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on Utility Models and Prospect Theory |
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Issue of 2014‒01‒17
twenty-one papers chosen by Alexander Harin Modern University for the Humanities |
| By: | Luo, Yulei; Young, Eric |
| Abstract: | We study the portfolio decision of a household with limited information-processing capacity (rational inattention or RI) in a setting with recursive utility. We find that rational inattention combined with a preference for early resolution of uncertainty could lead to a significant drop in the share of portfolios held in risky assets, even when the departure from standard expected utility with rational expectations is small. In addition, we show that the equilibrium equity premium increases with the degree of inattention because inattentive investors with recursive utility face greater long-run risk and thus require higher compensation in equilibrium. Our results are robust to the presence of correlation between the equity return and the RI-induced noise and the presence of non-tradable labor income. |
| Keywords: | Rational Inattention, Recursive Utility, Portfolio Choice, Asset Pricing |
| JEL: | D53 D81 G11 |
| Date: | 2013–07–08 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:52904&r=upt |
| By: | Kraft, Holger; Seifried, Frank Thomas |
| Abstract: | We establish a convergence theorem that shows that discrete-time recursive utility, as developed by Kreps and Porteus (1978), converges to stochastic differential utility, as introduced by Duffie and Epstein (1992), in the continuous-time limit of vanishing grid size. -- |
| Keywords: | Stochastic differential utility,recursive utility,convergence,backward stochastic differential equation |
| JEL: | D81 D91 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:safewp:17&r=upt |
| By: | Donkers, B.; Lourenço, C.J.S.; Dellaert, B.G.C.; Goldstein, D.G. |
| Abstract: | In this paper we propose the use of preferred outcome distributions as a new method to elicit individuals’ value and probability weighting functions in decisions under risk. Extant approaches for the elicitation of these two key ingredients of individuals’ risk attitude typically rely on a long, chained sequence of lottery choices. In contrast, preferred outcome distributions can be elicited through an intuitive graphical interface, and, as we show, the information contained in two preferred outcome distributions is sufficient to identify non-parametrically both the value function and the probability weighting function in rank-dependent utility models. To illustrate our method and its advantages, we run an incentive-compatible lab study in which participants use a simple graphical interface – the Distribution Builder (Goldstein et al. 2008) – to construct their preferred outcome distributions, subject to a budget constraint. Results show that estimates of the value function are in line with previous research but that probability weighting biases are diminished, thus favoring our proposed approach based on preferred outcome distributions. |
| Keywords: | decision making, distribution builder, micro economics, preference elicitation, rank dependent utility, risk preference |
| JEL: | C44 D81 D83 M31 M39 |
| Date: | 2013–05–08 |
| URL: | http://d.repec.org/n?u=RePEc:ems:eureri:39958&r=upt |
| By: | Patrick Beißner (Center for Mathematical Economics, Bielefeld University) |
| Abstract: | The present paper considers a class of general equilibrium economics when the primitive uncertainty model features uncertainty about continuous-time volatility. This requires a set of mutually singular priors, which do not share the same null sets. For this setting we introduce an appropriate commodity space and the dual of linear and continuous price systems. All agents in the economy are heterogeneous in their preference for uncertainty. Each utility functional is a variational type. The existence of equilibrium is approached by a generalized excess utility fixed point argument. Such Arrow-Debreu allocations can be implemented into a Radner economy with continuous-time trading. Effective completeness of the market spaces alters to an endogenous property. Only mean unambiguous claims equivalently satisfying the classical martingale representation property build the marketed space. |
| Keywords: | Knightian uncertainty, variational preferences, general equilibrium, mutually singular priors, dynamic consistency, volatility uncertainty, excess utility map, gross substitutes, risk adjusted priors, sublinear expectation, Radner implementation, incomplete markets |
| JEL: | G10 D50 C62 |
| Date: | 2013–12 |
| URL: | http://d.repec.org/n?u=RePEc:bie:wpaper:493&r=upt |
