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on Utility Models and Prospect Theory |
| By: | Ralph Bayer; Subir Bose; Matthew Polisson (Institute for Fiscal Studies and University of Leicester); Ludovic Renou |
| Abstract: | We derive necessary and sufficient conditions for data sets composed of state-contingent prices and consumption to be consistent with two prominent models of decision making under uncertainty: variational preferences and smooth ambiguity. The revealed preference conditions for subjective expected utility, maxmin expected utility, and multiplier preferences are characterised as special cases. We implement our tests on data from a portfolio choice experiment. |
| Keywords: | ambiguity, expected utility, maxmin, revealed preference, smooth, uncertainty, variational |
| JEL: | D1 D8 |
| Date: | 2013–03 |
| URL: | http://d.repec.org/n?u=RePEc:ifs:ifsewp:13/05&r=upt |
| By: | Leonard J. Mirman; Marc Santugini |
| Abstract: | We study the effect of changing income on optimal decisions in the multidimensional expected utility framework. Using the KM utility representation, we show that the comparative analysis under uncertainty is founded on classical demand theory under certainty and is linked to the effect of changing risk aversion, which also depends on classical demand theory. |
| Keywords: | Classical Demand Theory, Consumption-Saving Problem, Income, Risk Aversion, Uncertainty |
| JEL: | D01 D81 D91 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:lvl:lacicr:1306&r=upt |
| By: | Andersson, Ola (Research Institute of Industrial Economics (IFN)); Tyran, Jean-Robert (Department of Economics, University of Vienna); Wengström, Erik (Department of Economics, Lund University); Holm, Håkan J. (Department of Economics, Lund University) |
| Abstract: | Recent experimental studies suggest that risk aversion is negatively related to cognitive ability. In this paper we report evidence that this relation might be spurious. We recruit a large subject pool drawn from the general Danish population for our experiment. By presenting subjects with choice tasks that vary the bias induced by random choices, we are able to generate both negative and positive correlations between risk aversion and cognitive ability. Structural estimation allowing for heterogeneity of noise yields no significant relation between risk aversion and cognitive ability. Our results suggest that cognitive ability is related to random decision making, rather than to risk preferences. |
| Keywords: | Risk preference; cognitive ability; experiment; noise |
| JEL: | C81 C91 D12 D81 |
| Date: | 2013–04–12 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:lunewp:2013_009&r=upt |
| By: | Marianne Andries (Chicago Booth) |
| Abstract: | I incorporate loss aversion in a consumption-based asset pricing model with recursive preferences and solve for asset prices in closed-form. I find loss aversion increases expected returns substantially relative to the standard recursive utility model. This feature of my model improves the ability to match moments on asset prices. Further, I find loss aversion induces important nonlinearities into the expected excess returns as a function of the exposure to the consumption shocks. In particular, the elasticities of expected returns with respect to the exposure to the consumption shocks are greater for assets with smaller exposures to the shocks, thus generating interesting predictions for the cross-section of returns. I provide strong empirical evidence supporting this outcome. The model with loss aversion correctly predicts both a negative premium for skewness and a security market line, the excess returns as a function of the exposure to market risk, flatter than the CAPM. |
| Date: | 2012 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed012:571&r=upt |
| By: | Delprat, Gaëtan (University of Québec at Montréal); Leroux, Marie-Louise (University of Québec at Montréal); Michaud, Pierre-Carl (University of Québec at Montréal) |
| 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: | risk aversion toward the length of life, intertemporal choice, stated-preference |
| JEL: | D12 D91 I10 J26 |
| Date: | 2013–03 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp7317&r=upt |
| By: | Irina Penner (CEREMADE); Anthony Reveillac (CEREMADE) |
| Abstract: | The paper analyzes risk assessment for cash flows in continuous time using the notion of convex risk measures for processes. By combining a decomposition result for optional measures, and a dual representation of a convex risk measure for bounded \cd processes, we show that this framework provides a systematic approach to the both issues of model ambiguity, and uncertainty about the time value of money. We also establish a link between risk measures for processes and BSDEs. |
| Date: | 2013–04 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1304.4853&r=upt |
| By: | Bernt \Oksendal; Agn\`es Sulem |
| Abstract: | A celebrated financial application of convex duality theory gives an explicit relation between the following two quantities: \begin{myenumerate} \item The optimal terminal wealth $X^*(T) : = X_{\varphi^*}(T)$ of the classical problem to maximize the expected $U$-utility of the terminal wealth $X_{\varphi}(T)$ generated by admissible portfolios $\varphi(t); 0 \leq t \leq T$ in a market with the risky asset price process modeled as a semimartingale \item The optimal scenario $\frac{dQ^*}{dP}$ of the dual problem to minimize the expected $V$-value of $\frac{dQ}{dP}$ over a family of equivalent local martingale measures $Q$. Here $V$ is the convex dual function of the concave function $U$. \end{myenumerate} In this paper we consider markets modeled by It\^o-L\'evy processes, and in the first part we give a new proof of the above result in this setting, based on the maximum principle in stochastic control theory. An advantage with our approach is that it also gives an explicit relation between the optimal portfolio $\varphi^*$ and the optimal measure $Q^*$, in terms of backward stochastic differential equations. In the second part we present robust (model uncertainty) versions of the optimization problems in (i) and (ii), and we prove a relation between them. In particular, we show explicitly how to get from the solution of one of the problems to the solution of the other. We illustrate the results with explicit examples. |
| Date: | 2013–04 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1304.5040&r=upt |
| By: | Nobuyuki Hanaki (Aix-Marseille University); Nicolas Jacquemet (University of Lorraine and Paris School of Economics); Stéphane Luchini (Aix-Marseille University); Adam Zylbersztejn (University of Lorraine and Paris School of Economics) |
| Abstract: | How much of the failures to achieve Pareto efficient outcome observed in a simple 2 2 dominance solvable game can be attributed to strategic uncertainty and how much is actually due to individual bounded rationality? We address this question by conducting a set of experiments involving two main treatments: one in which two human subjects interact, and another in which one human subject interacts with a computer program whose behavior is known. By making the behavior of the computer opponent perfectly predictable, the latter treatment eliminates strategic uncertainty. Our results suggest that observed coordination failures can be attributed equally to individual bounded rationality and strategic uncertainty. |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:uwa:wpaper:13-14&r=upt |