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on Utility Models and Prospect Theory |
| By: | Lars P. Hansen; Thomas J. Sargent |
| Abstract: | A decision maker constructs a convex set of nonnegative martingales to use as likelihood ratios that represent parametric alternatives to a baseline model and also non-parametric models statistically close to both the baseline model and the parametric alternatives. Max-min expected utility over that set gives rise to equilibrium prices of model uncertainty expressed as worst-case distortions to drifts in a representative investor's baseline model. We offer quantitative illustrations for baseline models of consumption dynamics that display long-run risk. We describe a set of parametric alternatives that generates countercyclical prices of uncertainty. |
| JEL: | C01 C02 C14 C52 E3 |
| Date: | 2016–02 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:22000&r=upt |
| By: | Hiromasa Takahashi (Faculty of International Studies, Hiroshima City University); Junyi Shen (Research Institute for Economics & Business Administration (RIEB), Kobe University, Japan); Kazuhito Ogawa (Faculty of Sociology and Center for Experimental Economics, Kansai University) |
| Abstract: | We examine gender-specific reference-dependent preferences in a trust game experiment. Different participation fees and one question eliciting subjects' reference points were used to categorize subjects into three frames: the gain frame, gain or loss frame, and loss frame. We find that (i) men are risk-seeking in both the gain and the loss frame; (ii) women are not always more risk-averse than men; and (iii) women display other-regarding preferences only when they are in the gain frame. These results demonstrate the importance of taking account of both gender differences and reference-dependent preferences when examining individuals' economic behavior. |
| Keywords: | Reference-dependent preference, Gender difference, Trust game experiment, Risk preference, Other-regarding preference |
| JEL: | C72 C91 |
| Date: | 2016–09 |
| URL: | http://d.repec.org/n?u=RePEc:kob:dpaper:dp2016-09&r=upt |
| By: | Holger Gerhardt; Guido P. Biele; Hauke R. Heekeren; Harald Uhlig |
| Abstract: | We investigate how stable individuals’ risk attitudes are with respect to changes in cognitive load. In a laboratory experiment using pairwise lottery choice and a within-subject design, we showthat putting subjects under load via a concurrent working-memory task significantly increases their risk aversion. Subjects made significantly faster choices under load. Regardless of load, they responded faster when choosing the less risky option in safe–risky trials, but not in risky–risky trials. We discuss how these findings relate to both dual-system and unitarysystem theories of decision making.We observe that predictions of both recent dual-system and drift–diffusion models of the decision-making process are confirmed by our data and argue for a convergence of these to-date separate strands of the literature. |
| Keywords: | Risk aversion, cognitive load, working memory, dual-system approach, multiplesystem approach, dual-self model, drift–diffusion model, response times |
| JEL: | C91 D03 D81 D87 |
| Date: | 2016–03 |
| URL: | http://d.repec.org/n?u=RePEc:hum:wpaper:sfb649dp2016-011&r=upt |
| By: | Anouar El Haji (Amsterdam Business School, University of Amsterdam); Michał Krawczyk (Faculty of Economic Sciences, University of Warsaw); Marta Sylwestrzak (Faculty of Economic Sciences, University of Warsaw); Ewa Zawojska (Faculty of Economic Sciences, University of Warsaw) |
| Abstract: | Auctions often require risk taking under time pressure. However, little is known about how time pressure moderates the relationship between uncertainty of outcomes and bidding behavior. This study consists of a field experiment in which participants are invited to a Vickrey auction to elicit their willingness to pay for a lottery ticket. The time available to place a bid and also the skewness of the lottery (holding the expected value constant) are systematically manipulated. We find that under high time pressure participants are less likely to place a bid at all. Furthermore, participants who do place a bid under high time pressure bid significantly less than participants under low time pressure. The main finding is thus that increased time pressure significantly decreases risk taking. The effect seems to be particularly strong for the lottery with a high probability of winning and for female subjects. |
| Keywords: | Internet auctions, Vickrey auction, risk taking, time pressure |
| JEL: | C9 D44 |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:war:wpaper:2016-04&r=upt |
| By: | Jean-Pierre Fouque; Ruimeng Hu |
| Abstract: | In this paper, we study the portfolio optimization problem with general utility functions and when the return and volatility of underlying asset are slowly varying. An asymptotic optimal strategy is provided within a specific class of admissible controls under this problem setup. Specifically, we first establish a rigorous first order approximation of the value function associated to a fixed zeroth order suboptimal trading strategy, which is given by the heuristic argument in [J.-P. Fouque, R. Sircar and T. Zariphopoulou, {\it Mathematical Finance}, 2016]. Then, we show that this zeroth order suboptimal strategy is asymptotically optimal in a specific family of admissible trading strategies. Finally, we show that our assumptions are satisfied by a particular fully solvable model. |
| Date: | 2016–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1603.03538&r=upt |
| By: | Paolo Bertoletti; Federico Etro; Ina Simonovska |
