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on Utility Models and Prospect Theory |
| By: | Stéphane Zuber (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics) |
| Abstract: | This paper studies the extension of Harsanyi's theorem (Harsanyi, 1995) in a framework involving uncertainty. It seeks to extend the aggregation result to a wide class of Monotonic Bernoullian and Archimedean preferences (Cerreia-Vioglio et al., 2011) that subsumes many models of choice under uncertainty proposed in the literature. An impossibility result is obtained, unless we are in the specific framework where all individuals and the decision-maker are subjective expected utility maximizers sharing the same beliefs. This implies that non-expected utility preferences cannot be aggregated consistently. |
| Keywords: | Subjective expected utility,Harsanyi's theorem,Pareto principle,Monotonic Bernoullian and Archimedean preferences |
| Date: | 2015–09 |
| URL: | http://d.repec.org/n?u=RePEc:hal:cesptp:halshs-01224145&r=upt |
| By: | Benedikt Hoechner (Faculty of Economics and Management, Otto-von-Guericke University Magdeburg); Peter Reichling (Faculty of Economics and Management, Otto-von-Guericke University Magdeburg); Gordon Schulze (Faculty of Economics and Management, Otto-von-Guericke University Magdeburg) |
| Abstract: | The Sharpe ratio has been criticized with regard to the assumptions of mean-volatility portfolio selection. Downside performance measures were developed to resolve this critique; they are consistent with expected utility under less restrictive assumptions. The most prominent family of downside performance measures is known as Kappa ratios and puts above target returns into relation to lower partial moments. While the Sharpe ratio of a mutual fund examines whether portfolios of mutual fund and risk-free asset dominate risk-adjusted passive portfolios of benchmark and risk-free asset, this characteristic cannot be transferred to downside performance measures with arbitrary targets. We show that Kappa ratios assign different values to passive strategies with varying fractions of benchmark and risk-free asset if the target differs from the risk-free rate. This effect can lead to reverse rankings of inferior and superior performing mutual funds. In addition, even the ratio of excess return and excess downside risk of passive portfolios is not constant in general. Therefore, downside performance measures turn out to be only applicable in asset management if the target is set equal to the risk-free rate. |
| Keywords: | Downside risk, Kappa ratios, lower partial moment, performance measurement, Sharpe ratio |
| JEL: | D81 G11 |
| Date: | 2015–11 |
| URL: | http://d.repec.org/n?u=RePEc:mag:wpaper:150018&r=upt |
| By: | AMARANTE, Massimiliano; GHOSSOUB, Mario; PHELPS, Edmund |
| Abstract: | Empirical evidence suggests that ambiguity is prevalent in insurance pricing and underwriting, and that often insurers tend to exhibit more ambiguity than the insured individuals (e.g., [23]). Motivated by these findings, we consider a problem of demand for insurance indemnity schedules, where the insurer has ambiguous beliefs about the realizations of the insurable loss, whereas the insured is an expected-utility maximizer. We show that if the ambiguous beliefs of the insurer satisfy a property of compatibility with the non-ambiguous beliefs of the insured, then there exist optimal monotonic indemnity schedules. By virtue of monotonicity, no ex-post moral hazard issues arise at our solutions (e.g., [25]). In addition, in the case where the insurer is either ambiguity-seeking or ambiguity-averse, we show that the problem of determining the optimal indemnity schedule reduces to that of solving an auxiliary problem that is simpler than the original one in that it does not involve ambiguity. Finally, under additional assumptions, we give an explicit characterization of the optimal indemnity schedule for the insured, and we show how our results naturally extend the classical result of Arrow [5] on the optimality of the deductible indemnity schedule. |
| Keywords: | Optimal insurance; Deductible; Ambiguity; Choquet integral; Distorted probabilities |
| JEL: | G22 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:mtl:montde:2015-03&r=upt |
| By: | van Bilsen, Servaas (Tilburg University, School of Economics and Management) |
