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on Utility Models and Prospect Theory |
| By: | Giuseppe Benedetti; Luciano Campi |
| Abstract: | We consider the problem of exponential utility indifference valuation under the simplified framework where traded and nontraded assets are uncorrelated but where the claim to be priced possibly depends on both. Traded asset prices follow a multivariate Black and Scholes model, while nontraded asset prices evolve as generalized Ornstein–Uhlenbeck processes. We provide a BSDE characterization of the utility indifference price (UIP) for a large class of non-smooth, possibly unbounded, payoffs depending simultaneously on both classes of assets. Focusing then on Vanilla claims and using the Gaussian structure of the model allows us to employ some BSDE techniques (in particular, a Malliavin-type representation theorem due to Ma and Zhang, Ann Appl Probab 12:1390–1418, 2002) to prove the regularity of Z and to characterize the UIP for possibly discontinuous Vanilla payoffs as a viscosity solution of a suitable PDE with continuous space derivatives. The optimal hedging strategy is also identified essentially as the delta hedging strategy corresponding to the UIP. Since there are no closed-form formulas in general, we also obtain asymptotic expansions for prices and hedging strategies when the risk aversion parameter is small. Finally, our results are applied to pricing and hedging power derivatives in various structural models for energy markets |
| Keywords: | Utility indifference pricing; optimal investment; backward stochastic differential equations; viscosity solutions; electricity markets |
| JEL: | C1 F3 G3 |
| Date: | 2016–04 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:63016&r=upt |
| By: | Rhys Bidder; Ian Dew-Becker |
| Abstract: | We study an investor who is unsure of the dynamics of the economy. Not only are parameters unknown, but the investor does not even know what order model to estimate. She estimates her consumption process nonparametrically – allowing potentially infinite-order dynamics – and prices assets using a pessimistic model that minimizes lifetime utility subject to a constraint on statistical plausibility. The equilibrium is exactly solvable and we show that the pricing model always includes long-run risks. With risk aversion of 4.7, the model matches major facts about asset prices, consumption, and dividends. The paper provides a novel link between ambiguity aversion and non-parametric estimation. |
| JEL: | C14 D83 D84 G12 |
| Date: | 2016–07 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:22416&r=upt |
| By: | Nuno Azevedo; Diogo Pinheiro; Stylianos Xanthopoulos; Athanasios Yannacopoulos |
| Abstract: | Within the setup of continuous-time semimartingale financial markets, we show that a multiprior Gilboa-Schmeidler minimax expected utility maximizer forms a portfolio consisting only of the riskless asset if and only if among the investor's priors there exists a probability measure under which all admissible wealth processes are supermartingales. Furthermore, we show that under a certain attainability condition (which is always valid in finite or complete markets) this is also equivalent to the existence of an equivalent (local) martingale measure among the investor's priors. As an example, we generalize a no betting result due to Dow and Werlang. |
| Date: | 2016–08 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1608.02446&r=upt |
| By: | David Hummels; Jakob Munch; Chong Xiang |
| Abstract: | Increased job effort can raise productivity and income but put workers at increased risk of illness and injury. We combine Danish data on individuals’ health with Danish matched worker-firm data to understand how rising exports affect individual workers’ effort, injury, and illness. We find that when firm exports rise for exogenous reasons: 1. Workers work longer hours and take fewer sick-leave days; 2. Workers have higher rates of injury, both overall and correcting for hours worked; and 3. Women have higher sickness rates. For example, a 10% exogenous increase in exports increases women’s rates of injury by 6.4%, and hospitalizations due to heart attacks or strokes by 15%. Finally, we develop a novel framework to calculate the marginal dis-utility of any non-fatal disease, such as heart attacks, and to aggregate across multiple types of sickness conditions and injury to compute the total utility loss. While the ex-ante utility loss for the average worker is small relative to the wage gain from rising exports, the ex-post utility loss is much larger for those who actually get injured or sick. |
| JEL: | F1 F6 I1 J2 J3 |
| Date: | 2016–07 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:22365&r=upt |
| By: | Ngoc Huy Chau; Wolfgang Runggaldier; Peter Tankov |
| Abstract: | We study arbitrage opportunities, market viability and utility maximization in market models with an insider. Assuming that an economic agent possesses from the beginning an additional information in the form of a random variable G, which only becomes known to the ordinary agents at date T, we give criteria for the No Unbounded Profits with Bounded Risk property to hold, characterize optimal arbitrage strategies, and prove duality results for the utility maximization problem faced by the insider. Examples of markets satisfying NUPBR yet admitting arbitrage opportunities are provided for both atomic and continuous random variables G. |
| Date: | 2016–08 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1608.02068&r=upt |
| By: | Stephen J. Redding; David E. Weinstein |