| By: | Noé Biheng (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris); Jean-Marc Bonnisseau (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris) |
| Abstract: | We consider a family of exchange economies where consumers have multiprior preferences representing their ambiguity aversion. Under a linear independence assumption, we prove that regular economies are generic. Regular economies exhibit enjoyable properties: odd finite number of equilibrium prices, local constancy of this number and local differentiable selections of the equilibrium prices. Thus, even if ambiguity aversion is represented by non-differentiable multiprior preferences, economies retain generically the properties of the differentiable approach. |
| Keywords: | Demand function; general equilibrium; ambiguity aversion; multiprior preferences; regular economies; Lipschitz behavior |
| Date: | 2013–12 |
| URL: | http://d.repec.org/n?u=RePEc:hal:cesptp:halshs-00922782&r=upt |
| By: | Lean, H.H.; McAleer, M.J.; Wong, W-K. |
| 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: | futurres market, mean variance, risk averter, risk seeker, spot market, stochastic dominance |
| JEL: | G12 G15 |
| Date: | 2013–08–01 |
| URL: | http://d.repec.org/n?u=RePEc:ems:eureir:41467&r=upt |
| By: | Michael FinusAlistair Ulph; Alistair Ulph |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:man:sespap:1329&r=upt |
| By: | Ascheberg, Marius; Branger, Nicole; Kraft, Holger |
| Abstract: | We consider the continuous-time portfolio optimization problem of an investor with constant relative risk aversion who maximizes expected utility of terminal wealth. The risky asset follows a jump-diffusion model with a diffusion state variable. We propose an approximation method that replaces the jumps by a diffusion and solve the resulting problem analytically. Furthermore, we provide explicit bounds on the true optimal strategy and the relative wealth equivalent loss that do not rely on results from the true model. We apply our method to a calibrated affine model and find that relative wealth equivalent losses are below 1.16% if the jump size is stochastic and below 1% if the jump size is constant and ... 5. We perform robustness checks for various levels of risk-aversion, expected jump size, and jump intensity. -- |
| Keywords: | Optimal investment,jumps,stochastic volatility,welfare loss |
| JEL: | G11 C63 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:safewp:16&r=upt |
| By: | Kiyohiko G. Nishimura (The University of Tokyo); Hiroyuki Ozaki (Keio Universityo) |
| Abstract: | We consider an infinite-horizon model of a risk-neutral fund-manager who contemplates in each period whether or not to make an irreversible investment which, if made, generates some return under a stochastic environment. Here, the fund-manager evaluates uncertainty by the Choquet expected utility with respect to a convex capacitary kernel and hence she exhibits uncertainty aversion. We provide the exact solution to this problem and show that it takes the form of a reservation strategy: There exists the reservation function such that if the current return exceeds the value of this function, the fund-manager should invest all the money subject to a cash-in-advance constraint; if it does not, she should not make any investment. We also conduct some sensitivity analyses to show that if risk increases in the sense of mean-preserving spread, then the reservation function is raised and that if uncertainty increases in the sense that the set of priors expands, then the reservation function is lowered. |
| Date: | 2014–01 |
| URL: | http://d.repec.org/n?u=RePEc:cfi:fseres:cf337&r=upt |
| By: | Sujoy Mukerji; Robin Cubitt; Gijs van de Kuilen |
| Abstract: | The exchange between Epstein (2010) and Klibanoff et al. (2012) identified a behavioral issue that sharply distinguishes between two classes of models of ambiguity sensitivity, exemplified by the�α-MEU model and the smooth ambiguity model, respectively. The issue in question is whether a subject’s preference for a randomized act (compared to its pure constituents) is influenced by a desire to hedge independently resolving ambiguities. Building on this insight, we implement an experiment whose design provides a qualitative test that discriminates between these importantly distinct classes of models. Among subjects identified as ambiguity sensitive, we find greater support for the class exemplified by the smooth ambiguity model; the relative support is stronger among subjects identified as ambiguity averse. � |
| Keywords: | Ambiguity sensitivity; ambiguity attitude; testing models of ambiguity sensitive preference |
| JEL: | C91 D01 D03 D81 G02 |
| Date: | 2014–01–08 |
| URL: | http://d.repec.org/n?u=RePEc:oxf:wpaper:692&r=upt |
