
on Utility Models and Prospect Theory 
By:  Zhang, Bei (Federal Reserve Bank of Kansas City); Chu, RongWei; Zhang, Bei 
Keywords:  Wealth distribution; Risk aversion 
Date:  2014–01–01 
URL:  http://d.repec.org/n?u=RePEc:fip:fedkrw:rwp1309&r=upt 
By:  Frederik Herzberg (Center for Mathematical Economics, Bielefeld University) 
Abstract:  The problem of how to rationally aggregate probability measures occurs in particular (i) when a group of agents, each holding probabilistic beliefs, needs to rationalise a collective decision on the basis of a single ‘aggregate belief system’ and (ii) when an individual whose belief system is compatible with several (possibly infinitely many) probability measures wishes to evaluate her options on the basis of a single aggregate prior via classical expected utility theory (a psychologically plausible account of individual decisions). We investigate this problem by first recalling some negative results from preference and judgment aggregation theory which show that the aggregate of several probability measures should not be conceived as the probability measure induced by the aggregate of the corresponding expectedutility preferences. We describe how McConway’s (Journal of the American Statistical Association, vol. 76, no. 374, pp. 410–414, 1981) theory of probabilistic opinion pooling can be generalised to cover the case of the aggregation of infinite profiles of finitely additive probability measures, too; we prove the existence of aggregation functionals satisfying responsiveness axioms à la McConway plus additional desiderata even for infinite electorates. On the basis of the theory of propositionalattitude aggregation, we argue that this is the most natural aggregation theory for probability measures. Our aggregation functionals for the case of infinite electorates are neither oligarchic nor integralbased and satisfy (at least) a weak anonymity condition. The delicate settheoretic status of integralbased aggregation functionals for infinite electorates is discussed. 
Keywords:  probabilistic opinion pooling, general aggregation theory, Richard Bradley, multiple priors, Arrow’s impossibility theorem, Bayesian epistemology, society of mind, finite anonymity, ultrafilter, measure problem, nonstandard analysis 
JEL:  D71 D81 C11 
Date:  2014–01 
URL:  http://d.repec.org/n?u=RePEc:bie:wpaper:499&r=upt 
By:  Annalisa Fabretti (University of Rome Tor Vergata); Stefano Herzel (University of Rome Tor Vergata); Mustafa C. Pinar (Bilkent University, Dept of Industrial Engineering) 
Abstract:  We examine the problem of setting optimal incentives for a portfolio manager hired by an investor who wants to induce ambiguityrobust portfolio choices with respect to estimation errors in expected returns. We consider a oneperiod model with a set of risky assets (with multivariate normal returns) whose expected returns are estimated with uncertainty and a linear sharing rule between a riskneutral investor and a risk averse portfolio manager. The manager accepts the contract if the compensation offered is at least as large as a minimum compensation he determines from his minimum acceptable utility level. Adopting a worstcase maxmin approach we obtain in closedform the optimal compensation in various cases where the investor and the manager, respectively adopt or relinquish an ambiguity averse attitude. We apply our result to compute the compensation fees for an investment strategy restricted by Socially Responsible rules. The application shows, for instance, that the additional premium requested by a manager for restricting the investment set should decrease when the aversion to ambiguity increases. 
Keywords:  Delegated Portfolio Management, ambiguity, robust optimization 
Date:  2014–02–06 
URL:  http://d.repec.org/n?u=RePEc:rtv:ceisrp:304&r=upt 
By:  Frank M. Fossen; Daniela Glocker 
Abstract:  Stated survey measures of risk preferences are increasingly being used in the literature, and they have been compared to revealed risk aversion primarily by means of experiments such as lottery choice tasks. In this paper, we investigate educational choice, which involves the comparison of risky future income paths and therefore depends on risk and time preferences. In contrast to experimental settings, educational choice is one of the most important economic decisions taken by individuals, and we observe actual choices in representative panel data. We estimate a structural microeconometric model to jointly reveal risk and time preferences based on educational choices, allowing for unobserved heterogeneity in the ArrowPratt risk aversion parameter. The probabilities of membership in the latent classes of persons with higher or lower risk aversion are modelled as functions of stated risk preferences elicited in the survey using standard questions. Two types are identified: A small group with high risk aversion and a large group with low risk aversion. The results indicate that persons who state that they are generally less willing to take risks in the survey tend to belong to the latent class with higher revealed risk aversion, which indicates consistency of stated and revealed risk preferences. The relevance of the distinction between the two types for educational choice is demonstrated by their distinct reactions to a simulated tax policy scenario. 
