|
on Utility Models and Prospect Theory |
| By: | José Apesteguía; Miguel Angel Ballester |
| Abstract: | We analyze the use of discrete choice models for the estimation of risk aversion and show a fundamental flaw in the standard random utility model which is commonly used in the literature. Specifically, we find that given two gambles, the probability of selecting the riskier gamble may be larger for larger levels of risk aversion. We characterize when this occurs. By contrast, we show that the alternative random preference approach is free of such problems. |
| Keywords: | discrete choice, structural estimation, risk aversion, random utility models, random preference models |
| JEL: | C25 D81 |
| Date: | 2014–09 |
| URL: | http://d.repec.org/n?u=RePEc:bge:wpaper:788&r=upt |
| By: | Attema, Arthur; Brouwer, Werner; l'Haridon, Olivier; Pinto, Jose Luis |
| Abstract: | This paper is the first to apply prospect theory to societal health-related decision making. In particular, we allow for utility curvature, equity weighting, sign-dependence, and loss aversion in choices concerning quality of life of other people. We find substantial inequity aversion, both for gains and losses, which can be attributed to both diminishing marginal utility and differential weighting of better-off and worse-off. There are also clear framing effects, which violate expected utility. Moreover, we observe loss aversion, indicating that respondents give more weight to one group’s loss than another group’s gain of the same absolute magnitude. We also elicited some information on the effect of the age of the studied group. The amount of inequity aversion is to some extent influenced by the age of the considered patients. In particular, more inequity aversion is observed for gains of older people than gains of younger people. |
| Keywords: | equity weighting, loss aversion, prospect theory, QALYs |
| JEL: | D63 I10 |
| Date: | 2014–09–02 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:58262&r=upt |
| By: | Erick W. Rengifo (Fordham University); Debra Emanuela Trifan (Bayerngas Energy); Debra Rossen Trendafilov (Truman State University) |
| Abstract: | This paper focuses on the attitude of non-professional investors towards financial losses and their decisions on wealth allocation, and how these change subject to behavioral factors. Our contribution concerns the integration of behavioral elements into the classic portfolio optimization. Individual perceptions are modeled according to an extended prospect-theory framework: Losses loom larger than gains of the same size (loss aversion) and the past riskyportfolio performance changes the subjective valuation of risky investments. The utility of financial investments is overemphasized (myopia). The portfolio model with individual VaR delivers an optimal wealth assignment between risky and risk-free assets. |
| Keywords: | VaR, Non-Professional Investor, Prospect Theory, Non-Expected Utility. |
| JEL: | G10 G11 D81 E27 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:frd:wpaper:dp2014-03&r=upt |
| By: | Heyen, Daniel; Wiesenfarth, Boris R. |
| Abstract: | The well-known Blackwell's theorem states the equivalence of statistical informativeness and economic valuableness. Celen (2012) generalizes this theorem, which is well-known for subjective expected utility (SEU), to maxmin expected utility (MEU) preferences. We demonstrate that the underlying definition of the value of information used in Celen (2012) is in contradiction with the principle of recursively defined utility. As a consequence, Celen's framework features dynamic inconsistency. Our main contribution consists in the definition of a value of information for MEU preferences that is compatible with recursive utility and thus respects dynamic consistency. |
| Keywords: | Value of information; Maxmin expected utility; Recursive utility |
| Date: | 2014–10–21 |
| URL: | http://d.repec.org/n?u=RePEc:awi:wpaper:0572&r=upt |
| By: | Rafael Serrano |
| Abstract: | We explore martingale and convex duality techniques to study optimal investment strategies that maximize expected risk-averse utility from consumption and terminal wealth in a pure-jump model driven by (multivariate) marked point processes and in presence of margin requirements such as different interest rates for borrowing and lending and risk premiums for short positions. Margin requirements are modelled by adding in a margin payment function to the investor's wealth equation which is nonlinear with respect to the portfolio proportion process. We give sufficient conditions for existence of optimal policies and find closed-form solutions for the optimal value function in the case of pure-jump models with jump-size distributions modulated by a two-state Markov chain and agents with logarithmic and fractional power utility. |
| Date: | 2014–11 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1411.1103&r=upt |