| Abstract: | We develop a general equilibrium model of monopolistic competition and trade based on indirectly additive preferences and heterogenous firms. It generates markups independent from destination population but increasing in destination per capita income, as documented empirically. Trade liberalization delivers an increase in consumed variety and incomplete cost pass-through. This leads to welfare gains that can be much lower than those predicted by comparable models with different preferences. We introduce a tractable utility function that further predicts that small firms grow more during trade liberalization and pass through cost changes more than do large firms. Once we estimate the model to match moments from cross-firm and cross-country data we (i) find quantitatively large differences in the welfare gains from trade relative to models based on homothetic preferences, and (ii) evaluate the gains and losses from the Transatlantic Trade and Investment Partnership agreement. |
| JEL: | D11 D43 F12 L11 |
| Date: | 2016–02 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:21984&r=upt |
| By: | Hitoshi Shigeoka; Katsunori Yamada |
| Abstract: | Economists have long been aware of utility externalities such as a tendency to compare own income with others'. If welfare losses from income comparisons are significant, any governmental interventions that alter such attitudes may have large welfare consequences. We conduct an original online survey of discrete-choice questions to estimate such attitudes in the US and the UK. We find that the UK respondents compare incomes more than US respondents do. We then manipulate our respondents with simple information to examine whether the attitudes can be altered. Our information treatment suggesting that comparing income with others may diminish welfare even when income levels increase makes UK respondents compare incomes more rather than less. Interestingly, US respondents are not affected at all. The mechanism behind the UK results seems to be that our treatment gives moral license to make income comparisons by providing information that others do so. |
| JEL: | C9 D1 D3 |
| Date: | 2016–02 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:21998&r=upt |
| By: | Teemu Pennanen; Ari-Pekka Perkki\"o |
| Abstract: | This paper studies convex duality in optimal investment and contingent claim valuation in markets where traded assets may be subject to nonlinear trading costs and portfolio constraints. Under fairly general conditions, the dual expressions decompose into tree terms, corresponding to the agent's risk preferences, trading costs and portfolio constraints, respectively. The dual representations are shown to be valid when the market model satisfies an appropriate generalization of the no-arbitrage condition and the agent's utility function satisfies an appropriate generalization of asymptotic elasticity conditions. When applied to classical liquid market models or models with bid-ask spreads, we recover well-known pricing formulas in terms of martingale measures and consistent price systems. Building on the general theory of convex stochastic optimization, we also derive optimality conditions in terms of an extended notion of a "shadow price". |
| Date: | 2016–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1603.02867&r=upt |
| By: | HORAN, Sean |
| Abstract: | I provide choice-theoretic foundations for a simple two-stage model, called transitive shortlist methods, where choices are made by sequentially by applying a pair of transitive preferences (or rationales) to eliminate inferior alternatives. Despite its simplicity, the model accommodates a wide range of choice phenomena including the status quo bias, framing, homophily, compromise, and limited willpower. I establish that the model can be succinctly characterized in terms of some well-documented context effects in choice. I also show that the underlying rationales are straightforward to determine from readily observable reversals in choice. Finally, I highlight the usefulness of these results in a variety of applications. |
| Keywords: | Shortlisting; axiomatization; revealed preference; identification |
| JEL: | D01 |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:mtl:montde:2016-01&r=upt |
| By: | Zuzana Brokesova (University of Economics in Bratislava); Cary Deck (College of Business and Public Policy University of Alaska Anchorage and Sam M. Walton College of Business, University of Arkansas and Economic Science Institute, Chapman University,); Jana Peliova (Faculty of National Economy, University of Economics in Bratislava) |
| Abstract: | Controlled laboratory experiments have become a generally accepted method for studying economic behavior, but there are two issues that regularly arise with such work. The first pertains to the ability to generalize experimental results outside the laboratory. While laboratory experiments are typically designed to mimic naturally occurring situations, ceteris paribus comparisons are rare. Using data from a promotional campaign by a bank and a matching laboratory experiment, we find similar patterns of risk taking behavior controlling for gender and age. The second issue pertains to the impact that the payment procedure in an experiment has on observed risk taking behavior. Specifically, we compare behavior on a risk taking task where that is the only task and payment is assured, where it is one of several similar tasks of which one will be randomly selected for payment, and where it is the only task but there is only a small probability of receiving payment. We find similar behavior across these three payment procedures. |
| Keywords: | Natural Experiment, Laboratory Experiment, Experimental Methodology, Risk Attitudes |
