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on Utility Models and Prospect Theory |
| By: | Robert E. Marks (School of Economics, Australian School of Business, the University of New South Wales) |
| Abstract: | The purpose of this research is to search for the best (highest performing) risk profile of agents who successively choose among risky prospects. An agent’s risk profile is his attitude to perceived risk, which can vary from risk preferring to risk neutral (an expected-value decision maker) to risk averse. We use the Genetic Algorithm to search in the complex stochastic space of repeated lotteries. We find that agents with a CARA utility function learn to possess risk-neutral risk profiles. Since CARA utility functions are wealth-independent, this is not surprising. When agents have wealth-dependent, CRRA utility functions, however, they also learn to possess risk profiles that are about risk neutral (from slightly risk-averse to even slightly risk-preferring), which is surprising. |
| Keywords: | risk profile, decision-making under uncertainty, simulation |
| JEL: | D81 |
| Date: | 2014–01 |
| URL: | http://d.repec.org/n?u=RePEc:swe:wpaper:2014-10&r=upt |
| By: | Fossen, Frank M.; Glocker, Daniela |
| 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 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:fubsbe:20143&r=upt |
| By: | Peter N, Bell |
| Abstract: | In this paper I consider a portfolio optimization problem where an agent holds an endowment of stock and is allowed to buy some quantity of a put option on the stock. This basic question (how much insurance to buy?) has been addressed in insurance economics through the literature on rational insurance purchasing. However, in contrast to the rational purchasing literature that uses exact algebraic analysis with a binomial probability model of portfolio value, I use numerical techniques to explore this problem. Numerical techniques allow me to approximate continuous probability distributions for key variables. Using large sample, asymptotic analysis I identify the optimal quantity of put options for three types of preferences over the distribution of portfolio value. The location of the optimal quantity varies across preferences and provides examples of important concepts from the rational purchasing literature: coinsurance for log utility (q* 1). I calculate the shape of the objective function and show the optimum is well defined for mean-variance utility and quantile-based preferences in an asymptotic setting. Using resampling, I show the optimal values are stable for the mean-variance utility and the quantile-based preferences but not the log utility. For the optimal value with mean-variance utility I show that the put option affects the probability distribution of portfolio value in an asymmetric way, which confirms that it is important to analyze the optimal use of derivatives in a continuous setting with numerical techniques. |
| Keywords: | Portfolio; optimization; financial derivative; put option; quantity; expected utility; numerical analysis |
| JEL: | C02 C15 C63 G11 G22 |
| Date: | 2014–03–13 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:54394&r=upt |
| By: | Jakub Trybu{\l}a; Dariusz Zawisza |
| Abstract: | We consider an incomplete market with a non-tradable stochastic factor and an investment problem with optimality criterion based on a functional which is a modification of a monotone mean-variance preferences. We formulate it as a stochastic differential game problem and use Hamilton Jacobi Bellman Isaacs equations to derive the optimal investment strategy and the value function. Finally, we show that our solution coincides with the solution to classical mean-variance problem with risk aversion coefficient which is dependent on stochastic factor. |
| Date: | 2014–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1403.3212&r=upt |
| By: | Yehuda Izhakian; David Yermack |
| Abstract: | We investigate the importance of ambiguity, or Knightian uncertainty, in executives’ decisions about when to exercise stock options. We develop an empirical estimate of ambiguity and include it in regression models alongside the more traditional measure of risk, equity volatility. We show that each variable has a statistically significant effect on the timing of option exercises, with volatility causing executives to hold their options longer in order to preserve remaining option value, and ambiguity increasing the tendency for executives to exercise early in response to risk aversion. Regression estimates for the volatility and ambiguity variables imply similar magnitudes of economic impact upon the exercise decision, with the volatility variable being about 2.5 times stronger. |
| JEL: | G12 G13 G34 J33 |
| Date: | 2014–03 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:19975&r=upt |
| By: | Buss, Adrian; Uppal, Raman; Vilkov, Grigory |
