nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2014‒03‒08
ten papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Performance of Utility Based Hedges By John Cotter; Jim Hanly
  2. Arbitrage and asset market equilibrium in finite dimensional economies with short-selling and risk-averse expected utilities By Thai Ha-Huy; Cuong Le Van
  3. Stated and Revealed Heterogeneous Risk Preferences in Educational Choice By Frank M. Fossen; Daniela Glocker
  4. No Two Experiments are Identical By Epstein, Larry G.; Halevy, Yoram
  5. Prospect Theory for Online Financial Trading By Yang-Yu Liu; Jose C. Nacher; Tomoshiro Ochiai; Mauro Martino; Yaniv Altshuler
  6. Time-Inconsistent Mean-Utility Portfolio Selection with Moving Target By Hanqing Jin; Yimin Yang
  7. Buying and Selling Risk - An Experiment Investigating Evaluation Asymmetries By Werner Güth; Matteo Ploner; Ivan Soraperra
  8. Expert Opinions and Logarithmic Utility Maximization in a Market with Gaussian Drift By Abdelali Gabih; Hakam Kondakji; J\"orn Sass; Ralf Wunderlich
  9. Incomplete Contracting, Renegotiation, and Expectation-Based Loss Aversion By Herweg, Fabian; Karle, Heiko; Müller, Daniel
  10. Global Risk Aversion, the Benchmark Index and the Foreign Investors: The case of Borsa Istanbul By Evren Arik; Elif Mutlu

  1. By: John Cotter (UCD School of Business, University College Dublin); Jim Hanly (UCD School of Business, University College Dublin)
    Abstract: Hedgers as investors are concerned with both risk and return; however the literature has generally neglected the role of both returns and investor risk aversion by its focus on minimum variance hedging. In this paper we address this by using utility based performance metrics to evaluate the hedging effectiveness of utility based hedges for hedgers with both moderate and high risk aversion together with the more traditional minimum variance approach. We apply our approach to two asset classes, equity and energy, for three different hedging horizons, daily,weekly and monthly. We find significant differences between the minimum variance and utility based hedges and their attendant performance in-sample for all frequencies. However out of sample performance differences persist for the monthly frequency only.
    Keywords: Energy, Hedging Performance; Utility, Risk Aversion
    JEL: G10 G12 G15
    Date: 2014–02–19
  2. By: Thai Ha-Huy; Cuong Le Van
    Abstract: We consider a model with an finite number of states of nature where short sells are allowed.
    Keywords: asset market equilibrium, individually rational attainable allocations, individually rational utility set, no-arbitrage prices, no-arbitrage condition.
    JEL: C62 D50 D81 D84 G1
    Date: 2014–02–25
  3. 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 Arrow-Pratt 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
  4. By: Epstein, Larry G.; Halevy, Yoram
    Abstract: We study choice between bets on the colors of two balls, where one ball is drawn from each of two urns. Though you are told the same about each urn, you are told very little, so that you are not given any reason to be certain that the compositions are identical. We identify choices that reveal an aversion to ambiguity about the relation between urns, thus identifying a source of uncertainty different from the usual Knightian distinction between risk and ambiguity. Choice behavior is studied in a controlled high-stakes laboratory experiment, and the ability of new and existing models to rationalize the experimental findings is examined.
    Keywords: ambiguity, uncertainty, correlation, Ellsberg
    JEL: D81 D91
    Date: 2014–02–22
  5. By: Yang-Yu Liu; Jose C. Nacher; Tomoshiro Ochiai; Mauro Martino; Yaniv Altshuler
    Abstract: Prospect theory is widely viewed as the best available descriptive model of how people evaluate risk in experimental settings. According to prospect theory, people are risk-averse with respect to gains and risk-seeking with respect to losses, a phenomenon called "loss aversion". Despite of the fact that prospect theory has been well developed in behavioral economics at the theoretical level, there exist very few large-scale empirical studies and most of them have been undertaken with micro-panel data. Here we analyze over 28.5 million trades made by 81.3 thousand traders of an online financial trading community over 28 months, aiming to explore the large-scale empirical aspect of prospect theory. By analyzing and comparing the behavior of winning and losing trades and traders, we find clear evidence of the loss aversion phenomenon, an essence in prospect theory. This work hence demonstrates an unprecedented large-scale empirical evidence of prospect theory, which has immediate implication in financial trading, e.g., developing new trading strategies by minimizing the effect of loss aversion. Moreover, we introduce three risk-adjusted metrics inspired by prospect theory to differentiate winning and losing traders based on their historical trading behavior. This offers us potential opportunities to augment online social trading, where traders are allowed to watch and follow the trading activities of others, by predicting potential winners statistically based on their historical trading behavior rather than their trading performance at any given point in time.