| Abstract: | The measurement of price changes, economic welfare, and demand parameters is currently based on three disjoint approaches: macroeconomic models derived from time-invariant utility functions, microeconomic estimation based on time-varying utility (demand) systems, and actual price and real output data constructed using formulas that differ from either approach. The inconsistencies are so deep that the same assumptions that form the foundation of demand-system estimation can be used to prove that standard price indexes are incorrect, and the assumptions underlying standard exact and superlative price indexes invalidate demand-system estimation. In other words, we show that extant micro and macro welfare estimates are biased and inconsistent with each other as well as the data. We develop a unified approach to demand and price measurement that exactly rationalizes observed micro data on prices and expenditure shares while permitting exact aggregation and meaningful macro comparisons of welfare over time. We show that all standard price indexes are special cases of our approach for particular values of the elasticity of substitution, constant preferences for each good, and a constant set of goods. In contrast to these standard index numbers, our approach allows us to compute changes in the cost of living that take into account both changes in the preferences for individual goods and the entry and exit of goods over time. Using barcode data for the U.S. consumer goods industry, we show that allowing for the entry and exit of products, changing preferences for individual goods, and a value for the elasticity of substitution estimated from the data yields substantially different conclusions for changes in the cost of living from standard index numbers. |
| Keywords: | elasticity of substitution, price index, consumer valuation bias, new goods, welfare |
| JEL: | D11 D12 E01 E31 |
| Date: | 2016–08 |
| URL: | http://d.repec.org/n?u=RePEc:cep:cepdps:dp1445&r=upt |
| By: | Pierre-André Chiappori (Institute for Fiscal Studies and Columbia University); Monica Costa Dias (Institute for Fiscal Studies and Institute for Fiscal Studies); Costas Meghir (Institute for Fiscal Studies and Yale University) |
| Abstract: | We develop an equilibrium lifecycle model of education, marriage and labor supply and consumption in a transferable utility context. Individuals start by choosing their investments in education anticipating returns in the marriage market and the labor market. They then match based on the economic value of marriage and on preferences. Equilibrium in the marriage market determines intrahousehold allocation of resources. Following marriage households (married or single) save, supply labor and consume private and public commodities under uncertainty. Marriage thus has the dual role of providing public goods and offering risk sharing. The model is estimated using the British HPS. |
| Date: | 2016–07–18 |
| URL: | http://d.repec.org/n?u=RePEc:ifs:ifsewp:16/09&r=upt |
| By: | Michel Beine (CREA, Université du Luxembourg); Marco Delogu (CREA, Université du Luxembourg); Lionel Ragot (Université de Paris Ouest) |
| Abstract: | This paper studies the determinants of international students mobility at the university level, focusing specifically on the role of tuition fees. We derive a gravity model based on a Random Utility Maximization model of location choice for international students. The last layer of the model is estimated using new data on students migration flows at the university level for Italy and the UK. The particular institutional setting of the two destinations countries allows to control for the potential endogeneity of tuition fees. We obtain evidence for a clear and negative effect of fees on international student mobility and confirm the positive impact of quality of education. The estimations find also support for an important role of additional destination-specific variables such as host capacity, expected return of education and cost of living in the vicinity of the university. |
| Keywords: | Foreign Students, Tuition fees, Location choice, University quality |
| JEL: | F22 H52 O16 |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:luc:wpaper:16-06&r=upt |
| By: | Corneo, Giacomo |
| Abstract: | This paper revisits the standard model of labor supply under two additional assumptions: consumption requires time and some limited amount of work is enjoyable. Whereas introducing each assumption without the other one does not produce novel insights, combining them together does if the wage rate is sufficiently high. For top earners, work has a positive marginal utility at the optimum and above a critical wage level it converts into a pure consumption good. Their labor-supply curve is first backward bending and then vertical. This can justify an optimal marginal tax rate on top incomes equal to 100 percent. Top earners in the vertical half-line of the labor-supply curve optimally refrain from spending their entire income. At the macroeconomic level, this can generate a lack of effective demand. With some qualifications, these findings carry over to models that incorporate savings and philanthropy. |
| Keywords: | Effective demand; Labor Supply; Optimal taxation of top labor incomes; Super-rich; Time allocation |
| Date: | 2016–08 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:11424&r=upt |
| By: | Dan Villeneuve |
