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on Utility Models and Prospect Theory |
| By: | Brocas, Isabelle; Carrillo, Juan D; Giga, Aleksandar; Zapatero, Fernando |
| Abstract: | We conduct a controlled laboratory experiment where subjects dynamically choose their portfolio allocation between a safe and a risky asset. We first derive analytically the optimal allocation of an expected utility maximizer with HARA utility function. We then fit the experimental choices to this model to assess the risk attitude of our subjects. Despite the substantial heterogeneity across subjects, decreasing absolute risk aversion and increasing relative risk aversion are the most prevalent risk types, and we can classify more than 50% of the subjects in this combined category. We also find evidence of increased risk taking after a gain but the effect is small in magnitude. Overall, our robustness tests show that the behavior of subjects is generally well accounted for by the HARA expected utility model. Finally, the analysis at the session level suggests that the behavior of the representative agent is less heterogeneous and closer to (though statistically different from) constant relative risk aversion. |
| Keywords: | CRRA; HARA; laboratory experiments; portfolio allocation; risk aversion |
| JEL: | C91 D03 D81 G11 |
| Date: | 2015–01 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:10332&r=upt |
| By: | Xiaohong Chen; Jack Favilukis; Sydney C. Ludvigson |
| Abstract: | This paper presents estimates of key preference parameters of the Epstein and Zin (1989, 1991) and Weil (1989) recursive utility model, evaluates the model's ability to fit asset return data relative to other asset pricing models, and investigates the implications of such estimates for the unobservable aggregate wealth return. Our empirical results indicate that the estimated relative risk aversion parameter ranges from 17 to 60, with higher values for aggregate consumption than for stockholder consumption, while the estimated elasticity of intertemporal substitution is above 1. In addition, the estimated model-implied aggregate wealth return is found to be weakly correlated with the Center for Research in Security Prices value-weighted stock market return, suggesting that the return to human wealth is negatively correlated with the aggregate stock market return. |
| Keywords: | Consumption based asset pricing; semiparametric estimation; limited stock market participation |
| JEL: | E21 G12 |
| Date: | 2013–03 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:37392&r=upt |
| By: | Howard Kunreuther; Mark Pauly |
| Abstract: | This paper describes the results of a web-based multi-period insurance purchasing experiment focusing on how individuals make insurance choices for low-probability, high-consequence events. Participants were told the probability and resulting losses of a hurricane occurring and were informed that these were stable from period to period. We contrast the model of informed expected utility [E(U)] maximization with alternative behavioral models of choice as explanations for what we observe. The majority of individuals (63 percent) behaved in ways that were consistent with expected utility theory, although we do not know whether these individuals were utilizing other decision rules. A sizeable number of uninsured individuals decided to purchase insurance after learning that they had suffered a loss and revealing that they were unhappy about having been uninsured. In this sense, the study shows that a loss coupled with emotions is likely to play an important role in convincing an uninsured person to buy coverage. In contrast, insured individuals who did not suffer a loss rarely dropped coverage. The paper concludes by raising questions regarding the welfare implications of this behavior. |
| JEL: | C90 D12 D60 D81 G22 |
| Date: | 2015–01 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:20886&r=upt |
| By: | Leonard C. MacLean; Yonggan Zhao; William T. Ziemba |
| Abstract: | The optimal capital growth strategy or Kelly strategy, has many desirable properties such as maximizing the asympotic long run growth of capital. However, it has considerable short run risk since the utility is logarithmic, with essentially zero Arrow-Pratt risk aversion. Most investors favor a smooth wealth path with high growth. In this paper we provide a method to obtain the maximum growth while staying above a predetermined ex-ante discrete time smooth wealth path with high probability, with shortfalls below the path penalized with a convex function of the shortfall so as to force the investor to remain above the wealth path. This results in a lower investment fraction than the Kelly strategy with less risk, and lower but maximal growth rate under the assumptions. A mixture model with Markov transitions between several normally distributed market regimes is used for the dynamics of asset prices. The investment model allows the determination of the optimal constrained growth wagers at discrete points in time in an attempt to stay above the ex-ante path. |
| JEL: | J1 |
| Date: | 2014–07–28 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:59292&r=upt |
| By: | Emma Soane; Iljana Schubert; Rebecca Lunn; Simon Pollard |
| Abstract: | We examined the relationship between information processing style and information seeking, and its moderation by anxiety and information utility. Information about Salmonella, a potentially commonplace disease, was presented to 2960 adults. Two types of information processing were examined: preferences for analytical or heuristic processing, and preferences for immediate or delayed processing. Information seeking was captured by measuring the number of additional pieces of information sought by participants. Preferences for analytical information processing were associated positively and directly with information seeking. Heuristic information processing was associated negatively and directly with information seeking. The positive relationship between preferences for delayed decision making and information seeking was moderated by anxiety and by information utility. Anxiety reduced the tendency to seek additional information. Information utility increased the likelihood of information seeking. The findings indicate that low levels of anxiety could prompt information seeking. However, information seeking occurred even when information was perceived as useful and sufficient, suggesting that it can be a form of procrastination rather than a useful contribution to effective decision making. |
| Keywords: | decision making; dual process theory; information processing; information seeking; RISP theory |
| JEL: | J50 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:59704&r=upt |
| By: | Carlson, Murray; Chapman, David A.; Kaniel, Ron; Yan, Hong |
| Abstract: | We use a general equilibrium model as a laboratory for generating predictable excess returns and for assessing the properties of the estimated consumption/portfolio rules, under both the empirical and the true dynamics of excess returns. The advantage of this approach, relative to the existing literature, is that the equilibrium model delineates the precise nature of the risk/return trade-off within an optimizing setting that endogenizes return predictability. In the experiments that we consider, the estimation issues are so severe that simple unconditional consumption and portfolio rules actually outperform (in a utility cost sense) both simple and bias-corrected empirical estimates of conditionally optimal policies. |