| Abstract: | This dissertation consists of two parts, preceded by an introductory chapter. Part I (Chapters 2, 3 and 4) considers optimal consumption and portfolio choice using preference models. Chapter 2 analyzes optimal consumption and portfolio choice under loss aversion and endogenous updating of the reference level. I find that loss aversion triggers a demand for ‘‘guarantee like’’ features in pension products, and endogenous updating justifies a mechanism for smoothing the change in consumption due to financial shocks. Chapter 3 extends Chapter 2 by including probability weighting. I show that if the agent substantially distorts small probabilities, the model generates an endogenous floor on consumption. Chapter 4 considers a consumption and portfolio<br/>choice model that combines the ratio model of habit formation with stochastic differential utility. I show that the agent gradually adjusts consumption to financial shocks, justifying a return smoothing mechanism. Part II (Chapters 5, 6 and 7) explores the modelling of pension plans. Chapter 5 formalizes a new pension contract, a so-called personal pension plan with risk sharing (PPR). This chapter explores a consumption approach and an investment approach to a PPR. Chapter 6 explores the pricing and risk management of variable annuities for<br/>which the payouts respond gradually to financial shocks. I show that the market-consistent discount rate rises with the investment horizon. Finally, Chapter 7 explores the pricing and risk management of variable annuities in an economy with multiple risk factors.<br/> |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:tiu:tiutis:3475a3c2-b85d-404f-8b5d-21027bb1a085&r=upt |
| By: | Ram Yamarthy (University of Pennsylvania); Amir Yaron (University of Pennsylvania); Joao Gomes (University of Pennsylvania) |
| Abstract: | Models with financial frictions have been shown to create amplification and persistence effects in macroeconomic fluctuations. We test the ability that Costly State Verification (CSV) has to generate empirically plausible risk exposures in asset markets, when Epstein and Zin (1989) preferences are implemented. Under the setup of Carlstrom and Fuerst (1997) alongside recursive preferences, we find that the CSV friction is negligible in augmenting the aggregate equity premium, explaining roughly thirty basis points when monitoring costs are increased. Additionally we find that the separation between the elasticity of intertemporal substitution and risk aversion plays a key role in explaining financial market dynamics. We are only able to generate sizable equity premium when the elasticity is greater than one. |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed015:1267&r=upt |
| By: | Christophe Courbage (The Geneva Association, Geneva, Switzerland); Béatrice Rey (Université de Lyon, F-69007, France; CNRS, GATE Lyon St Etienne, 93, Chemin des Mouilles, F-69130, Ecully, France; Université Lyon 2, Lyon, F-69007, France) |
| Abstract: | This paper investigates the notion of changes in ambiguity over loss probabilities in the smooth ambiguity model developed by Klibanoff, Marinacci and Mukerji (2005). Changes in ambiguity over loss probabilities are expressed through the specific concept of stochastic dominance of order n defined by Ekern (1980). We characterize conditions on the function capturing attitudes towards ambiguity under which an individual always considers one situation to be more ambiguous than another in a model of two states of nature. We propose an intuitive interpretation of the properties of this function in terms of preferences for harms disaggregation over probabilities, also labelled ambiguity apportionment. |
| Keywords: | Smooth ambiguity aversion, more ambiguity, ambiguity apportionment, stochastic dominance |
| JEL: | D81 H50 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:gat:wpaper:1527&r=upt |
| By: | Katsutoshi Wakai |
| Abstract: | We derive an equilibrium asset pricing relation analogous to the cap-ital asset pricing model (CAPM) for investors whose preferences follow the robust mean-variance preferences introduced by Maccheroni, Mari-nacci, and Ru‘ no (2013). Our model de?nes a precise relation between the value of alpha from the market regression and ambiguity: alpha is positive if the asset has greater exposure to market ambiguity than market risk, and vice versa. |
| Keywords: | Ambiguity aversion, asset pricing, capital asset pricing model (CAPM), robust mean-variance preferences |
| JEL: | D81 G11 G12 |
| Date: | 2015–11 |
| URL: | http://d.repec.org/n?u=RePEc:kue:epaper:e-15-010&r=upt |
| By: | Christophe Courbage (The Geneva Association); Béatrice Rey-Fournier (GATE Lyon Saint-Étienne - Groupe d'analyse et de théorie économique - ENS Lyon - École normale supérieure - Lyon - UL2 - Université Lumière - Lyon 2 - UCBL - Université Claude Bernard Lyon 1 - Université Jean Monnet - Saint-Etienne - PRES Université de Lyon - CNRS) |
| Abstract: | This paper investigates the notion of changes in ambiguity over loss probabilities in the smooth ambiguity model developed by Klibanoff, Marinacci and Mukerji (2005). Changes in ambiguity over loss probabilities are expressed through the specific concept of stochastic dominance of order n defined by Ekern (1980). We characterize conditions on the function capturing attitudes towards ambiguity under which an individual always considers one situation to be more ambiguous than another in a model of two states of nature. We propose an intuitive interpretation of the properties of this function in terms of preferences for harms disaggregation over probabilities, also labelled ambiguity apportionment. |