| Abstract: | In this paper, we study the effect of proportional transaction costs on consumption-portfolio decisions and asset prices in a dynamic general equilibrium economy with a financial market that has a single-period bond and two risky stocks, one of which incurs the transaction cost. Our model has multiple investors with stochastic labor income, heterogeneous beliefs, and heterogeneous Epstein-Zin-Weil utility functions. The transaction cost gives rise to endogenous variations in liquidity. We show how equilibrium in this incomplete-markets economy can be characterized and solved for in a recursive fashion. We have three main findings. One, costs for trading a stock lead to a substantial reduction in the trading volume of that stock, but have only a small effect on the trading volume of the other stock and the bond. Two, even in the presence of stochastic labor income and heterogeneous beliefs, transaction costs have only a small effect on the consumption decisions of investors, and hence, on equity risk premia and the liquidity premium. Three, the effects of transaction costs on quantities such as the liquidity premium are overestimated in partial equilibrium relative to general equilibrium. -- |
| Keywords: | liquidity premium,incomplete markets,portfolio choice,heterogeneous agents |
| JEL: | G11 G12 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:safewp:41&r=upt |
| By: | Humphreys, Brad (University of Alberta, Department of Economics); Zhou, Li (University of Alberta, Department of Economics) |
| Abstract: | Professional sports teams receive large public subsidies for new facility construction. Empirical research suggests that these subsidies cannot be justified by tangible or intangible economic benefits. We develop a model of bargaining between local governments and teams over subsidies that includes league expansion decisions. The model features loss aversion by fans that captures lost utility when a team leaves a city. The model predicts that teams exploit this loss aversion to extract larger than expected subsidies from local governments, providing an explanation for these large subsidies and highlighting the importance of anti-trust exemptions in enhancing teams' bargaining positions. |
| Keywords: | Endowment Effect; Loss aversion; major league sports; bargaining |
| JEL: | D42 H25 L12 L83 |
| Date: | 2014–03–02 |
| URL: | http://d.repec.org/n?u=RePEc:ris:albaec:2014_003&r=upt |
| By: | Eric Swanson (Federal Reserve Bank of San Francisco) |
| Abstract: | A flexible labor margin allows households to absorb shocks to asset values with changes in hours worked as well as changes in consumption. This ability to absorb shocks along both margins can greatly alter the household's attitudes toward risk, as shown by Swanson (2012a). The present paper analyzes how those results are affected by labor market frictions and shows that: 1) risk aversion is higher in recessions, 2) risk aversion is higher in more frictional labor markets, and 3) risk aversion is higher for households that are less employable. Quantitatively, labor market flow rates in the U.S. and other OECD countries are large relative to the discount rate, implying that the cost of labor market frictions is small because frictions only delay adjustment. Thus, the frictionless formulas in Swanson (2012a,b) appear to be very good approximations in frictional labor markets as well. |
| Date: | 2013 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed013:1137&r=upt |
| By: | Nicholas Bloom |
| Abstract: | This review article tries to answer four questions: (i) what are the stylized facts about uncertainty over time; (ii) why does uncertainty vary; (iii) do fluctuations in uncertainty matter; and (iv) did higher uncertainty worsen the Great Recession of 2007-2009? On the first question both macro and micro uncertainty appears to rise sharply in recessions. On the second question the types of exogenous shocks like wars, financial panics and oil price jumps that cause recessions appear to directly increase uncertainty, and uncertainty also appears to endogenously rise further during recessions. On the third question, the evidence suggests uncertainty is damaging for short-run investment and hiring, but there is some evidence it may stimulate longer-run innovation. Finally, in terms of the Great Recession, the large jump in uncertainty in 2008 potentially accounted for about one third of the drop in GDP. |
| Keywords: | Uncertainty, risk, volatility, investment |
| JEL: | E2 E3 O3 O4 |
| Date: | 2014–03 |
| URL: | http://d.repec.org/n?u=RePEc:cen:wpaper:14-17&r=upt |
| By: | Angerer, Silvia (University of Innsbruck); Glätzle-Rützler, Daniela (University of Innsbruck); Lergetporer, Philipp (University of Innsbruck); Sutter, Matthias (European University Institute) |
| Abstract: | We study with a sample of 1,070 primary school children, aged seven to eleven years, how altruism in a donation experiment is related to children's risk attitudes and intertemporal choices. Examining such a relationship is motivated by theories of reciprocal altruism that provide a cornerstone to understand human social behavior. We find that higher risk tolerance and patience in intertemporal choice increase, in general, the level of donations, albeit the effects are non-linear. We confirm earlier results that altruism increases with age during childhood and that girls are more altruistic than boys. Having older brothers makes subjects less altruistic. |
| Keywords: | altruism, donations, risk attitudes, intertemporal choices, experiment, children |
| JEL: | C91 D03 D63 D64 |
| Date: | 2014–03 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp8020&r=upt |