|
on Utility Models and Prospect Theory |
| By: | Alessandra Cillo; Philippe Delquié |
| Abstract: | We study a Mean-Risk model derived from a behavioral theory of Disappointment with multiple reference points. One distinguishing feature of the risk measure is that it is based on mutual deviations of outcomes, not deviations from a specific target. We prove necessary and sufficient conditions for strict first and second order stochastic dominance, and show that the model is, in addition, a Convex Risk Measure. The model allows for richer, and behaviorally more plausible, risk preference patterns than competing models with equal degrees of freedom, including Expected Utility (EU), Mean-Variance (MV), Mean-Gini (MG), and models based on non-additive probability weighting, such a Dual Theory (DT). For example, in asset allocation, the decision-maker can abstain from diversifying in a risky asset unless it meets a threshold performance, and gradually invest beyond this threshold, which appears more acceptable than the extreme solutions provided by either EU and MV (always diversify) or DT and MG (always plunge). In asset trading, the model allows no-trade intervals, like DT and MG, in some, but not all, situations. An illustrative application to portfolio selection is presented. The model can provide an improved criterion for Mean-Risk analysis by injecting a new level of behavioral realism and flexibility, while maintaining key normative properties. Key words: Risk analysis; Uncertainty modeling; Utility theory; Stochastic dominance; Convex risk measures |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:igi:igierp:498&r=upt |
| By: | Hooi Hooi Lean; Michael McAleer (University of Canterbury); Wing-Keung Wong |
| Abstract: | This paper examines risk-averse and risk-seeking investor preferences for oil spot and futures prices by using the mean-variance (MV) criterion and stochastic dominance (SD) approach. The MV findings cannot distinguish between the preferences of spot and futures markets. However, the SD tests show that spot dominates futures in the downside risk, while futures dominate spot in the upside profit. On the other hand, the SD findings suggest that spot dominates futures in downside risk, while futures dominate spot in upside profit. Risk-averse investors prefer investing in the spot index. Risk seekers are attracted to the futures index to maximize their expected utility but not expected wealth in the entire period, as well as for both the OPEC and Iraq War sub-periods. The SD findings show that there is no arbitrage opportunity between the spot and futures markets, and these markets are not rejected as being efficient. |
| Keywords: | Stochastic dominance, mean-variance, risk averter, risk seeker, futures market, spot market. |
| JEL: | C14 G12 G15 |
| Date: | 2013–09–10 |
| URL: | http://d.repec.org/n?u=RePEc:cbt:econwp:13/30&r=upt |
| By: | Larry G. Epstein (Department of Economics, Boston University); Emmanuel Farhi; Tomasz Strzaleck |
| Abstract: | Though risk aversion and the elasticity of intertemporal substitution have been the subjects of careful scrutiny when calibrating preferences, the long-run risks literature as well as the broader literature using recursive utility to address asset pricing puzzles have ignored the full implications of their parameter specica- tions. Recursive utility implies that the temporal resolution of risk matters and a quantitative assessment of how much it matters should be part of the calibration process. This paper gives a sense of the magnitudes of implied timing premia. Its objective is to inject temporal resolution of risk into the discussion of the quantitative properties of long-run risks and related models. |
| Date: | 2013–02 |
| URL: | http://d.repec.org/n?u=RePEc:bos:wpaper:wp2013-002&r=upt |
| By: | Kent Smetters; Xingtan Zhang |
| Abstract: | While the Sharpe ratio is still the dominant measure for ranking risky assets, a substantial effort has been made over the past three decades to find a way to account for non-Normally distributed risks. This paper derives a generalized ranking measure which, under a regularity condition, correctly ranks risks relative to the original investor problem for a broad probability space. Moreover, like the Sharpe ratio, the generalized measure maintains wealth separation for the broad HARA utility class. Besides being effective in the presence of “fat tails,” the generalized measure is also a foundation for multi-asset class portfolio optimization due to its ability to pairwise rank two risks following two different probability distributions. This paper also explores the theoretical foundations of risk ranking, including proving a key impossibility theorem: any ranking measure that is valid for non-Normal distributions cannot generically be free from investor preferences. Finally, this paper shows that the generalized ratio provides substantially more ranking power than simpler approximation measures that have sometimes been used in the past to account for non-Normal higher moments, even if those approximations are extended to include an infinite number of higher moments. |
| JEL: | G11 |