| By: | Robert Bordley; Marco LiCalzi; Luisa Tibiletti |
| Abstract: | The "hard-easy effect" is a well-known cognitive bias on self-confidence calibration that refers to a tendency to overestimate the probability of success in hard-perceived tasks, and to underestimate it in easy-perceived tasks. This paper provides a target-based foundation for this effect, and predicts its occurrence in the expected utility framework when utility functions are S-shaped and asymmetrically tailed. First, we introduce a definition of hard-perceived and easy-perceived task based on the mismatch between an uncertain target to meet and a suitably symmetric reference point. Second, switching from a target-based language to a utility-based language, we show how this maps to an equivalence between the hard-perceived target/gain seeking and the easy-perceived target/loss aversion. Third, we characterize the agent's miscalibration in self-confidence. Finally, we derive sufficient conditions for the Òhard-easy effectÓ and the "reversed hard-easy effect" to hold. |
| Keywords: | Expected utility, Hard-easy effect bias, Endowment effect bias, Sunk cost effect bias, Benchmarking procedure, Loss-gain asymmetry, van Zwet skewness conditions |
| JEL: | C91 D81 |
| Date: | 2014–10 |
| URL: | http://d.repec.org/n?u=RePEc:vnm:wpdman:94&r=upt |
| By: | Martin Koudstaal (University of Amsterdam); Randolph Sloof (University of Amsterdam, the Netherlands); Mirjam van Praag (Copenhagen Business School, Denmark) |
| Abstract: | Theory predicts that entrepreneurs have distinct attitudes towards risk and uncertainty, but empirical evidence is mixed. To better understand the unique behavioral characteristics of entrepreneurs and the causes of these mixed results, we perform a large ‘lab-in-the-field’ experiment comparing entrepreneurs to managers – a suitable comparison group – and employees (n = 2288). The results indicate that entrepreneurs perceive themselves as less risk averse than managers and employees, in line with common wisdom. However, when using experimental incentivized measures, the differences are subtler. Entrepreneurs are only found to be unique in their lower degree of loss aversion, and not in their risk or ambiguity aversion. This combination of results might be explained by our finding that perceived risk attitude is not only correlated to risk aversion but also to loss aversion. Overall, we therefore suggest using a broader definition of risk that captures this unique feature of entrepreneurs; their willingness to risk losses. |
| Keywords: | Entrepreneurs, managers, risk aversion, loss aversion, ambiguity aversion, lab-in- the field experiment |
| JEL: | L26 C93 D03 |
| Date: | 2014–10–17 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:uvatin:20140136&r=upt |
| By: | Fausto Corradin (GRETA Associati, Venice); Domenico Sartore (Department of Economics, Ca’ Foscari University of Venice) |
| Abstract: | This paper compares the performance of a quadratic utility function and discusses how to change its characteristic parameter, ARA, so that rating is consistent with return and risk measurements. In particular, this parameter is modified in such a way that a positive return Fund has always a rating higher than one with a negative yield. This modification confirms the possibility of building a new ranking procedure which is more coherent with the actual behaviour of investors. |
| Keywords: | quadratic utility function, positive and negative returns, absolute risk aversion, Morningstar rating, truncated normal distribution, incomplete gamma function, Italian Pension Fund |
| JEL: | G11 G14 G24 |
| URL: | http://d.repec.org/n?u=RePEc:ven:wpaper:2014:17&r=upt |
| By: | Esther Regnier (Centre d'Economie de la Sorbonne - Paris School of Economics); Katheline Schubert (Centre d'Economie de la Sorbonne - Paris School of Economics) |
| Abstract: | This article analyzes the impact of the introduction of aquaculture on wild fish stocks and consumer utility, taking into account three key components: (1) the dependence of aquaculture on reduction fisheries for the feeding of the farmed species; (2) biological interactions between the wild edible species –the predator– and the wild feed species –the prey–; (3) consumer preferences for wild and farmed fish. Fisheries are in open access while the aquaculture sector is competitive. We show that when biological interactions are moderate, the introduction of aquaculture is beneficial in the long run; it improves consumer utility and alleviates the pressure on the edible fish stock. Results are deeply modified when biological interactions are strong: the stock of edible wild fish is reduced and the introduction of aquaculture may even cause a decrease in consumer utility. Finally, we explore the consequences of an improvement in aquaculture efficiency and of a sensitivity of consumer preferences to the farmed fish diet, in the case where biological interaction are absent. |