| By: | Qian Lin (Center for Mathematical Economics, Bielefeld University); Frank Riedel (Center for Mathematical Economics, Bielefeld University) |
| Abstract: | We consider optimal consumption and portfolio choice in the presence of Knightian uncertainty in continuous time. We embed the problem into the new framework of stochastic calculus for such settings, dealing in particular with the issue of non-equivalent multiple priors. We solve the problem completely by identifying the worst-case measure. Our setup also allows to consider interest rate uncertainty; we show that under some robust parameter constellations, the investor optimally puts all his wealth into the asset market, and does not save or borrow at all. |
| Date: | 2014–01 |
| URL: | http://d.repec.org/n?u=RePEc:bie:wpaper:497&r=upt |
| By: | Kiss, Hubert Janos; Rodriguez-Lara, Ismael; Rosa-García, Alfonso |
| Abstract: | We report experimental evidence on gender differences in financial decision that involves three depositors choosing between waiting or withdrawing their money from a common bank. We find that the position in the line, the fact of being observed and the observed decisions are key determinants to explain subjects’ behavior. Although both men and women value being observed, it has a greater effect on women’s decisions. Observing a withdrawal increases the likelihood of withdrawal but women and men do not react differently to what is observed, so they are equally likely to panic if a bank run is already underway. Interestingly, risk aversion has no predictive power on depositors’ behavior. |
| Keywords: | bank run; gender difference; strategic uncertainty; experimental evidence; coordination |
| JEL: | C91 D03 D8 G02 J16 |
| Date: | 2014–01–13 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:52912&r=upt |
| By: | Elisa Pagani (Department of Economics (University of Verona)) |
| Abstract: | This paper compares dierent centralized collective models for maximizing the utility of a household from the point of view of the single members that compose it. We describe the collective maximization program as a vector optimization problem and analyze the household welfare and Pareto specication as special scalar cases. The comparisons of these programs reveals interesting relationships among the Lagrangian multiplier and the sharing rule parameters. We also generalize a multiobjective dual problem that leads to the characterization of the individual shares of total income. Hence, we have a measure of the distribution of wealth inside the household. |
| Keywords: | Collective Household Model, Vector Optimization Problems, Scalarization, Vector Duality. |
| JEL: | C61 C30 D11 D13 |
| Date: | 2013–01 |
| URL: | http://d.repec.org/n?u=RePEc:ver:wpaper:02/2013&r=upt |
| By: | Branger, Nicole; Grüning, Patrick; Kraft, Holger; Meinerding, Christoph |
| Abstract: | We analyze the equilibrium in a two-tree (sector) economy with two regimes. The output of each tree is driven by a jump-diffusion process, and a downward jump in one sector of the economy can (but need not) trigger a shift to a regime where the likelihood of future jumps is generally higher. Furthermore, the true regime is unobservable, so that the representative Epstein-Zin investor has to extract the probability of being in a certain regime from the data. These two channels help us to match the stylized facts of countercyclical and excessive return volatilities and correlations between sectors. Moreover, the model reproduces the predictability of stock returns in the data without generating consumption growth predictability. The uncertainty about the state also reduces the slope of the term structure of equity. We document that heterogeneity between the two sectors with respect to shock propagation risk can lead to highly persistent aggregate price-dividend ratios. Finally, the possibility of jumps in one sector triggering higher overall jump probabilities boosts jump risk premia while uncertainty about the regime is the reason for sizeable diffusive risk premia. -- |
| Keywords: | General Equilibrium,Contagion Risk,Partial Information,Filtering,Recursive Utility |
| JEL: | G01 G12 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:safewp:34&r=upt |
| By: | Camille Cornand (GATE Lyon Saint-Étienne - Groupe d'analyse et de théorie économique - CNRS : UMR5824 - Université Lumière - Lyon II - École Normale Supérieure (ENS) - Lyon - PRES Université de Lyon); Frank Heinemann (Fachgebiet Makroökonomik - Technische Universität Berlin) |
