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on Utility Models and Prospect Theory |
| By: | Christoph Czichowsky; Walter Schachermayer |
| Abstract: | While absence of arbitrage in frictionless financial markets requires price processes to be semimartingales, non-semimartingales can be used to model prices in an arbitrage-free way, if proportional transaction costs are taken into account. In this paper, we show, for a class of price processes which are not necessarily semimartingales, the existence of an optimal trading strategy for utility maximisation under transaction costs by establishing the existence of a so-called shadow price. This is a semimartingale price process, taking values in the bid ask spread, such that frictionless trading for that price process leads to the same optimal strategy and utility as the original problem under transaction costs. Our results combine arguments from convex duality with the stickiness condition introduced by P. Guasoni. They apply in particular to exponential utility and geometric fractional Brownian motion. In this case, the shadow price is an Ito process. As a consequence we obtain a rather surprising result on the pathwise behaviour of fractional Brownian motion: the trajectories may touch an Ito process in a one-sided manner without reflection. |
| Date: | 2015–05 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1505.02416&r=upt |
| By: | Luo, Yulei |
| Abstract: | This paper provides a tractable continuous-time constant-absolute-risk averse (CARA)-Gaussian framework to explore how the interactions of fundamental uncertainty, model uncertainty due to a preference for robustness (RB), and state uncertainty due to information-processing constraints (rational inattention or RI) affect strategic consumption-portfolio rules and precautionary savings in the presence of uninsurable labor income. Specifically, after solving the model explicitly, I compute and compare the elasticities of strategic asset allocation and precautionary savings to risk aversion, robustness, and inattention. Furthermore, for plausibly estimated and calibrated model parameters, I quantitatively analyze how the interactions of model uncertainty and state uncertainty affect the optimal share invested in the risky asset, and show that they can provide a potential explanation for the observed stockholding behavior of households with different education and income levels. |
| Keywords: | Robustness, Model Uncertainty, Rational Inattention, Uninsurable Labor Income, Strategic Asset Allocation, Precautionary Savings |
| JEL: | E21 G00 G11 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:64312&r=upt |
| By: | Foellmi, Reto; Legge, Stefan; Schmid, Lukas |
| Abstract: | Does information processing affect individual risk-taking behavior? In this paper, we provide evidence that professional athletes suffer from a left-digit bias when dealing with signals about differences in performance. Using data from the highly competitive field of World Cup alpine skiing for the period of 1992-2014, we show that athletes misinterpret actual differences in race times by focusing on the leftmost digit, resulting in increased risk-taking behavior. For the estimation of causal effects, we exploit the fact that tiny time differences can be attributed to random shocks. We link our findings to prior research in psychology and economics, suggesting that different ways of information processing can explain our results. In contrast to recent studies in the field of behavioral economics, we then argue that high stakes and individual experience can magnify behavioral biases. |
| Keywords: | Risk Taking, Limited Attention, Left-Digit Bias |
| JEL: | D03 D81 D83 L83 |
| Date: | 2015–05 |
| URL: | http://d.repec.org/n?u=RePEc:usg:econwp:2015:11&r=upt |
| By: | Jaume Belles-Sampera (Department of Econometrics, Riskcenter-IREA, Universitat de Barcelona); Montserrat Guillén (Department of Econometrics, Riskcenter-IREA, Universitat de Barcelona); Miguel Santolino (Department of Econometrics, Riskcenter-IREA, Universitat de Barcelona) |
| Abstract: | Understanding the attitude to risk implicit within a risk measure sheds some light on the way in which decision makers perceive losses. In this paper, a two-stage strategy is developed to characterize the underlying risk attitude involved in a risk evaluation, when executed by the family of distortion risk measures. First, we show that aggregation indicators defined for discrete Choquet integrals provide informa- tion about the implicit global risk attitude of the agent. Second, an analysis of the distortion function offers a local description of the agent's stance on risk in relation to the occurrence of accumulated losses. Here, the concepts of absolute risk attitude and local risk attitude arise naturally. An example is provided to illustrate the usefulness of this strategy for characterizing risk attitudes in an insurance company. |
| Keywords: | Risk management, Risk tolerance, GlueVaR, Solvency II, Basel III. |
| Date: | 2015–05 |
| URL: | http://d.repec.org/n?u=RePEc:bak:wpaper:201505&r=upt |
| By: | Zetterdahl, Emma (Department of Economics, Umeå School of Business and Economics) |
| Abstract: | This thesis consists of an introductory part and four self-contained papers related to individual financial behavior and risk-taking in financial markets. <p> In Paper [I] we estimate within-family and community social interaction effects upon an individual’s stock market entry, participation, and exit decision. Interestingly, community sentiment towards the stock market (based on portfolio outcomes in the community) does not influence individuals’ likelihood to enter, while a positive sentiment increases (decreases) the likelihood of participation (exit). Overall, the results stress the importance of accounting for family social influence and highlight potentially important differences between family and community effects in individuals’ stock market participation. <p> In Paper [II] novel evidence is provided indicating that the influence from family (parents and partners) and peer social interaction on individuals’ stock market participation vary over different types of individuals. Results imply that individuals’ exposure to, and valuation of, stock market related social signals are of importance and thus, contribute to the understanding of the heterogeneous influence of social interaction. Overall, the results are interesting and enhance the understanding of the underlying mechanisms of social interaction on individuals’ financial decision making. <p> In Paper [III] the impact of divorce on individual financial behavior is empirically examined in a dynamic setting. Evidence that divorcing individuals increase their saving rates before the divorce is presented. This may be seen as a response to the increase in background risk that divorce produces. After the divorce, a negative divorce effect on individual saving rates and risky asset shares are established, which may lead to disparities in wealth accumulation possibilities between married and divorced. Women are, on average, shown to not adjust their precautionary savings to the same extent as men before the divorce. I also provide tentative evidence that women reduce their financial risk-taking more than men after a divorce, which could be a result of inequalities in financial positions or an adjustment towards individual preferences. <p> Paper [IV] provides novel empirical evidence that gender identity is of importance for individuals’ financial risk-taking. Specifically, by use of matching and by dividing male and females into those with “traditional” versus “nontraditional” gender identities, comparison of average risk-taking between groupings indicate that over a third (about 35-40%) of the identified total gender risk differential is explained by differences in gender identities. Results further indicate that risky financial market participation is 19 percentage points higher in groups of women with nontraditional, compared with traditional, gender identities. The results, obtained while conditioning upon a vast number of controls, are robust towards a large number of alternative explanations and indicate that some individuals (mainly women) partly are fostered by society, through identity formation and socially constructed norms, to a relatively lower financial risk-taking. |
| Keywords: | Asset allocation; Behavioral finance; Divorce; Financial literacy; Financial risk-taking; Gender identity; Household finance; Panel data; Asset allocation; Behavioral finance; Divorce; Financial literacy; Financial risk-taking; Gender identity; Household finance; Panel data; Propensity score matching; Risky asset share; Risk aversion; Saving behavior; Stock market participation; Social interaction; Trust |
| JEL: | D01 D03 D14 D14 D83 G02 G11 J12 J16 |
| Date: | 2015–05–13 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:umnees:0908&r=upt |