| Abstract: | This adverse outcome pathway details the linkage between inhibition of gonadal aromatase activity in females and reproductive dysfunction, as measured through the adverse effect of reduced cumulative fecundity and spawning. Initial development of this AOP draws heavily on evidence collected using repeat-spawning fish species. Cumulative fecundity is the most apical endpoint considered in the OECD 229 Fish Short Term Reproduction Assay. The OECD 229 assay serves as screening assay for endocrine disruption and associated reproductive impairment (OECD 2012). Cumulative fecundity is one of several variables known to be of demographic significance in forecasting fish population trends. Therefore, this AOP has utility in supporting the application of measures of aromatase, or in silico predictions of the ability to inhibit aromatase, as a means to identify chemicals with known potential to adversely affect fish populations and potentially other oviparous vertebrates. |
| Keywords: | aromatase inhibition, reduced cumulative fecundity, reproductive toxicity, repeat-spawning fish species, Fish Short Term Reproduction Assay |
| Date: | 2016–08–06 |
| URL: | http://d.repec.org/n?u=RePEc:oec:envaad:4-en&r=upt |
| By: | Christopher Taber; Rune Vejlin |
| Abstract: | In this paper we develop a model capturing key features of the Roy model, a search model, compensating differentials, and human capital accumulation on-the-job. We establish which features of the model can be non-parametrically identified and which can not. We estimate the model and use it to asses the relative contribution of the different factors for overall wage inequality. We find that Roy model inequality is the most important component accounting for the majority of wage variation. We also demonstrate that there is substantial interaction between the other features - most notably the importance of the job match obtained by search frictions varies from around 9% to around 29% depending on how we account for other features. Compensating differentials and search are both very important for explaining other features of the data such as the variation in utility. Search is important for turnover, but so is compensating differentials: 1/3 of all choices between two jobs would have resulted in a different outcome if the worker only cared about wages. |
| JEL: | J3 |
| Date: | 2016–07 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:22439&r=upt |
| By: | Jonathan D. Cohen; Keith Marzilli Ericson; David Laibson; John Myles White |
| Abstract: | We review research that measures time preferences – i.e., preferences over intertemporal tradeoffs. We distinguish between studies using financial flows, which we call “money earlier or later” (MEL) decisions and studies that use time-dated consumption/effort. Under different structural models, we show how to translate what MEL experiments directly measure (required rates of return for financial flows) into a discount function. We summarize empirical regularities found in MEL studies and the predictive power of those studies. We explain why MEL choices are driven in part by some factors that are distinct from underlying time preferences. |
| JEL: | D03 D9 |
| Date: | 2016–07 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:22455&r=upt |
| By: | Lichand, Guilherme (Harvard University); Mani, Anandi (University of Warwick) |
| Abstract: | This paper tests whether uncertainty about future rainfall affects farmers’ decision-making through cognitive load. Behavioral theories predict that rainfall risk could impose a psychological tax on farmers, leading to material consequences at all times and across all states of nature, even within decisions unrelated to consumption smoothing, and even when negative rainfall shocks do not materialize down the line. Using a novel technology to run lab experiments in the field, we combine survey experiments with recent rainfall shocks to test the effects of rainfall risk on farmers’ cognition, and find that it decreases farmers’ attention, memory and impulse control, and increases their susceptibility to a variety of behavioral biases. Effects are quantitatively important, equivalent to losing 25% of one’s harvest at the end of the rainy season. Evidence that farmer’s cognitive performance is relatively less impaired in tasks involving scarce resources suggests that the effects operate through the mental bandwidth mechanism. |
| Keywords: | JEL Classification: |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:cge:wacage:298&r=upt |
| By: | Baker, Erin; Bosetti, Valentina; Salo, Ahti |
| Abstract: | We address the problem of choosing a portfolio of policies under “deep uncertainty.” We introduce the idea of belief dominance as a way to derive a set of non-dominated portfolios and robust individual alternatives. Our approach departs from the tradition of providing a single recommended portfolio; rather, it derives a group of good portfolios. The belief dominance concept allows us to synthesize multiple expert- or model- based beliefs by uncovering the range of alternatives that are intelligent responses to the range of beliefs. This goes beyond solutions that are optimal for any specific set of beliefs to uncover other defensible solutions that may not otherwise be revealed. We illustrate our approach using an important problem in the climate change and energy policy context: choosing among clean energy technology R&D portfolios. We demonstrate how the belief dominance concept can reveal portfolios and alternatives that would otherwise remain uncovered. |
| Keywords: | Deep Uncertainty, Decision Making under Uncertainty, Robust, Dominance, Risk and Uncertainty, D8, D78, D81, |
| Date: | 2016–07–31 |
| URL: | http://d.repec.org/n?u=RePEc:ags:feemmi:243147&r=upt |