Keywords:  Educational choice, stated preferences, revealed preferences, risk aversion, time preference 
JEL:  I20 D81 
Date:  2014 
URL:  http://d.repec.org/n?u=RePEc:diw:diwwpp:dp1361&r=upt 
By:  Malakhov, Sergey 
Abstract:  The paper argues that sunk costs’ sensitivity can lead to the optimal consumptionleisure choice under price dispersion. The increase in quantity to be purchased with the extension of the time horizon of the consumptionleisure choice equalizes marginal costs of search with its marginal benefits. The implicit optimal choice results in the explicit satisficing decision. The transformation of cognitive mechanism of discouragement into satisficing happens only in the “common model” of consumer behavior. The paper argues that the cognitive mechanism of aspiration takes place when consumers try to get marginal savings on purchase greater than the wage rate and, therefore, they follow the “leisure model” of behavior where both the marginal utility of labor income and the marginal utility of consumption become negative. 
Keywords:  sunk costs, consumptionleisure choice, search, satisficing, maximizing 
JEL:  D11 D83 
Date:  2014–02 
URL:  http://d.repec.org/n?u=RePEc:pra:mprapa:53493&r=upt 
By:  Daniel Friedman (University of California at Santa Cruz) József Sákovics (The University of Edinburgh) 
Abstract:  We derive a rational model of separable consumer choice which can also serve as a behavioral model. The central construct is lambda, the marginal utility of money, derived from the consumer's restoflife problem. We present a robust approximation of lambda, and show how to incorporate liquidity constraints, indivisibilities and adaptation to a changing environment. We find connections with numerous historical and recent constructs, both behavioral and neoclassical, and draw contrasts with standard partial equilibrium analysis. The result is a better grounded, more flexible and more intuitive description 
Keywords:  distributed choice, moneysworth demand, value for money. 
JEL:  D01 D03 D11 
Date:  2014–02–03 
URL:  http://d.repec.org/n?u=RePEc:edn:esedps:240&r=upt 
By:  Breaban, A.; Noussair, C.N. (Tilburg University, Center for Economic Research) 
Abstract:  Abstract: We report results from an asset market experiment, in which we investigate how the time path of the fundamental value trajectory affects the level of adherence to fundamentals. In contrast to previous experiments with longlived assets, there is a phase in which fundamental values are constant before the onset of a trend. The trend is either increasing or decreasing, depending on the treatment. We compare the level of mispricing between the decreasing and increasing fundamental value trajectories. Before the market begins, risk aversion, loss aversion, and cognitive reflection protocols are administered to traders. We find evidence for closer adherence to fundamental values when the trajectory follows a decreasing, than when it has an increasing, trend. Greater average risk aversion on the part of traders in the market predicts lower market prices. The greater the level of loss aversion of the trader cohort, the lower the quantity traded. The greater the average cognitive reflection test score, the smaller the differences between market prices and fundamental values. The variation between groups in risk aversion, loss aversion, and CRT score, explains an additional 44% and 18% of the cohortlevel variation in price level and mispricing, respectively, compared to a model including only treatment, experience level, and subject pool. 
Keywords:  Bubble;Experiment;Risk Aversion;Loss Aversion;Cognitive Reflection 
JEL:  C9 G12 
Date:  2014 
URL:  http://d.repec.org/n?u=RePEc:dgr:kubcen:2014010&r=upt 
By:  Sarah Necker; Michael Ziegelmeyer 
Abstract:  This study investigates whether and how the crisis in 2008/2009 affects households' risk attitudes, subjective risk and return expectations, and planned financial risk taking using the German SAVE study. Households' wealth change from end2007 to end2009 is not found to have an effect. However, households that attribute losses to the crisis decreased their risk tolerance and planned risk taking; the probability of expecting an increase in risks and returns is raised. According to economic theory, wealth changes attributed to a dramatic event should not have a different effect than other wealth changes. The results suggest an emotional reaction. 