| Abstract: | In games with strategic complementarities, public information about the state of the world has a larger impact on equilibrium actions than private information of the same precision, because public signals are more informative about the likely behavior of others. We present an experiment in which agents' optimal actions are a weighted average of the fundamental state and their expectations of other agents' actions. We measure the responses to public and private signals. We find that, on average, subjects put a larger weight on the public signal. In line with theoretical predictions, as the relative weight of the coordination component in a player's utility increases, players put more weight on the public signal when making their choices. However, the weight is smaller than in equilibrium, which indicates that subjects underestimate the information contained in public signals about other players' beliefs. |
| Keywords: | coordination games; strategic uncertainty; private information; public information |
| Date: | 2014–01–07 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:halshs-00925018&r=upt |
| By: | Kraft, Holger; Munk, Claus; Seifried, Frank Thomas; Wagner, Sebastian |
| Abstract: | We show that the optimal consumption of an individual over the life cycle can have the hump shape (inverted U-shape) observed empirically if the preferences of the individual exhibit internal habit formation. In the absence of habit formation, an impatient individual would prefer a decreasing consumption path over life. However, because of habit formation, a high initial consumption would lead to high required consumption in the future. To cover the future required consumption, wealth is set aside, but the necessary amount decreases with age which allows consumption to increase in the early part of life. At some age, the impatience outweighs the habit concerns so that consumption starts to decrease. We derive the optimal consumption strategy in closed form, deduce sufficient conditions for the presence of a consumption hump, and characterize the age at which the hump occurs. Numerical examples illustrate our findings. We show that our model calibrates well to U.S. consumption data from the Consumer Expenditure Survey. -- |
| Keywords: | Consumption hump,life-cycle utility maximization,habit formation,impatience |
| JEL: | D91 D11 D14 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:safewp:15&r=upt |
| By: | Michael Kumhof; Romain Ranciere; Pablo Winant |
| Abstract: | The paper studies how high household leverage and crises can arise as a result of changes in the income distribution. Empirically, the periods 1920-1929 and 1983-2008 both exhibited a large increase in the income share of high-income households, a large increase in debt leverage of the remainder, and an eventual financial and real crisis. The paper presents a theoretical model where higher leverage and crises arise endogenously in response to a growing income share of high-income households. The model matches the profiles of the income distribution, the debt-to-income ratio and crisis risk for the three decades prior to the Great Recession. |
| Keywords: | Income distribution;Private sector;Credit demand;Debt;Financial crisis;Income inequality; wealth inequality; debt leverage; financial crises; wealth in utility; global solution methods. |
| Date: | 2013–12–17 |
| URL: | http://d.repec.org/n?u=RePEc:imf:imfwpa:13/249&r=upt |
| By: | Ketter, W.; Collins, J.; Reddy, P.; Weerdt, M.M. |
| Abstract: | This is the specification for the Power Trading Agent Competition for 2013 (Power TAC 2013). Power TAC is a competitive simulation that models a “liberalized” retail electrical energy market, where competing business entities or “brokers” offer energy services to customers through tariff contracts, and must then serve those customers by trading in a wholesale market. Brokers are challenged to maximize their profits by buying and selling energy in the wholesale and retail markets, subject to fixed costs and constraints. Costs include fees for publication and withdrawal of tariffs, and distribution fees for transporting energy to their contracted customers. Costs are also incurred whenever there is an imbalance between a broker’s total contracted energy supply and demand within a given time slot. The simulation environment models a wholesale market, a regulated distribution utility, and a population of energy customers, situated in a real location on Earth during a specific period for which weather data is available. The wholesale market is a relatively simple call market, similar to many existing wholesale electric power markets, such as Nord Pool in Scandinavia or FERC markets in North America, but unlike the FERC markets we are modeling a single region, and therefore we do not model location-marginal pricing. Customer models include households and a variety of commercial and industrial entities, many of which have production capacity (such as solar panels or wind