| Keywords: | Smooth ambiguity aversion, more ambiguity, ambiguity apportionment, stochastic dominance |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:halshs-01223230&r=upt |
| By: | Alain Chateauneuf (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics, IPAG - Business School); Michèle Cohen (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics); Mina Mostoufi (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics); Jean-Christophe Vergnaud (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics) |
| Abstract: | The main purpose of this paper is to show that left monotone risk aversion, a meaningful refinement of strong risk aversion, characterizes Yaari's decision makers for whom deductible insurance is optimal. A second goal is to offer a detailed proof of the deductible's computation, which proves the tractability of Yaari's model under left-monotone risk aversion. |
| Abstract: | Le but essentiel de ce papier est de montrer que la « left-monotone risk aversion », un raffinement pertinent de l'aversion forte au risque caractérise les décideurs à la Yaari pour lesquels l'assurance avec franchise est optimale. Un second but est d'offrir une preuve détaillée du calcul de la franchise, ce qui montre la maniabilité du modèle de Yaari sous l'hypothèse de la « left-monotone risk aversion ». |
| Keywords: | Yaari's model,Jewitt's left-monotone risk aversion,optimality of deductible,modèle de Yaari,left-monotone risk aversion de Jewitt,optimalité du contrat de franchise |
| Date: | 2015–09 |
| URL: | http://d.repec.org/n?u=RePEc:hal:cesptp:halshs-01224502&r=upt |
| By: | Müller, Stephan; Rau, Holger A. |
| Abstract: | In a within-subjects experiment we test the relation of risk preferences and charitable giving. Women not only give substantially more than men, but also show an economically significant positive correlation between risk tolerance and donation levels. We find no such correlation for men. Men and relative risk-averse women do not differ in donations. Thus, common findings of gender differences in charitable giving may be explained by risk-tolerant women donating more. |
| Keywords: | dictator game,experiment,gender differences,risk preferences |
| JEL: | C91 D64 D81 J16 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:cegedp:264&r=upt |
| By: | Strulik, Holger |
| Abstract: | In this paper, I suggest a novel explanation for a hump-shaped ageconsumption profile, based on human aging. The model integrates health in the utility function and utilizes recent estimates on the effects of health on the marginal utility of consumption. The parsimonious model has a closed-form solution for the age of peak consumption and the consumption level at that age relative to initial consumption. A calibration of the model with data from gerontology produces an empirically plausible hump in consumption. |
| Keywords: | health,aging,life-cycle consumption |
| JEL: | D91 E21 I10 |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:cegedp:263&r=upt |
| By: | Michel Grabisch (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics); Christophe Labreuche (UMP CNRS/THALES - Unité mixte de physique CNRS/Thalès - CNRS - THALES) |
| Abstract: | The GAI (Generalized Additive Independence) model proposed by Fishburn is a generalization of the additive utility model, which need not satisfy mutual preferential independence. Its great generality makes however its application and study difficult. We consider a significant subclass of GAI models, namely the discrete 2-additive GAI models, and provide for this class a decomposition into nonnegative monotone terms. This decomposition allows a reduction from exponential to quadratic complexity in any optimization problem involving discrete 2-additive models, making them usable in practice. |
| Abstract: | Le modèle GAI (Indépendance Additive Généralisée) proposé par Fishburn est une généralisation du modèle de l'utilité additive, qui ne satisfait pas nécessairement à l'indépendance mutuelle préférentielle. Sa grande généralité rend cependant son usage et son étude difficiles. Nous considérons une sous-classe significative des modèles GAI, précisément les modèles GAI discrets 2-additifs, et nous obtenons pour cette classe une décomposition en termes positifs et croissants. Cette décomposition permet une réduction de la complexité, passant de la complexité exponentielle à la complexité quadratique, pour tout problème d'optimisation utilisant ces modèles discrets 2-additifs, les rendant ainsi utilisables dans la pratique. |
| Keywords: | Multiattribute utility,Multichoice games,Utilité multi-attribut,jeux multichoix |
| Date: | 2015–09 |
| URL: | http://d.repec.org/n?u=RePEc:hal:cesptp:halshs-01222546&r=upt |
| By: | Carl Gaigne (INRA); Anne-Celia Disdier (Paris School of Economics-INRA); Jose de Sousa (University of Paris-Sud) |