| JEL: | C91 C99 D81 |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:chu:wpaper:16-06&r=upt |
| By: | Markandya, Anil; De Cian, Enrica; Drouet, Laurent; Polanco-Martìnez, Josué M.; Bosello, Francesco |
| Abstract: | This paper proposes an operationally simple and easily generalizable methodology to incorporate climate change damage uncertainty into Integrated Assessment Models (IAMs). Uncertainty is transformed into a risk-premium, damage-correction, region-specific factor by extracting damage distribution means and variances from an ensemble of socio economic and climate change scenarios. This risk premium quantifies what society would be willing to pay to insure against the uncertainty of the damages, and it can be considered an add-up to the standard “average damage”. Our computations show the addition to be significant, but highly sensitive to the coefficient of relative risk aversion. Once the climate change damage function incorporates the risk premium into the model, results show a substantial increase in both mitigation and adaptation, reflecting a more conservative attitude by the social planner. Interestingly, adaptation is stimulated more than mitigation in the first half of the century, while the situation reverses afterwards. Over the century, the risk premium correction fosters more mitigation, which doubles, than adaptation, which rises by about 80%. |
| Keywords: | Risk, Uncertainty, Climate, Adaptation, Mitigation, Environmental Economics and Policy, Q2, Q3, D8, D9, D62, |
| Date: | 2016–03–10 |
| URL: | http://d.repec.org/n?u=RePEc:ags:feemei:232719&r=upt |
| By: | Jang-Ting Guo (Department of Economics, University of California Riverside); Shu-Hua Chen (National Taipei University) |
| Abstract: | We examine the theoretical interrelations between progressive income taxation and macroeconomic (in)stability in an otherwise standard one-sector AK model of endogenous growth with utility-generating government purchases of goods and services. In sharp contrast to traditional Keynesian-type stabilization policies, progressive taxation operates like an automatic destabilizer that generates equilibrium indeterminacy and belief-driven fluctuations in our endogenously growing macroeconomy. This instability result is obtained regardless of (i) the degree of the public-spending preference externality, and (ii) whether private and public consumption expenditures are substitutes, complements, or additively separable in the household's utility function. |
| Keywords: | Progressive Income Taxation, Equilibrium (In)determinacy, Utility-Generating Government Spending, Endogenous Growth. |
| JEL: | E32 E62 |
| Date: | 2016–03 |
| URL: | http://d.repec.org/n?u=RePEc:ucr:wpaper:201604&r=upt |
| By: | Beatriz Martínez (Department of Business Finance, University of Valencia); Hipòlit Torró (Financial and Actuarial Economics, University of Valencia) |
| Abstract: | In many futures markets, trading is concentrated in the front contract and positions are rolled-over until the strategy horizon is attained. In this paper, a pair-wise comparison between the conventional risk premium and the accrued risk premium in rolled-over positions in the front contract is carried out for UK natural gas futures. Several novel results are obtained. Firstly, and most importantly, the accrued risk premium in rollover strategies is significatively larger than conventional risk premiums and increases with the time to delivery. Specifically, for strategy horizons between three and six months, this difference increases from 1% to 10%. Secondly, it is the first time that risk premium in day-ahead futures has been measured in this market. The average value of the day-ahead risk premium is 0.5% per day and it is statistically significant. Thirdly, all risk premiums are significantly larger and more volatile in winter. Finally, risk premium time-variation is analyzed using a regression model. It is shown that reservoirs, weather, liquidity, volatility, skewness, and seasons are able in all cases to explain between 21% and 59% of the risk premium time-variation (depending on the futures maturity and sub-period). |
| Keywords: | Natural Gas Market, Futures Premium, Rollover, Seasonal Risk Premiums |
| JEL: | G13 L95 |
| Date: | 2016–01 |
| URL: | http://d.repec.org/n?u=RePEc:fem:femwpa:2016.06&r=upt |
| By: | Robert J. Barro; Gordon Y. Liao |
| Abstract: | A new options-pricing formula applies to far-out-of-the money put options on the overall stock market when disaster risk is the dominant force, the size distribution of disasters follows a power law, and the economy has a representative agent with Epstein-Zin utility. In the applicable region, the elasticity of the put-options price with respect to maturity is close to one. The elasticity with respect to exercise price is greater than one, roughly constant, and depends on the difference between the power-law tail parameter and the coefficient of relative risk aversion, γ. The options-pricing formula conforms with data from 1983 to 2015 on far-out-of-the-money put options on the U.S. S&P 500 and analogous indices for other countries. The analysis uses two types of data—indicative prices on OTC contracts offered by a large financial firm and market data provided by OptionMetrics, Bloomberg, and Berkeley Options Data Base. The options-pricing formula involves a multiplicative term that is proportional to the disaster probability, p. If γ and the size distribution of disasters are fixed, time variations in p can be inferred from time fixed effects. The estimated disaster probability peaks particularly during the recent financial crisis of 2008-09 and the stock-market crash of October 1987. |
| JEL: | E44 G12 G13 |
| Date: | 2016–01 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:21888&r=upt |