nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2014‒10‒13
seven papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Portfolio Selection Optimization under Cumulative Prospect Theory – a parameter sensibility analysis By Luis A.G. Coelho
  2. Is utility additive? The case of alcohol Creation Date: 1997 By K.W. Clements; W. Yang; S.W. Zheng
  3. Real Effects of Nominal Shocks: a 2-Sector Dynamic Model with Slow Capital Adjustment and Money-in-the-Utility By Peter BENCZUR
  4. Measuring the Behavioral Component of Financial Fluctuations: An Analysis Based on the S&P 500 By Massimiliano Caporin; Luca Corazzini; Michele Costola
  5. Partial Utility of the Biofuels Use in the Public Transport By Luca Rigamonti; Pirani Alberto; Anna Gaviglio; Rigamonti Luca; Martina Licitra Pedol
  6. Multi-asset consumption-investment problems with infinite transaction costs By David Hobson; Yeqi Zhu
  7. A Utility-Based Model of Sales with Informative Advertising By Sandro Shelegia; Chris M. Wilson

  1. By: Luis A.G. Coelho (CEFAGE-UE and Management Department, Évora University)
    Abstract: The Cumulative Prospect Theory (CPT) is one of the most popular theories for evaluating the behavior of decision makers in the context of risk and uncertainty. This theory emerged as a generalization of the Expected Utility Theory (EUT) and being a relatively recent theory, its application has been somewhat reduced, especially when linked to optimization models. This paper intends to analyze the behavior of CPT, with a power value function and a two-parameter probability weighting function, as an objective function of a portfolio selection model. The parameterization of the objective function parameters allows us to analyze the composition of portfolios such as loss aversion, risk aversion in gains and risk preference in the range of losses. The results suggest that loss aversion and risk aversion in gains lead to the choice of portfolios with lower profitability and variability and that the risk preference in losses leads to the choice of portfolios with higher profitability and variability. The results are also compared with those obtained with EUT, and allow us to conclude that CPT leads to more diversified solutions which are therefore more easily adjusted to the investors’ behavioral profile.
    Keywords: Cumulative Prospect Theory; Portfolio Selection; Loss Aversion; Risk Aversion; Expected Utility.
    JEL: C61 D81 G11
    Date: 2014
  2. By: K.W. Clements; W. Yang; S.W. Zheng
  3. By: Peter BENCZUR
  4. By: Massimiliano Caporin (University of Padova); Luca Corazzini (University of Padova); Michele Costola (University Ca’ Foscari of Venice)
    Abstract: We study the evolution of the behavioral component of the financial market by estimating a Bayesian mixture model in which two types of investors coexist: one rational, with standard subjective expected utility theory (SEUT) preferences, and one behavioral, endowed with an S-shaped utility function. We perform our analysis by using monthly data on the constituents of the S&P 500 index from January 1962 to April 2012. We assume that agents take investment decisions by ranking the alternative assets according to their performance measures. A tuning parameter blending the rational and the behavioral choices can be estimated by using a criterion function. The estimated parameter can be interpreted as an endogenous market sentiment index. This is confirmed by a number of checks controlling for the correlation of our endogenous index with measures of (implied) financial volatility, market sentiments and financial stress. Our results confirm the existence of a significant behavioral component that reaches its peaks during periods of recession. Moreover, after controlling for a number of covariates, we observe a significant correlation between the estimated behavioral component and the S&P 500 return index.
    Keywords: Investment decision, behavioral agents, mixture model, behavioral expectations
    JEL: G01 G02 G11 G17 C58
    Date: 2014–09–30
  5. By: Luca Rigamonti; Pirani Alberto; Anna Gaviglio; Rigamonti Luca; Martina Licitra Pedol
  6. By: David Hobson; Yeqi Zhu
    Abstract: The subject of this paper is an optimal consumption/optimal portfolio problem with transaction costs and with multiple risky assets. In our model the transaction costs take a special form in that transaction costs on purchases of one of the risky assets (the endowed asset) are infinite, and transaction costs involving the other risky assets are zero. Effectively, the endowed asset can only be sold. In general, multi-asset optional consumption/optimal portfolio problems are very challenging, but the extra structure we introduce allows us to make significant progress towards an analytical solution. For an agent with CRRA utility we completely characterise the different types of optimal behaviours. These include always selling the entire holdings of the endowed asset immediately, selling the endowed asset whenever the ratio of the value of the holdings of the endowed asset to other wealth gets above a critical ratio, and selling the endowed asset only when other wealth is zero. This characterisation is in terms of solutions of a boundary crossing problem for a first order ODE. The technical contribution is to show that the problem of solving the HJB equation, which is a second order, non-linear PDE subject to smooth fit at an unknown free boundary, can be reduced to this much simpler problem involving an explicit first order ODE. This technical contribution is at the heart of our analytical and numerical results, and allows us to prove monotonicity of the critical exercise threshold and the certainty equivalent value in the model parameters.
    Date: 2014–09
  7. By: Sandro Shelegia; Chris M. Wilson
    Abstract: This paper presents a generalised framework to understand mixed-strategy sales behaviour with informative advertising. By introducing competition in the utility space into a clearinghouse sales model, we oer a highly tractable framework that can i) provide a novel welfare analysis of intra-personal price discrimination in sales markets, ii) characterise sales in a range of new contexts including complex market settings and situations where rms conduct sales with two-part taris or non-price variables such as package size, and iii) synthesise past research and highlight its key forces and assumptions.
    JEL: L13 D43 M37 D83
    Date: 2014–09

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