nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2014‒04‒05
six papers chosen by
Alexander Harin
Modern University for the Humanities

  1. A Note on the Quantile Formulation By Zuo Quan Xu
  2. A Test of Mechanical Ambiguity By Oechssler, Jörg; Roomets, Alex
  3. Pseudo Linear Pricing Rule for Utility Indifference Valuation By Vicky Henderson; Gechun Liang
  4. Risk and ambiguity preferences and the adoption of new agricultural technologies: Evidence from field experiments in rural India: By Ward, Patrick S.; Singh, Vartika
  5. Utility indifference pricing of derivatives written on industrial loss indexes By Gunther Leobacher; Philip Ngare
  6. Distortion Risk Measures or the Transformation of Unimodal Distributions into Multimodal Functions By Dominique Guegan; Bertrand Hassani

  1. By: Zuo Quan Xu
    Abstract: Many investment models in discrete or continuous-time settings boil down to maximizing an objective of the quantile function of the decision variable. This quantile optimization problem is known as the quantile formulation of the original investment problem. Under certain monotonicity assumptions, several schemes to solve such quantile optimization problems have been proposed in the literature. In this paper, we propose a change-of-variable and relaxation method to solve the quantile optimization problems without using the calculus of variations or making any monotonicity assumptions. The method is demonstrated through a portfolio choice problem under rank-dependent utility theory (RDUT). We show that solving a portfolio choice problem under RDUT reduces to solving a classical Merton's portfolio choice problem under expected utility theory with the same utility function but a different pricing kernel explicitly determined by the given pricing kernel and probability weighting function. With this result, the feasibility, well-posedness, attainability and uniqueness issues for the portfolio choice problem under RDUT are solved. The method is applicable to general models with law-invariant preference measures including portfolio choice models under cumulative prospect theory (CPT) or RDUT, Yaari's dual model, Lopes' SP/A model, and optimal stopping models under CPT or RDUT.
    Date: 2014–03
  2. By: Oechssler, Jörg; Roomets, Alex
    Abstract: We implement an experiment to elicit subjects’ ambiguity attitudes in the spirit of Ellsberg’s three-color urn. The procedure includes three design elements that (together) have not been featured in similar experiments: Strict ambiguity preferences, a single decision, and a mechanical randomization device with an unknown distribution (to both subjects and experimenters). We use this device in order to eliminate possible ‘strategic’ ambiguity related to subjects’ beliefs about the experimenters’ motivations. In addition, we survey 40 experimental studies on Ellsberg’s two- and three-color problems, and find that, on average, slightly more than half of subjects are classified as ambiguity averse. Our results, with our new design, fall on the low end of the range of results in the surveyed studies, and are comparable to a control test where “strategic” ambiguity was induced.
    Keywords: ambiguity aversion; uncertainty; experiment; Ellsberg.
    Date: 2014–03–21
  3. By: Vicky Henderson; Gechun Liang
    Abstract: This paper considers exponential utility indifference pricing for a multidimensional non-traded assets model, and provides two linear approximations for the utility indifference price. The key tool is a probabilistic representation for the utility indifference price by the solution of a functional differential equation, which is termed \emph{pseudo linear pricing rule}. We also provide an alternative derivation of the quadratic BSDE representation for the utility indifference price.
    Date: 2014–03
  4. By: Ward, Patrick S.; Singh, Vartika
    Abstract: Advances in agricultural development have largely been a direct result of increased usage of new technologies. Among other important factors, farmers’ perceptions of risks associated with the new technology as well as their ability or willingness to take risks greatly influences their adoption decisions. In this paper we conduct a series of field experiments in rural India in order to measure preferences related to risk, potential loss, and ambiguity. Disaggregating by gender, we find that on average women are significantly more risk averse and loss averse than men, though the higher average risk aversion arises due to a greater share of women who are extremely risk averse.
    Keywords: Technology adoption, rural population, Agricultural technology, uncertainty, propect theory,
    Date: 2014
  5. By: Gunther Leobacher; Philip Ngare
    Abstract: We consider the problem of pricing derivatives written on some industrial loss index via utility indifference pricing. The industrial loss index is modelled by a compound Poisson process and the insurer can adjust her portfolio by choosing the risk loading, which in turn determines the demand. We compute the price of a CAT(spread) option written on that index using utility indifference pricing.
    Date: 2014–04
  6. By: Dominique Guegan (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris 1 - Panthéon-Sorbonne); Bertrand Hassani (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris 1 - Panthéon-Sorbonne)
    Abstract: The particular subject of this paper, is to construct a general framework that can consider and analyse in the same time upside and downside risks. This paper offers a comparative analysis of concept risk measures, we focus on quantile based risk measure (ES and VaR), spectral risk measure and distortion risk measure. After introducing each measure, we investigate their interest and limit. Knowing that quantile based risk measure cannot capture correctly the risk aversion of risk manager and spectral risk measure can be inconsistent to risk aversion, we propose and develop a new distortion risk measure extending the work of Wang (2000) [38] and Sereda et al (2010) [34]. Finally, we provide a comprehensive analysis of the feasibility of this approach using the S&P500 data set from o1/01/1999 to 31/12/2011.
    Keywords: Risk; VaR; distorsion measures
    Date: 2014–02

This nep-upt issue is ©2014 by Alexander Harin. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.