| Abstract: | Does demand volatility matter for exports? How do exporting firms deal with skewed demand? A simple model of risk aversion shows that exporters react to an increase in demand volatility in destination markets by increasing their export prices and decreasing their export volumes. In sharp contrast, exporters decrease prices and increase volumes when demand skewness rises. We also show that the moments of the distribution of demand affect the extensive margin of trade. These theoretical predictions are put to the test by using French firm-level exports across destination markets with different levels of demand volatility and skewness. The firm-level results, over the period 2000-2009, are broadly consistent with our predictions. |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed015:1272&r=upt |
| By: | Aloisio Araujo (IMPA - Instituto Nacional de Matemática Pura e Aplicada - Instituto Nacional de matematica pura e aplicada, FGV-EPGE - Universidad de Brazil); Jean-Marc Bonnisseau (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics); Alain Chateauneuf (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics); Rodrigo Novinski (Faculdades Ibmec - Faculdades Ibmec) |
| Abstract: | We prove that under mild conditions individually rational Pareto optima will exist even in presence of non-convex preferences. We consider decision makers dealing with a countable flow of payoffs or choosing among financial assets whose outcomes depend on the realization of a countable set of states of the world. Our conditions for the existence of Pareto optima can be interpreted as a requirement of impatience in the first context and of some pessimism or not unrealistic optimism in the second context. A non-existence example is provided when, in the second context, some decision maker is too optimistic. We furthermore show that at an individually rational Pareto optimum at most one strictly optimistic decision maker will avoid ruin at each state or date. Considering a risky context this entails that even is risk averters will share risk in a comonotonic way as usual, at most one classical strong risk lover will avoid ruin at each state or date. Finally some examples illustrate circumstances when a risk averter could take advantage of sharing risk with a risk lover rather than with a risk averter. |
| Abstract: | Nous montrons que sous des conditions peu contraignantes des optima de Pareto individuellement rationnels existent même en présence de préférences non-convexes. Nous considérons des décideurs munis de flux dénombrables de paiements ou choisissant parmi des actifs financiers dont les gains dépendent de la réalisation d'un ensemble dénombrable d'états du monde. Nos conditions pour l'existence d'optima de Pareto peuvent s'interpréter comme une exigence d'impatience dans le premier contexte et d'un certain pessimisme ou d'un optimisme non irréaliste dans le second contexte. Un exemple de non-existence est proposé lorsque dans le second contexte l'un des décideurs est trop optimiste. De plus, nous montrons qu'à un optimum de Pareto individuellement rationnel au plus un décideur strictement optimiste évitera la ruine à chaque date ou dans chaque état. Finalement, quelques exemples illustrent dans quelles circonstances un adversaire du risque aurait avantage à partager ses risques avec un joueur plutôt qu'avec un adversaire du risque. |
| Keywords: | Pareto optimum,optimistic,Risk sharing,optimiste,optimum de Pareto,Partage de risque |
| Date: | 2015–09 |
| URL: | http://d.repec.org/n?u=RePEc:hal:cesptp:halshs-01224491&r=upt |
| By: | Slotwinski, Michaela (University of Basel); Stutzer, Alois (University of Basel) |
| Abstract: | This paper uses the vote on the Swiss minaret initiative as a natural experiment to identify the causal effect of negative attitudes towards immigrants on foreigners' location choices and thus indirectly on their utility. Based on a regression discontinuity design with unknown discontinuity points and administrative data on the population of foreigners, we find that the probability of their moving to a municipality that unexpectedly expressed strong reservations decreases initially by about 60 percent. The effect levels off over a period of about 5 months. Consistent with a reduction in the identity utility for immigrants in general, the reaction is not confined to Muslims, whereby high-skilled foreigners seem to be most sensitive to the newly revealed reservations. |
| Keywords: | attitudes, foreigners, identity utility, location choice, RDD |
| JEL: | D83 J61 R23 Z13 |
| Date: | 2015–11 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp9497&r=upt |
| By: | Xiaoling Mei; Fco. Javier Nogales Martin |
