nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2013‒04‒13
eight papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Responsibility effects in decision making under risk By Pahlke, Julius; Strasser, Sebastian; Vieider, Ferdinand M.
  2. Keynesian Utilities: Bulls and Bears By Anat Bracha; Donald J. Brown
  3. Variation in risk seeking behavior following large losses: A natural experiment By Lionel Page; David A. Savage; Benno Torgler
  4. A Theoretical and Experimental Appraisal of Five Risk Elicitation Methods By Paolo Crosetto; Antonio Filippin
  5. Skewness Risk Premium: Theory and Empirical Evidence By Lehnert, Thorsten; Lin, Yuehao; Wolff, Christian C
  6. Preference for randomization: Empirical and experimental evidence By Dwenger, Nadja; Kübler, Dorothea; Weizsäcker, Georg
  7. Gaming and Strategic Ambiguity in Incentive Provision By Ederer, Florian; Holden, Richard; Meyer, Margaret A
  8. Is Stochastic Volatility relevant for Dynamic Portfolio Choice under Ambiguity? By Gonçalo Faria; João Correia-da-Silva

  1. By: Pahlke, Julius; Strasser, Sebastian; Vieider, Ferdinand M.
    Abstract: We explore situations in which a decision-maker bears responsibility for somebody else's outcomes as well as for her own. For gains we confirm the intuition that being responsible for somebody else's payoffs increases risk aversion, while in the loss domain we find increased risk seeking. In a second experiment we replicate the finding of increased risk aversion for large probabilities of a gain, while for small probability gains we find an increase of risk seeking under conditions of responsibility. This discredits hypotheses of a cautious shift under responsibility, and indicates an accentuation of the fourfold pattern of risk attitudes usually found for individual choices. --
    Keywords: risk attitude,prospect theory,social norms,responsibility,other-regarding preferences
    JEL: D03 D81
    Date: 2012
  2. By: Anat Bracha (Federal Reserve Bank of Boston); Donald J. Brown (Dept. of Economics, Yale University)
    Abstract: We propose Keynesian utilities as a new class of non-expected utility functions representing the preferences of investors for optimism, defined as the composition of the investor's preferences for risk and her preferences for ambiguity. The optimism or pessimism of Keynesian utilities is determined by empirical proxies for risk and ambiguity. Bulls and bears are defined respectively as optimistic and pessimistic investors. The resulting family of Afriat inequalities are necessary and sufficient for rationalizing the asset demands of bulls and bears with Keynesian utilities.
    Keywords: Uncertainty, Optimism, Afriat inequalities
    JEL: D81 G11
    Date: 2013–04
  3. By: Lionel Page; David A. Savage; Benno Torgler
    Abstract: This study explores people's risk attitudes after having suffered large real-world losses following a natural disaster. Using the margins of the 2011 Australian floods (Brisbane) as a natural experimental setting, we find that homeowners who were victims of the floods and face large losses in property values are 50% more likely to opt for a risky gamble { a scratch card giving a small chance of a large gain ($500,000) { than for a sure amount of comparable value ($10). This finding is consistent with prospect theory predictions of the adoption of a risk-seeking attitude after a loss.
    Keywords: Decision under risk, large losses, natural experiment
    JEL: D03 D81 C93
    Date: 2013–03–14
  4. By: Paolo Crosetto; Antonio Filippin
    Abstract: We perform a comparative analysis of five incentivized tasks used to elicit risk preferences. Theoretically, we compare the elicitation methods in terms of completeness of the range of the estimates as well as their precision, the likelihood of triggering loss aversion, and problems arising when multiple choices are required. Using original data from a homogeneous population, we experimentally investigate the distribution of estimated risk preferences, whether they differ by gender, and the complexity of the tasks. We do so using both non-parametric tests and a structural model estimated with maximum likelihood. We find that the estimated risk aversion parameters vary greatly across tasks and that gender differences appear only when the task is more likely to trigger loss aversion.
    Keywords: Risk attitudes, Elicitation methods, Experiment
    JEL: C81 C91 D81
    Date: 2013
  5. By: Lehnert, Thorsten; Lin, Yuehao; Wolff, Christian C
    Abstract: Using an equilibrium asset and option pricing model in a production economy under jump diffusion, we show theoretically that the aggregated excess market returns can be predicted by the skewness risk premium, which is constructed to be the difference between the physical and the risk-neutral skewness. In an empirical application of the model using more than 20 years of data on S&P500 index options, we find that, in line with theory, risk-averse investors demand risk-compensation for holding stocks when the market skewness risk premium is high. However, when we characterize periods of high and low risk aversion, we show that in line with theory, the relationship only holds when risk aversion is high. In periods of low riskaversion, investors demand lower risk compensation, thus substantially weakening the skewness-risk-premium-return trade off.
    Keywords: asset pricing; central moments; investor sentiment; option markets; risk aversion; skewness risk premium
    JEL: C15 G12
    Date: 2013–02
  6. By: Dwenger, Nadja; Kübler, Dorothea; Weizsäcker, Georg
    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 decisionmaker 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 effect is the desire to avoid having to make the decision. A large data set on (highstake) 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
  7. By: Ederer, Florian; Holden, Richard; Meyer, Margaret A
    Abstract: It is often suggested that incentive schemes under moral hazard can be gamed by an agent with superior knowledge of the environment, and that deliberate lack of transparency about the incentive scheme can reduce gaming. We formally investigate these arguments. Ambiguous incentive schemes induce more balanced efforts from an agent who performs multiple tasks and is better informed about the environment, but also impose more risk on the agent. If tasks are sufficiently complementary for the principal, ambiguous schemes can dominate the best deterministic scheme and can completely eliminate the efficiency losses from the agent's better knowledge of the environment.
    Keywords: ambiguity; contracts; gaming; incentives; randomization
    JEL: L13 L22
    Date: 2013–01
  8. By: Gonçalo Faria (CEF.UP and Faculdade de Economia (Universidade do Porto) and RGEA (Universidad de Vigo)); João Correia-da-Silva (CEF.UP and Faculdade de Economia (Universidade do Porto))
    Abstract: Literature on dynamic portfolio choice has been finding that volatility risk has low impact on portfolio choice. For example, using long-run U.S. data, Chacko and Viceira (2005) found that intertemporal hedging demand (required by investors for protection against adverse changes in volatility) is empirically small even for highly risk-averse investors. We want to assess if this continues to be true in the presence of ambiguity. Adopting robust control and perturbation theory techniques, we study the problem of a long-horizon investor with recursive preferences that faces ambiguity about the stochastic processes that generate the investment opportunity set. We find that ambiguity impacts portfolio choice, with the relevant channel being the return process. Ambiguity about the volatility process is only relevant if, through a specific correlation structure, it also induces ambiguity about the return process. Using the same long-run U.S. data, we find that ambiguity about the return process may be empirically relevant, much more than ambiguity about the volatility process. Anyway, intertemporal hedging demand is still very low: investors are essentially focused in the short-term risk-return characteristics of the risky asset.
    Keywords: Dynamic Portfolio Choice, Stochastic Volatility, Ambiguity, Robust Control, Perturbation Theory
    JEL: C61 D81 E21 G11
    Date: 2012–10

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