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on Utility Models and Prospect Theory |
| By: | Mikl\'os R\'asonyi; Andrea Meireles Rodrigues |
| Abstract: | This paper examines an optimal investment problem in a continuous-time (essentially) complete financial market with a finite horizon. We deal with an investor who behaves consistently with principles of Cumulative Prospect Theory, and whose utility function on gains is bounded above. The well-posedness of the optimisation problem is trivial, and a necessary condition for the existence of an optimal trading strategy is derived. This condition requires that the investor's probability distortion function on losses does not tend to 0 near 0 faster than a given rate, which is determined by the utility function. Under additional assumptions, we show that this condition is indeed the borderline for attainability, in the sense that for slower convergence of the distortion function there does exist an optimal portfolio. |
| Date: | 2013–09 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1309.0362&r=upt |
| By: | Eizo Akiyama (Faculty of Engineering, Information and Systems, University of Tsukuba); Nobuyuki Hanaki (Aix-Marseille University (Aix-Marseille School of Economics), CNRS & EHESS, and IUF); Ryuichiro Ishikawa (Faculty of Engineering, Information and Systems, University of Tsukuba) |
| Abstract: | To what extent is the observed mis-pricing in experimental asset markets caused by strategic uncertainty (SU) and by individual bounded rationality (IBR)? We address this question by comparing subjects initial price forecasts in two market environments – one with six human traders, and the other with one human and five computer traders. We find that both SU and IBR account equally for the median initial forecasts deviation from the fundamental values. The effect of SU is greater for subjects with a perfect score in the Cognitive Reflection Test, and it is not significant for those with low scores. |
| Keywords: | Bounded rationality, Strategic uncertainty, Experiment, Asset markets, Computer traders,Cognitive Re?ection Test |
| JEL: | C90 D84 |
| Date: | 2013–08–08 |
| URL: | http://d.repec.org/n?u=RePEc:aim:wpaimx:1340&r=upt |
| By: | Ekaterina Selezneva (IOS Regensburg); Philippe Van Kerm |
| Abstract: | This paper exploits data from the German Socio-Economic Panel (SOEP) to re-examine the gender wage gap in Germany on the basis of inequality-adjusted measures of wage differentials which fully account for gender differences in pay distributions. The inequality-adjusted gender pay gap measures are significantly larger than suggested by standard indicators, especially in East Germany. Women appear penalized twice, with both lower mean wages and greater wage inequality. A hypothetical risky investment question collected in 2004 in the SOEP is used to estimate individual risk aversion parameters and benchmark the ranges of inequality-adjusted wage differentials measures. |
| Keywords: | gender gap, wage differentials, wage inequality, expected utility, risk aversion, East and West Germany, SOEP, Singh-Maddala distribution, copula-based selection model |
| JEL: | D63 J31 J70 |
| Date: | 2013–08 |
| URL: | http://d.repec.org/n?u=RePEc:ost:wpaper:334&r=upt |
| By: | Alexander Zimper |
| Abstract: | This paper introduces an equilibrium concept for boundedly rational agents who base their demand-supply decisions on incorrect price anticipations. Formally, we differentiate between equilibrium and out-of-equilibrium states. If the agents attach zero prior probability to all out-of-equilibrium states, our equilibrium concept coincides with Radner's (1979) concept of rational expectations equilibria (=REE). In contrast to REE, however, there may exist strict incentives for speculative asset trade whenever boundedly rational agents regard out-of-equilibrium states as possible. |
| Keywords: | Bounded Rationality, Speculative Trade, Rational Expectations, Incorrect Prices |
| JEL: | D51 D53 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:rza:wpaper:358&r=upt |
| By: | Andrea Carriero (Queen Mary, University of London); Haroon Mumtaz (Bank of England); Konstantinos Theodoridis (Bank of England); Angeliki Theophilopoulou (University of Westminister) |
| Abstract: | A growing empirical literature has considered the impact of uncertainty using SVAR models that include proxies for uncertainty shocks as endogenous variables. In this paper we consider the possible impact of measurement error in the uncertainty shock proxies on the estimated impulse responses from these SVAR models. We show via a Monte Carlo experiment that measurement error can result in attenuation bias in the SVAR impulse responses. In contrast, the proxy SVAR that uses the uncertainty shock proxy as an instrument to identify the underlying shock does not suffer from this bias. Applying this proxy SVAR method to the Bloom (2009) data set results in estimated impulse responses to uncertainty shocks that are larger in magnitude and persistence than those obtained from a standard recursive SVAR. |
| Keywords: | Uncertainty shocks, Proxy SVAR, Non-linear DSGE models |
| JEL: | C15 C32 E32 |
| Date: | 2013–08 |
| URL: | http://d.repec.org/n?u=RePEc:qmw:qmwecw:wp707&r=upt |
| By: | Jun Nagayasu (Faculty of engineering, information & systems, University of Tskuba) |