turbines) as well as electric vehicles. All have “real-time” metering to support allocation of their hourly supply and demand to their subscribed brokers, and all are approximate utility maximizers with respect to tariff selection, although the factors making up their utility functions may include aversion to change and complexity that can retard uptake of marginally better tariff offers. The distribution utility models the regulated natural monopoly that owns the regional distribution network, and is responsible for maintenance of its infrastructure and for real-time balancing of supply and demand. The balancing process is a market-based mechanism that uses economic incentives to encourage brokers to achieve balance within their portfolios of tariff subscribers and wholesale market positions, in the face of stochastic customer behaviors and weather-dependent renewable energy sources. The broker with the highest bank balance at the end of the simulation wins. |
| Keywords: | TAC, autonomous agents, electronic commerce, energy, policy guidance, portfolio management, power, preferences, sustainability, trading agent competition |
| JEL: | C63 O32 Q56 R4 |
| Date: | 2013–05–22 |
| URL: | http://d.repec.org/n?u=RePEc:ems:eureri:40138&r=upt |
| By: | John Karl Scholz (University of Wisconsin-Madison); Ananth Seshadri (University of Wisconsin-Madison) |
| Abstract: | We develop a rich model to study the complex interrelationship between health insurance and retirement decisions. The decision to retire depends on a number of factors including availability of health insurance, health shocks, pensions, Social Security, and how consumption and health interact in the utility function. We incorporate these features in a computational model of optimal wealth and retirement decisions, solving the model household-by-household using data from the HRS. We use the model to study two important SSA priority areas: first, to what extent do people remain in the labor force until age 65 in order to maintain health insurance for themselves (and after age 65 to maintain health insurance for their spouses)? Second, do early retirees have poorer health than others and does the availability of Medicare interact with their decision to claim benefits? |
| Date: | 2013–09 |
| URL: | http://d.repec.org/n?u=RePEc:mrr:papers:wp292&r=upt |
| By: | Hottenrott, Hanna; Lawson, Cornelia |
| Abstract: | This paper empirically investigates complementarities between different sources of research funding with regard to academic publishing. We find for a sample of UK engineering academics that competitive funding is associated with an increase in ex-post publications but that industry funding decreases the marginal utility of public funding by lowering the publication and citation rate increases associated with public grants. However, when holding all other explanatory variables at their mean, the negative effect of the interaction does not translate into an effective decrease in publication and citation numbers. The paper also shows that the positive effect of public funding is driven by UK research council and charity grants and that EU funding has no significant effect on publication outcomes. -- |
| Keywords: | Research Funding,University-Industry Collaboration,Scientific Productivity |
| JEL: | L31 O3 |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:dicedp:129&r=upt |
| By: | Blum, Matthias; Hanley, Nicholas; McLaughlin, Eoin |
| Abstract: | Genuine Savings (GS), also known as ‘net adjusted savings', is a composite indicator of the sustainability of economic development. Genuine Savings reflects year-on-year changes in the total wealth or capital of a country, including net investment in produced capita, investment in human capital, depletion of natural resources, and damage caused by pollution. A negative Genuine Savings rate suggests that the stock of national wealth is declining and that future utility must be less than current utility, indicating that economic development is non-sustainable (Hamilton and Clemens, 1999). We make use of data over a 150 year period to examine the relationship between Genuine Savings and a number of indicators of well-being over time, and compare the relative changes in human, produced, and components of natural capital over the period. Overall, we find that the magnitude of genuine savings is positively related to changes in future consumption, with some evidence of a cointegrating relationship. However, the relationships between genuine savings and infant mortality or average heights are less clear. |
| Keywords: | well-being; Genuine Savings; Net adjusted savings; economic development; Sustainability |
| Date: | 2013–12 |
| URL: | http://d.repec.org/n?u=RePEc:stl:stledp:2013-13&r=upt |