| Keywords: | consumption; equilibrium; excess returns; hedging; predictable |
| JEL: | E21 G11 G12 |
| Date: | 2015–01 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:10328&r=upt |
| By: | Ran Spiegler |
| Abstract: | I present a framework for analyzing decision makers with an imperfect understanding of their environment's correlation structure. The framework borrows the tool of "Bayesian networks", which is ubiquitous in statistics and artificial intelligence. In the model, a decision maker faces an objective multivariate probability distribution (his own action is one of the random variables). He is characterized by a directed acyclic graph over the set of random variables. His subjective belief filters the objective distribution through the graph via the factorization formula for Bayesian networks. This representation of the relation between objective and subjective distributions enables us to capture a variety of systematic departures from rational expectations, such as excessively coarse subjective models, reverse causality, missing variables, and various attribution errors. Optimal choices in this model is fundamentally an equilibrium notion, because the decision maker's own long-run behaviour may affect his perception (via his distorted beliefs) of the consequences of his own actions. Accordingly, I define a "personal equilibrium" notion of optimal choices. A few stylized macroeconomic illustrations of this framework are presented. In particular, I formalize the intuition that an incorrect causal interpretation of the debt-output correlation may lead to sub-optimal fiscal policy, and I translate Sargent's (1999) argument that a mis-specified Phillips curve can cause a central banker to implement above-optimal inflation. |
| JEL: | J1 |
| Date: | 2014–07 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:57994&r=upt |
| By: | Peter Kondor; Dimitri Vayanos |
| Abstract: | We develop a dynamic model of liquidity provision, in which hedgers can trade multiple risky assets with arbitrageurs. We compute the equilibrium in closed form when arbitrageurs’ utility over consumption is logarithmic or risk-neutral with a non-negativity constraint. Liquidity is increasing in arbitrageur wealth, while asset volatilities, correlations, and expected returns are hump-shaped. Liquidity is a priced risk factor: assets that suffer the most when liquidity decreases, e.g., those with volatile cashflows or in high supply by hedgers, offer the highest expected returns. When hedging needs are strong, arbitrageurs can choose to provide less liquidity even though liquidity provision is more profitable. |
| JEL: | F3 G3 |
| Date: | 2014–02 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:55910&r=upt |
| By: | Gabriel M. Ahfeldt |
| Abstract: | I define a composite amenity that provides aesthetic and consumption value to local residents: Urbanity. A novel data set of geo-tagged photos shared in internet communities serves as a proxy for urbanity. From the spatial pattern of house prices and photos I identify the value of urbanity in two of the largest cities in Europe: Berlin and London. I find an elasticity of indirect utility with respect to urbanity of about 1%. The aggregated willingness-to-pay equates to about $1bn per year in each city. The results demonstrate the important role cities play as centers of leisure, consumption, and beauty. |
| Keywords: | amenities; consumer city; hedonic analysis; photography geography; property prices |
| JEL: | N0 |
| Date: | 2013–05 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:59244&r=upt |
| By: | David McDaid; Ian Shemilt; Kevin Marsh; Catherine Henderson; Evelina Bertranou; Jacqueline Mallander; Michael Drummond; Miranda Mugford; Luke Vale |
| Abstract: | Background: Methods for systematic reviews of the effects of health interventions have focused mainly on addressing the question of 'What works?' or 'Is this intervention effective in achieving one or more specific outcomes?' Addressing the question 'Is it worth it given the resources available?' has received less attention. This latter question can be addressed by applying an economic lens to the systematic review process. This paper reflects on the value and desire for the consideration by end users for coverage of an economic perspective in a Cochrane review and outlines two potential approaches and future directions. Methods: Two frameworks to guide review authors who are seeking to include an economic perspective are outlined. The first involves conducting a full systematic review of economic evaluations that is integrated into a review of intervention effects. The second involves developing a brief economic commentary. The two approaches share a set of common stages but allow the tailoring of the economic component of the Cochrane review to the skills and resources available to the review team. Results: The number of studies using the methods outlined in the paper is limited, and further examples are needed both to explore the value of these approaches and to further develop them. The rate of progress will hinge on the organisational leadership, capacity and resources available to the CCEMG, author teams and other Cochrane entities. Particular methodological challenges to overcome relate to understanding the key economic trade-offs and casual relationships for a given decision problem and informing the development of evaluations designed to support local decision-makers. Conclusions: Methods for incorporating economic perspectives and evidence into Cochrane intervention reviews are established. Their role is not to provide a precise estimate of 'cost-effectiveness' but rather to help end-users of Cochrane reviews to determine the implications of the economic components of reviews for their own specific decisions. |
| Keywords: | cost-utility analysis; cost-effectiveness analysis; systematic review; meta-analysis; cochrane collaboration |
| JEL: | N0 |
| Date: | 2013–09–20 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:53137&r=upt |
| By: | Gall, Thomas; Legros, Patrick; Newman, Andrew |
| Abstract: | This paper studies the aggregate economic effects of diversity policies such as affirmative action in college admission. If agents are constrained in the side payments they can make, the free market allocation displays excessive segregation relative to the first-best. Affirmative action policies can restore diversity within colleges but also affect incentives to invest in pre-college scholastic achievement. Affirmative action policies that are achievement-based can increase aggregate investment and income, reduce inequality, and increase aggregate welfare relative to the free market outcome. They may also be more effective than decentralized policies such as cross-subsidization of students by colleges. |
| Keywords: | affirmative action; education; matching; misallocation; multidimensional attributes; nontransferable utility; segregation |
| JEL: | C78 I28 J78 |
| Date: | 2015–01 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:10337&r=upt |