| Abstract: | This paper evaluates the forward premium puzzle using the Euro exchange rate. Unlike previous studies, our analysis utilizes time-varying parameter methods and is based on two approaches for evaluation of the puzzle; the traditional approach analyzing the sensitivity of interest rate differentials to the forward premium, and the other looking into deviations from the covered interest rate parity (CIRP) condition. Then we provide evidence that the forward premium puzzle indeed became more prominent around the time of the recent crisis periods such as the Lehman Shock and the Euro crisis. This is also shown to be consistent with a deterioration in the CIRP. |
| Keywords: | forward premium puzzle, risk premium, time varying parameters, financial crises |
| JEL: | F31 F36 |
| Date: | 2013–08 |
| URL: | http://d.repec.org/n?u=RePEc:str:wpaper:1317&r=upt |
| By: | Yu Zhu (University of Wisconsin - Madison); Randall Wright (University of Wisconsin); Chao He (Renmin University of China) |
| Abstract: | Housing, in addition to providing direct utility, facilitates credit transactions when home equity serves as collateral. We document big increases in home-equity loans coinciding with the start of the house-price boom, and suggest an explanation. When it is used as collateral, housing can bear a liquidity premium. Since liquidity is endogenous, even when fundamentals are deterministic and time invariant equilibrium house prices can display complicated patterns -- including cyclic, chaotic and stochastic trajectories -- some of which resemble bubbles. Our framework is tractable, with exogenous or with endogenous supply, and with exogenous or endogenous credit limits. Yet it captures several salient qualitative features of actual housing markets. Numerical work shows the model can also capture some, if not all, quantitative features, as well. The effects of monetary policy are also discussed. |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed013:168&r=upt |
| By: | Thomas Seegmuller (Aix-Marseille University (Aix-Marseille School of Economics), CNRS-GREQAM & EHESS); Lise Clain-Chamosset-Yvrard (Aix-Marseille University (Aix-Marseille School of Economics), CNRS-GREQAM and EHESS) |
| Abstract: | We explore the existence of endogenous fluctuations with a rational bubble and the stabilizing role of fiscal and monetary policies. Consumers' credit constraints, the role of collateral and a portfolio choice are the key ingredients of our analysis. We consider an overlapping generations model where households realize a portfolio choice between three assets with different returns (capital, money and bonds). Expectation-driven fluctuations and the multiplicity of steady states occur under a positive bubble on bonds, gross substitutability and large input substitution because of credit market imperfections. Focusing on the stabilizing role of policies, we show that a progressive taxation on capital income may rule out expectation-driven fluctuations and the multiplicity of steady states. In contrast, a monetary policy under a Taylor rule has a mitigated stabilizing role, depending on the reactiveness of the policy rule and the concavity of the utility function. When the monetary authority decides instead to fix the nominal interest rate regardless the inflation, decreasing the level of the nominal interest rate can rule out expectation-driven fluctuations, restore the uniqueness of steady states, but can damage the welfare at the steady state. |
| Keywords: | Indeterminacy; Rational bubble; Cash-in-advance constraint; Collateral; Progressive taxation; Monetary policy. |
| JEL: | D91 E32 E63 |
| Date: | 2013–08–17 |
| URL: | http://d.repec.org/n?u=RePEc:aim:wpaimx:1343&r=upt |
| By: | Yipeng Yang; Allanus Tsoi |
| Abstract: | A microeconomic approach is proposed to derive the fluctuations of risky asset price, where the market participants are modeled as prospect trading agents. As asset price is generated by the temporary equilibrium between demand and supply, the agents' trading behaviors can affect the price process, which is called the feedback effect. The prospect agents make actions based on their reactions to gains and losses, and as a consequence of the feedback effect, a relationship between the agents' trading behavior and the price fluctuations is constructed, which explains the implied volatility smile and skewness phenomena observed in actual market. |
| Date: | 2013–08 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1308.6759&r=upt |
| By: | Jorge Duran (Université Libre de Bruxelles); Omar Licandro (IAE-CSIC and Barcelona GSE) |
| Abstract: | The permanent decline of equipment prices relative to nondurable consumption prices rendered fixed-base quantity indexes obsolete, because of the well-known substitution bias. National Income and Product Accounts (NIPA) responded by switching to a flexible-base quantity index to measure GDP growth. We argue this is a welfare measure of output growth. In a two-sector endogenous growth model, we use the Bellman equation to explicitly represent preferences on consumption and investment, we apply a Fisher-Shell true quantity index to the this utility representation and show it is equal to the Divisia index, well approximated by the flexible-base quantity index used by NIPA. |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed013:191&r=upt |