are profit maximisation and robustness. The latter objective means that it musthold enough capital to meet a survival constraint across a range of availableestimates of the probability of ruin. We provide characterisations of when onebook of insurance is more ambiguous than another and formally explore thecircumstances in which a more ambiguous book requires at least as large acapital holding. This analysis allows us to derive several explicit formulae forthe price of ambiguous insurance contracts, each of which identifies the extraambiguity load. |
| Date: | 2012–11 |
| URL: | http://d.repec.org/n?u=RePEc:lsg:lsgwps:wp97&r=upt |
| By: | Alois Pichler |
| Abstract: | The net-premium principle is considered to be the most genuine and fair premium principle in actuarial applications. However, an insurance company, applying the net-premium principle, goes bankrupt with probability one in the long run, even if the company covers its entire costs by collecting the respective fees from its customers. It is therefore an intrinsic necessity for the insurance industry to apply premium principles, which guarantee at least further existence of the company itself; otherwise, the company naturally could not insure its clients to cover their potential, future claims. Beside this intriguing fact the underlying loss distribution typically is not known precisely. Hence alternative premium principles have been developed. A simple principle, ensuring risk-adjusted credibility premiums, is the distorted premium principle. This principle is convenient in insurance companies, as the actuary does not have to change his or her tools to compute the premiums or reserves. This paper addresses the distorted premium principle from various angles. First, dual characterizations are developed. Next, distorted premiums are typically computed by under-weighting or ignoring low, but over-weighting high losses. It is demonstrated here that there is an alternative, opposite point of view, which consists in leaving the probability measure unchanged, but increasing the outcomes instead. It turns out that this new point of view is natural in actuarial practice, as it can be used for premium calculations, as well as to determine the reserves of subsequent years in a time consistent way. |
| Date: | 2013–04 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1304.0490&r=upt |
| By: | Heiko Karle (ETH Zurich, Switzerland) |
| Abstract: | Complementing the existing literature on anchoring effects and loss aversion, we analyze how firms can influence loss–averse consumers’ willingness to pay by product information in the form of informative advertising rather than by prices. We find that consumers’ willingness to pay is greatest when only partial information about the product—i.e. only a fraction of product attributes—is disclosed, and that partial information disclosure is the optimal mode of advertising for a monopolistic firm. This causes the consumers’ realized product valuation to diverge from their intrinsic product valuation, which leads to a reduction of consumer surplus. Consequently, transparency policies can help to protect consumers. |
| Keywords: | Advertising; Loss Aversion; Information Disclosure. |
| JEL: | D83 L41 M37 |
| Date: | 2013–03 |
| URL: | http://d.repec.org/n?u=RePEc:eth:wpswif:13-177&r=upt |