    Date: 2014–02
  6. By: Hanqing Jin; Yimin Yang
    Abstract: In this paper, we solve the time inconsistent portfolio selection problem by using different utility functions with a moving target as our constraint. We solve this problem by finding an equilibrium control under the given definition as our optimal control. We firstly derive a sufficient equilibrium condition for second-order continuously differentiable utility funtions. Then we use power functions of order two, three and four in our problem and find the respective condtions for obtaining an equilibrium for our different problems. In the last part of the paper, we consider using another definition of equilibrium to solve our problem when the utility function that we use in our problem is the negative part of x and also find the condtions for obtaining an equilibrium.
    Date: 2014–02
  7. By: Werner Güth; Matteo Ploner; Ivan Soraperra
    Abstract: Experimental studies of the WTP-WTA gap avoid social trading by implementing an incentive compatible mechanism for each individual trader. We compare a traditional random price mechanism and a novel elicitation mechanism preserving social trading, without sacrificing mutual incentive compatibility. Furthermore, we focus on risky goods - binary monetary lotteries - for which asymmetries in evaluations are more robust with respect to experimental procedures. For both elicitation mechanisms, the usual asymmetry in evaluation by sellers and buyers is observed. An econometric estimation sheds new light on its causes: potential buyers are over-pessimistic and systematically underweight the probability of a good outcome.
    Keywords: WTP-WTA gap, risk, elicitation mechanisms, probability weighting
    JEL: D81
    Date: 2014
  8. By: Abdelali Gabih; Hakam Kondakji; J\"orn Sass; Ralf Wunderlich
    Abstract: This paper investigates optimal portfolio strategies in a financial market where the drift of the stock returns is driven by an unobserved Gaussian mean reverting process. Information on this process is obtained from observing stock returns and expert opinions. The latter provide at discrete time points an unbiased estimate of the current state of the drift. Nevertheless, the drift can only be observed partially and the best estimate is given by the conditional expectation given the available information, i.e., by the filter. We provide the filter equations in the model with expert opinion and derive in detail properties of the conditional variance. For an investor who maximizes expected logarithmic utility of his portfolio, we derive the optimal strategy explicitly in different settings for the available information. The optimal expected utility, the value function of the control problem, depends on the conditional variance. The bounds and asymptotic results for the conditional variances are used to derive bounds and asymptotic properties for the value functions. The results are illustrated with numerical examples.
    Date: 2014–02
  9. By: Herweg, Fabian; Karle, Heiko; Müller, Daniel
    Abstract: We consider a simple trading relationship between an expectation-based loss-averse buyer and profit-maximizing sellers. When writing a long-term contract the parties have to rely on renegotiations in order to ensure materially efficient trade ex post. The type of the concluded long-term contract affects the buyer’s expectations regarding the outcome of renegotiation. If the buyer expects renegotiation always to take place, the parties are always able to implement the materially efficient good ex post. It can be optimal for the buyer, however, to expect that renegotiation does not take place. In this case, a good of too high quality or too low quality is traded ex post. Based on the buyer’s expectation management, our theory provides a rationale for “employment contracts†in the absence of non-contractible investments. Moreover, in an extension with non-contractible investments, we show that loss aversion can reduce the hold-up problem.
    Keywords: Behavioral Contract Theory; Expectation-Based Loss Aversion; Incomplete Contracts; Renegotiation
    JEL: C78 D03 D86
    Date: 2014–02–13
  10. By: Evren Arik; Elif Mutlu
    Abstract: This paper investigates the foreign equity holdings at Borsa Ýstanbul. Employing the augmented VAR model, we find that the VIX Index which is accepted as a key indicator for global investor sentiment, has an explanatory power on the net foreign equity holdings, the foreign market capitalization ratio and the BIST 100 Index. Analyzing the interaction between the BIST 100 Index and the foreign equity holdings we find that the BIST 100 Index has the leading role; utilizing daily returns of up to 10 days, we also find evidence that foreign investors at Borsa Ýstanbul pursue momentum investing.
    Date: 2014–01

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