Keywords:  Financial and economic crisis, risk preferences, stock market expectations, wealth fluctuations, emotions 
JEL:  D81 D14 G11 
Date:  2014–02 
URL:  http://d.repec.org/n?u=RePEc:bcl:bclwop:bclwp085&r=upt 
By:  Grohn, Jan; Huck, Steffen; Valasek, Justin Mattias 
Abstract:  In this note we shall discuss a concept that  despite its prominence in both Hume (1739) and Smith (1759), its obvious relevance for social behavior, and its not so infrequent use in colloquial language  has never gained a foothold in economic theory: the concept of empathy. Specifically, we illustrate how some insights from the psychological literature on empathy can be incorporated into a standard utility framework, and demonstrate the potential interaction of beliefs and utility through the channel of empathy.  In diesem Artikel diskutieren wir das Konzept der Empathie. Dieses konnte in der ökonomischen Theorie nie wirklich Fuß fassen, trotz seiner Bedeutung sowohl bei Hume (1739) als auch Smith (1759), seiner offensichtlichen Relevanz für soziales Verhalten und seines durchaus verbreiteten Gebrauchs in der Umgangssprache. Insbesondere zeigen wir, wie einige Erkenntnisse aus der psychologischen Literatur über Empathie in ein Standardkonzept von 'Nutzen' integriert werden können und demonstrieren die potenzielle Interaktion von Erwartungen und Nutzen über den Weg der Empathie. 
Keywords:  Empathy,Belief Formation,Preferences 
JEL:  D03 D83 
Date:  2014 
URL:  http://d.repec.org/n?u=RePEc:zbw:wzbeoc:spii2014301&r=upt 
By:  Mark Dean; Anja Sautmann 
Abstract:  Incentivized experiments are commonly used to estimate marginal rate of intertemporal substitution (MRS) in the lab and in the ?eld, and to make inferences about subject’s time preference. This paper considers the implications of an integrated model of behavior in which individuals are subject to ?nancial shocks and credit constraints and take those into account when making experimental choices. The model shows that measured MRS depends on the individual’s e?ective interest rate and her marginal utility of current and future consumption. Experimental responses should therefore be correlated with other variables that describe the subject’s ?nancial situation, like savings, income and consumption shocks. We test the model with a panel data set from Mali and ?nd evidence for such e?ects. We discuss how our model can be combined with repeated time preference measures to identify time preferences and other household characteristics  including credit constraints and the importance of di?erent types of ?nancial shocks. 
Keywords:  # 
Date:  2014 
URL:  http://d.repec.org/n?u=RePEc:bro:econwp:20141&r=upt 
By:  Steven Shavell 
Abstract:  This article develops two points. First, insurance against the risk of legal change is largely unavailable, primarily because of the correlated nature of the losses that legal change generates. Second, given the absence of insurance against legal change, it is generally desirable for legal change to be attenuated. Specifically, in a model of uncertainty about two different types of legal change—in regulatory standards, and in payments for harm caused—it is demonstrated that the optimal new regulatory standard is less than the conventionally efficient standard, and that the optimal new payment for harm is less than the harm. 
JEL:  H8 K10 K20 
Date:  2014–02 
URL:  http://d.repec.org/n?u=RePEc:nbr:nberwo:19879&r=upt 
By:  Erhan Bayraktar; Yuchong Zhang 
Abstract:  We determine the optimal robust investment strategy of an individual who targets at a given rate of consumption and seeks to minimize the probability of lifetime ruin when she does not have perfect confidence in the drift of the risky asset. Using stochastic control, we characterize the value function as the unique classical solution of an associated HamiltonJacobiBellman (HJB) equation, obtain feedback forms for the optimal investment and drift distortion, and discuss their dependence on various model parameters. In analyzing the HJB equation, we establish the existence and uniqueness of viscosity solution using Perron's method, and then upgrade regularity by working with an equivalent convex problem obtained via the ColeHopf transformation. We show the original value function may lose convexity for a class of parameters and the Isaacs condition may fail. Numerical examples are also included to illustrate our results. 
Date:  2014–02 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1402.1809&r=upt 