| Keywords: | Fisheries, aquaculture, consumer preferences, food security, biological interactions. |
| Date: | 2013–01 |
| URL: | http://d.repec.org/n?u=RePEc:mse:cesdoc:13002r&r=upt |
| By: | Audrey Hu (University of Amsterdam, the Netherlands); Liang Zou (University of Amsterdam, the Netherlands) |
| Abstract: | We analyze sequential Dutch and Vickrey auctions where risk averse, or risk preferring, bidders may have heterogeneous risk exposures. We derive and characterize a pure strategy equilibrium of both auctions for arbitrary number of identical objects. A sufficient, and to certain extent necessary, condition for this result is that bidders' marginal utilities are log-submodular in income and type. We then show that when bidders are risk averse (preferring), the equilibrium price sequences should be downward (upward) drifting, and in each period the conditional expected revenue is higher (lower) in the Dutch than in the Vickrey sequential auctions. In particular, the "declining price anomaly" is perfectly consistent with nonincreasing absolute risk aversion when bidders have exposures to background risk. |
| Keywords: | sequential auction, background risk, risk preferences, declining prices, log-submodularity |
| JEL: | D44 D82 |
| Date: | 2014–10–20 |
| URL: | http://d.repec.org/n?u=RePEc:dgr:uvatin:20140139&r=upt |
| By: | Erick W. Rengifo (Fordham University); Debra Emanuela Trifan (Bayerngas Energy); Debra Rossen Trendafilov (Truman State University) |
| Abstract: | This paper proposes a new, individual measure of market risk, denoted as the individually acceptable loss (IAL). This measure can be used by portfolio managers in order to better meet the individual profiles of their non-professional clients, including phsychological traits. It can be easily assessed from general subjective and objective parameters. We formally define the IAL of loss averse investors, who narrowly frame financial investments, and are sensitive to the past performance of their risky portfolio. This individual risk measue is applied to the classic portfolio optimization framework in order to derive the optimal wealth allocation among different financial assets. our empirical results suggest that previous optimization relying on a portfolio-exogenous VaR-formulation, underestimates the aversion of individual investors towards financial losses. |
| Keywords: | market risk, prospect theory, loss aversion, capital allocation, Value-at-Risk. |
| JEL: | C32 C35 G10 |
| Date: | 2014 |
| URL: | http://d.repec.org/n?u=RePEc:frd:wpaper:dp2014-04&r=upt |
| By: | Johannes Emmerling (Fondazione Eni Enrico Mattei) |
| Abstract: | Uncertainty is prevalent in the context of climate change impacts. Moreover, the distribution across the globe is not uniform. We analyze how climate risks could be reduced via an insurance scheme at the global scale across regions and quantify the potential welfare gains from such a scheme. Starting from the standard welfare analysis in Integrated Assessment Models (IAMs), which assumes no risk sharing across region, we introduce global risk sharing via a market for state-dependent Arrow-Debreu securities. We show that this allows equalizing relative consumption differences between states of the world across regions. We estimate that such risk sharing scheme of climate risks could lead to welfare gains reducing the global costs of climate change by up to one third, while the amount of transfers required is substantial. This provides arguments for considering risk sharing in IAMs, but also for potentially welfare increasing negotiations about sharing risks of climate change at the global level. |
| Keywords: | Uncertainty, Risk Sharing, Insurance, Climate Change, Risk Aversion |
| JEL: | Q54 D81 D63 |
| Date: | 2014–09 |
| URL: | http://d.repec.org/n?u=RePEc:fem:femwpa:2014.78&r=upt |
| By: | Byrne, Joseph P; Korobilis, Dimitris; Ribeiro, Pinho J |
| Abstract: | We analyse the role of time-variation in coefficients and other sources of uncertainty in exchange rate forecasting regressions. Our techniques incorporate the notion that the relevant set of predictors and their corresponding weights, change over time. We find that predictive models which allow for sudden, rather than smooth, changes in coefficients significantly beat the random walk benchmark in out-of-sample forecasting exercise. Using an innovative variance decomposition scheme, we identify uncertainty in coefficients estimation and uncertainty about the precise degree of coefficients' variability, as the main factors hindering models' forecasting performance. The uncertainty regarding the choice of the predictor is small. |
| Keywords: | Instabilities; Exchange Rate Forecasting; Time-Varying Parameter Models; Bayesian Model Averaging; Forecast Combination; Financial Condition Indexes; Bootstrap |
| JEL: | C53 C58 E44 F37 G01 |
| Date: | 2014–09–26 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:58956&r=upt |