| Date: | 2013–10 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:19500&r=upt |
| By: | Francoise Forges (LEDa - Laboratoire d'Economie de Dauphine - Université Paris IX - Paris Dauphine, CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - CNRS : UMR7534 - Université Paris IX - Paris Dauphine); Vincent Iehlé (LEDa - Laboratoire d'Economie de Dauphine - Université Paris IX - Paris Dauphine, CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - CNRS : UMR7534 - Université Paris IX - Paris Dauphine) |
| Abstract: | We identify a natural counterpart of the standard GARP for demand data in which goods are all indivisible. We show that the new axiom (DARP, for "discrete axiom of revealed preference") is necessary and sufficient for the rationalization of the data by a well-behaved utility function. Our results complement the main finding of Polisson and Quah, Am. Econ. J.: Micro. 5(1) p.28-34 (2013), who rather minimally modify the original consumer problem with indivisible goods so that the standard GARP still applies. |
| Keywords: | Afriat's theorem, GARP; indivisible goods; rationalization; revealed preference |
| Date: | 2013–10–04 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:halshs-00870052&r=upt |
| By: | Sergiu Hart; Andreu Mas-Colell |
| Abstract: | Inspired by the existing work on correlated equilibria and regret-based dynamics in games, we carry out a first exploration of the links between the leading equilibrium concept for (exchange) economies, Walrasian equilibrium, and the dynamics, specifically regret-matching dynamics, of trading games that fit the economic structure and have the property that their pure Nash equilibria implement the Walrasian outcomes. Interestingly, in the case of quasilinear utilities (or "transferable utility"), all the concepts essentially coincide, and we get simple deterministic dynamics converging to Walrasian outcomes. Connections to sunspot equilibria are also studied. |
| Date: | 2013–09 |
| URL: | http://d.repec.org/n?u=RePEc:huj:dispap:dp648&r=upt |
| By: | Pigini, Claudia; Staffolani, Stefano |
| Abstract: | In this paper, we analyze the higher education choices of Italian secondary school leavers by addressing the roles of university quality, costs and geographical distance to the institution as well as the relationship between students’ choices and their personal and household’s attributes, such as individual secondary school background and the socio-economic condition of the family of origin. Grounding such decision process on the framework of the Random Utility Model (RUM), we provide empirical evidence on the determinants of students’ choices by estimating a nested logit model on the ISTAT survey of secondary school graduates. Results show that the effects of increasing costs of enrollments and university standards are strongly differentiated across sub-groups of individuals. In particular, the choice probability of weaker students, in the sense of secondary school background and household’s socio–economic condition, is more sensitive to changes in university costs and quality. |
| Keywords: | Enrollment cost, university quality, geographical distance, university choice, Random Utility Maximization model. |
| JEL: | C25 I21 I23 J24 |
| Date: | 2013–10–03 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:50364&r=upt |
| By: | Nicollier, Luciana A (Department of Economics, University of Warwick) |
| Abstract: | Empirical evidence suggests that online reviews are an important source of consumers information and a relevant determinant of the rms revenues. Little is known, however, about how prices and reviews a ect each other. This paper proposes a dynamic game to investigate this relationship. A long-lived monopoly faces a sequence of short-lived consumers whose only information about the value of an experience good is the one contained in the reviews completed by previous buyers. Neither the monopoly nor the consumers have private information about the value of the good. After buying the good, the consumers observe a quality realisation that is correlated with the actual value of the good and decide whether to complete reviews. The consumers complete reviews according to a social rule that maximises the present value of current and future consumers utility. It is shown that a necessary condition for the existence of reviews is that the firm cannot fully appropriate the surplus generated by this increased information. Furthermore, the reviews induce a mean preserving spread on the posterior beliefs about the value of the good which, combined with the convexity with respect to the prior of the indirect utility and profit functions, implies that reviews are valuable for both the consumers and the firm. Hence, both parties are willing to face some cost in order to increase the information available in the market. The main result of the paper is that, from the firm's perspective, this cost takes the form of a discount in the price o ered to current consumers. JEL classification: Customer Reviews ; Monopoly ; Information Transmission JEL codes: L12 ; L15; D42 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:wrk:warwec:1029&r=upt |