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on Utility Models and Prospect Theory |
| 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 |
| URL: | http://d.repec.org/n?u=RePEc:ucd:wpaper:201404&r=upt |
| By: | Peon, David; Calvo, Anxo; Antelo, Manel |
| Abstract: | Two relevant areas in the behaviorist literature are prospect theory and overconfidence. Many tests are available to elicit their different manifestations: utility curvature, probability weighting and loss aversion in PT; overestimation, overplacement and overprecision as measures of overconfidence. Those tests are suitable to deal with single manifestations but often unfeasible, in terms of time to be performed, to determine a complete psychological profile of a given respondent. This paper contributes to provide two short tests, based on classic works in the literature, to derive a complete profile on prospect theory and overconfidence. We conduct an experimental research with 126 students to validate the tests, revealing they are broadly efficient to replicate the regular results in the literature. The experimental analysis of all measures of overconfidence and prospect theory using the same sample of respondents allows us to provide new insights on the relationship between these two areas. Finally, enhancements for future research are suggested. |
| Keywords: | Experimental economics, overconfidence, prospect theory, behavioral finance, utility measurement, overestimation, overplacement, overprecision |
| JEL: | C91 D03 D81 |
| Date: | 2014–03–05 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:54135&r=upt |
| By: | Dominique Pepin (CRIEF - Centre de Recherche sur l'Intégration Economique et Financière - Université de Poitiers) |
| Abstract: | The standard asset pricing models (the CCAPM and the Epstein-Zin non-expected utility model) counterintuitively predict that equilibrium asset prices can rise if the representative agent's risk aversion increases. If the income effect, which implies enhanced saving as a result of an increase in risk aversion, dominates the substitution effect, which causes the representative agent to reallocate his portfolio in favour of riskless assets, the demand for securities increases. Thus, asset prices are forced to rise when the representative agent is more risk adverse. By disentangling risk aversion and intertemporal substituability, we demonstrate that the risky asset price is an increasing function of the coefficient of risk aversion only if the elasticity of intertemporal substitution (EIS) exceeds unity. This result, which was first proved par Epstein (1988) in a stationary economy setting with a constant risk aversion, is shown to hold true for non-stationary economies with a variable or constant risk aversion coefficient. The conclusion is that the EIS probably exceeds unity. |
| Keywords: | risk aversion ; elasticity of intertemporal substitution ; CCAPM ; asset prices |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-00955590&r=upt |
| By: | Aase, Knut K. (Dept. of Business and Management Science, Norwegian School of Economics) |
| Abstract: | We derive the equilibrium interest rate and risk premiums using recursive utility with heterogeneity in a continuous time model. Two ordinally equivalent versions are considered, each associated with a different set of risk premiums and interest rate. The first version has consumption history dependent marginal utility and is homogeneous of degree one in consumption, the second version is homothetic. When solving the resulting sup-convolution problem, this gives non-trivial results. A heterogeneous two-agent model is calibrated to the data of Mehra and Prescott (1985) assuming the market portfolio is not a proxy of the wealth portfolio. This results in stable and plausible values for the preference parameters of the two agents. |
| Keywords: | The equity premium puzzle; the risk-free rate puzzle; recursive utility; utility gradients; the stochastic maximum principle; heterogeneity; limited market participation |
| JEL: | D51 D53 D90 E21 G10 G12 |
| Date: | 2014–02–28 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:nhhfms:2014_005&r=upt |
| By: | Thai Ha-Huy; Cuong Le Van; Manh-Hung Nguyen |
| Abstract: | We consider a model with an inffnite number of states of nature, von Neumann - Morgenstern utilities, where agents have different probabil- ity beliefs and where short sells are allowed. We show that no-arbitrage conditions, deffned for ffnite dimensional asset markets models, are not sufficient to ensure existence of equilibrium in presence of an inffnite num- ber of states of nature. However, if the individually rational utility set U is compact, we obtain an equilibrium. We give conditions which imply the compactness of U. We give examples of non-existence of equilibrium when these conditions do not hold. |
| Keywords: | asset market equilibrium, individually rational attainable al- locations, individually rational utility set, no-arbitrage prices, no-arbitrage condition. |
| JEL: | C62 D50 D81 D84 G1 |
| Date: | 2014–02–25 |
| URL: | http://d.repec.org/n?u=RePEc:ipg:wpaper:2014-100&r=upt |
| By: | Sarah Jacobson (Williams College); Jason Delaney (School of Business Administration, Georgia Gwinnett College); Thorsten Moenig (Department of Mathematics, University of St. Thomas) |
| Abstract: | We develop an axiomatic theory that integrates the discovered preference hypothesis into neoclassical microeconomic choice theory. A theory in which preferences must be discovered through experience can explain patterns observed in choice data, including preference reversals, evolution of or instability in risky choice, and errors that decline with repetition as seen in contingent valuation data. With reasonable assumptions, we show that preferences for common, high-ranked, and non-stochastic choice items are learned quickly and thus should appear stable. However, initially low-ranked choice items may remain persistently mis-ranked. Preferences for choice items with stochastic outcomes are difficult to learn, so choice under uncertainty is subject to error. At finite time, a choice item is more likely to be mis-ranked if it has stochastic outcomes, if it is initially low-ranked, or if it appears rarely in choice sets. The existence of a default option may or may not render correct ranking more difficult. Undiscovered preferences can lead to real welfare loss as agents make choices not congruent with their true preferences. This theory is amenable to tests using laboratory experiments. Preference discovery has implications for policy, and the process of discovery may contaminate choice data in a variety of contexts. |