| Abstract: | We consider the portfolio optimization problem for a multiperiod investor who seeks to maximize her utility of consumption facing multiple risky assets and proportional transaction costs in the presence of return predictability. Due to the curse of dimensionality, this problem is very difficult to solve even numerically. In this paper, we propose several feasible policies that are based on optimizing quadratic programs. These proposed feasible policies can be easily computed even for many risky assets. We show how to compute upper bounds and use them to study how the losses associated with using the approximate policies depend on different problem parameters. |
| Keywords: | Portfolio optimization , Dynamic portfolio choice , Information relaxations |
| Date: | 2015–11 |
| URL: | http://d.repec.org/n?u=RePEc:cte:wsrepe:ws1521&r=upt |
| By: | Andrew Glover (University of Texas at Austin); Dean Corbae (University of Wisconsin) |
| Abstract: | We study a dynamic model of unsecured credit markets with adverse selection and an endogenous signal of a borrower's riskiness (modeled as a credit score). Credit contracts are statically constrained efficient in our environment, which is achieved by limiting the debt of low-risk borrowers while subsidizing the interest rate for the high-risk borrowers. A higher credit score (i.e. higher prior that the borrower is low risk) relaxes the constraint on low-risk borrowers and increases the subsidization for high-risk, which means that utility for both types increases with their credit scores. We calibrate the model to salient features of the unsecured credit market and consider the welfare consequences of different information regimes. |
| Date: | 2015 |
| URL: | http://d.repec.org/n?u=RePEc:red:sed015:1265&r=upt |
| By: | Carlos Ruiz Mora; Francisco J. Nogales Martín; Francisco Javier Prieto Fernández |
| Abstract: | The ongoing transformations of power systems worldwide pose important challenges,both economic and technical, for their appropriate planning and operation. A key approach to improve the efficiency of these systems is through demand-side management, i.e., to promote the active involvement of consumers in the system. In particular, the current trend it to conceive systems where electricity consumers can vary their load according to real-time price incentives, offered by retailing companies.Under this setting, retail competition plays an important role as inadequate prices orservices may entail consumers switching to a rival retailer. In this work we consider a game theoretical model where asymmetric retailers compete in prices to increase their profits by accounting for the utility function of consumers. Consumer preferences for retailers are uncertain and distributed within a Hotelling line. We analytically characterize the equilibrium of a retailer duopoly, establishing its existence and uniqueness conditions. Furthermore, sensitivities of the equilibrium prices with respect to relevant model parameters are also provided. The duopoly model is extended to a multiple retailer case for which we perform an empirical analysis via numerical simulations. Results indicate that, depending on the retailer costs, loyalty rewards and initial market shares, the resulting equilibrium can range from complete competition to one in which a retailer have a leading or even a dominant position in the market, decreasing the consumers' utility significantly. Moreover, the retailer network configuration also plays an important role in the competitiveness of the system. |
| Keywords: | Elastic consumers , Electricity market , Hotelling line , Market equilibrium , Retail competition , Switching consumers |
| Date: | 2015–11 |
| URL: | http://d.repec.org/n?u=RePEc:cte:wsrepe:ws1522&r=upt |
| By: | Coutts, Alexander |
| Abstract: | Optimistic beliefs affect important areas of economic decision making, yet direct knowledge on how belief biases operate remains limited. To better understand these biases I conduct an experiment examining beliefs about binary events with financial stakes. By varying financial prizes in outcomes, as well as incentive payments for accuracy, the experiment is able to distinguish between two leading theories of optimistic belief formation that differ in their assumptions about how such beliefs are constrained. The Optimal Expectations theory of Brunnermeier and Parker (2005) models beliefs as being constrained through the future costs of holding incorrect beliefs, while the Affective Decision Making model of Bracha and Brown (2012) argues that beliefs are constrained by mental costs of distorting reality. The results suggest that people hold optimistically biased beliefs, and comparative statics indicate that these beliefs are not constrained by increasing the costs of making inaccurate judgments. In fact, the results support the theory of Bracha and Brown (2012), as observed bias is increasing in the size of incentive payments for accuracy. |
| Keywords: | Beliefs, Optimism, Pessimism, Overconfidence, Anticipation, Affective expected utility. |
| JEL: | C91 D03 D80 D81 D83 D84 |
| Date: | 2015–08 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:67507&r=upt |