| Keywords: | discovered preferences, preference stability, learning, risk preferences |
| JEL: | D81 D83 D01 D03 |
| Date: | 2014–03 |
| URL: | http://d.repec.org/n?u=RePEc:wil:wileco:2014-02&r=upt |
| By: | Brendan Markey-Towler (School of Economics, The University of Queensland) |
| Abstract: | In standard models of rational choice it is typically taken for granted that preferences are given and defined over the alternatives alone, and the possibility of making a rational choice is simply a matter of assumption. In this paper I generalise this aspect of the economic model so that preferences over alternatives are constructed from given preferences defined over various characteristics of the alternatives under consideration. I characterise the decision problem before investigating what conditions a procedure for aggregating preferences over attributes into preferences over alternatives must satisfy in order for the latter to be rational. I then consider what the implications of these conditions for the procedural rationality of the aggregation process. |
| Date: | 2014–03–03 |
| URL: | http://d.repec.org/n?u=RePEc:qld:uq2004:507&r=upt |
| By: | Franz Dietrich; Christian List |
| Abstract: | "Reason-based rationalizations" explain an agent's choices by specifying which properties of the options or choice context he/she cares about (the "motivationally salient properties") and how he/she cares about these properties the "fundamental preference relation"). We characterize the choice-behavioural implications of reason-based rationalizability and identify two kinds of context-dependent motivation in a reason-based agent: he/she may (i) care about different properties in different contexts and (ii) care not only about properties of the options, but also about properties relating to the context. Reason-based rationalizations can explain non-classical choice behaviour, including boundedly rational and sophisticated rational behaviour, and predict choices in unobserved contexts, an issue neglected in standard choice theory. |
| JEL: | D01 |
| Date: | 2014–01 |
| URL: | http://d.repec.org/n?u=RePEc:cep:stitep:/2014/565&r=upt |
| By: | Jason Hartford and Nic Spearman |
| Abstract: | This study exploits a natural experiment to evaluate the gender bias effect associated with negative marking due to gender-differentiated risk aversion. This approach avoids framing effects that characterize experimental evaluation of negative marking assessments. Evidence of a gender bias against female students is found. Quantile regressions indicate that female students in higher quantiles are substantially more adversely affected by negative marking. This distribution effect has been overlooked by prior studies, but has important policy implications for higher learning institutions where access to bursary and scholarship funding, as well as access to further study opportunities, is reserved for top performing candidates. |
| Keywords: | Risk aversion, Gender Discrimination |
| JEL: | J16 D81 I24 A20 C21 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:rza:wpaper:418&r=upt |
| By: | FELIPE ALMEIDA |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:anp:en2013:008&r=upt |
| By: | Andersson, Ola (Research Institute of Industrial Economics (IFN)); Huysentruyt, Marieke (London School of Economics); Miettinen, Topi (Hanken School of Economics at HECER); Stephan, Ute (Aston Business School) |
| Abstract: | We investigate the effects of organizational culture and personal value orientations on performance under individual and team contest incentives. We develop a model of regard for others and in-group favoritism predicting interaction effects between organizational culture and personal values in the contest games. The predictions are tested in a computerized lab experiment with exogenous control of both organizational culture and incentives. In line with our theoretical model we find that prosocial (proself) orientated subjects exert more (less) effort in team contests in the primed prosocial organizational culture condition, relative to the neutrally primed baseline condition. Further, when the prosocial organizational culture is combined with individual contest incentives, prosocial subjects no longer outperform their proself counterparts. These findings provide a first, affirmative, causal test of person-organization fit theory. They also suggest the importance of a 'triple-fit' between personal preferences, organizational culture and incentive mechanisms for prosocially orientated individuals. |
| Keywords: | Tournaments; Organizational culture; Personal values; Person-organization fit; Teams; Economic incentives |
| JEL: | C91 D02 D23 J33 M52 |
| Date: | 2014–02–27 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:iuiwop:1010&r=upt |
| By: | Schwarz, Claudia |
| Abstract: | This paper uses the method developed by Bollerslev and Todorov (2011b) to estimate risk premia for extreme events for the US and the German stock markets. The method extracts jump tail measures from high-frequency futures price data and from options data. In a second step, jump tail distributions are approximated using the extreme value theory. Applying the method to German data yields very similar results to the ones shown for the US data. The risk premia for rare events constitute a considerable part of the total equity and variance risk premia for both markets. When using the results to build an investor fear index for the US and Germany, I find that the correlation of the fear index for the US with the VIX is 89.5% and that of the fear index for Germany with the VDAX is 90.6%. -- |
| Keywords: | crisis indicator,extreme value theory,implied moments |
| JEL: | C13 G10 G12 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:bubdps:032014&r=upt |