nep-upt New Economics Papers
on Utility Models and Prospect Theory
Issue of 2016‒09‒11
seven papers chosen by

  1. Portfolio Choice with High Frequency Data: CRRA Preferences and the Liquidity Effect By Rui Pedro Brito; Hélder Sebastião; Pedro Godinho
  2. On Jensen's inequality for generalized Choquet integral with an application to risk aversion By Wioletta Szeligowska; Marek Kaluszka
  3. Temporal stability, cross-validity, and external validity of risk preferences measures: experimental evidence from a UK representative sample By Matteo M. Galizzi; Sara R. Machado; Raffaele Miniaci
  4. Can Myopic Loss Aversion Explain the Equity Premium Puzzle? Evidence from a Natural Field Experiment with Professional Traders By Francis Larson; John List; Robert Metcalfe
  5. Multi-period investment strategies under Cumulative Prospect Theory By Liurui Deng; Traian A. Pirvu
  6. Deferred compensation and risk-taking incentives By Roman Inderst; Marcus Opp; Florian Hoffmann
  7. Intertemporal stability of survey-based measures of risk and time preferences over a three-year course By Drichoutis, Andreas C.; Vassilopoulos, Achilleas

  1. By: Rui Pedro Brito (GEMF, Faculty of Economics, University of Coimbra); Hélder Sebastião (GEMF, Faculty of Economics, University of Coimbra); Pedro Godinho (GEMF, Faculty of Economics, University of Coimbra)
    Abstract: This paper suggests a new approach for Portfolio Choice. In this framework, the investor, with CRRA preferences, has two objectives: the maximization of the expected utility and the minimization of the portfolio expected illiquidity. The CRRA utility is measured using the portfolio realized volatility, realized skewness and realized kurtosis, while the portfolio illiquidity is measured using the well-known Amihud illiquidity ratio. Therefore, the investor is able to make her choices directly in the expected utility/liquidity (EU/L) bi-dimensional space. We conduct an empirical analysis in a set of fourteen stocks of the CAC 40 stock market index, using high frequency data for the time span from January 1999 to December 2005 (seven years). The robustness of the proposed model is checked according to the out-of-sample performance of different EU/L portfolios relative to the minimum variance and equally weighted portfolios. For different risk aversion levels, the EU/L portfolios are quite competitive and in several cases consistently outperform those benchmarks, in terms of utility, liquidity and certainty equivalent.
    Keywords: Portfolio choice, high frequency data, realized moments, Ahmihud illiquidity ratio, CRRA preferences. JEL Classification: C44, C55, C58, C61, C63, C88, G11.
    Date: 2016–09
  2. By: Wioletta Szeligowska; Marek Kaluszka
    Abstract: In the paper we give necessary and sufficient conditions for the Jensen inequality to hold for the generalized Choquet integral with respect to a pair of capacities. Next, we apply obtained result to the theory of risk aversion by providing the assumptions on utility function and capacities under which an agent is risk averse. Moreover, we show that the Arrow-Pratt theorem can be generalized to cover the case, where the expectation is replaced by the generalized Choquet integral.
    Date: 2016–09
  3. By: Matteo M. Galizzi; Sara R. Machado; Raffaele Miniaci
    Abstract: We conduct an “artefactual” field experiment to incorporate three different risk preferences measures within the Innovation Panel (IP) of the UK Household Longitudinal Survey (UKHLS). We randomly allocate to an experimental module a nationally representative sample of 661 adult respondents to the IP Wave 6 (IP6). These subjects respond to the incentive-compatible tasks by Holt and Laury (2002) (HL), and by Binswanger (1980, 1981) and Eckel and Grossman (2008) (B-EG), and to the SOEP survey questions by Dohmen et al. (2011) for self-reported willingness to take risks in general (SOEP-G), in finance (SOEP-F), and in health (SOEP-H). One year later (IP7) the same measures are repeated for 413 of these respondents. This design allows us to systematically test, for a UK representative sample, the validity of the three measures along three dimensions. First, we look at cross-validity by testing how responses at one point in time correlate across the three tasks, assuming a Constant Relative Risk Aversion (CRRA) utility function. Second, we look at temporal stability by comparing the responses across IP6 and IP7. Third, we look at external validity by considering a range of risky health and financial behaviors in the UKHLS. We have three main findings. First, concerning cross-validity, we find evidence that the different measures generally correlate and map into each other, although their associations are not perfect. Second, concerning temporal stability, there are significant and positive correlations of the B-EG, HL, and SOEP measures across IP6 and IP7. Finally, we find mixed evidence concerning external validity.
    Keywords: Field Experiments; Risk Aversion; Behavioral Data Linking; Health Behaviors
    JEL: C93 D81
    Date: 2016–08–12
  4. By: Francis Larson; John List; Robert Metcalfe
    Abstract: Behavioral economists have recently put forth a theoretical explanation for the equity premium puzzle based on combining myopia and loss aversion. Complementing the behavioral theory is evidence from laboratory experiments, which provide strong empirical support consistent with myopic loss aversion (MLA). Yet, whether, and to what extent, such preferences underlie behaviors of traders in their natural domain remains unknown. Indeed, a necessary condition for the MLA theory to explain the equity premium puzzle is for marginal traders in markets to exhibit such preferences. Using minute-by-minute trading observations from over 864,000 price realizations in a natural field experiment, we find data patterns consonant with MLA: in their normal course of business, professional traders who receive infrequent price information invest 33% more in risky assets, yielding profits that are 53% higher, compared to traders who receive frequent price information. Beyond testing theory, these results have important implications for efficient resource allocation as well as characterizing the optimal structure of social and economic policies.
    Date: 2016
  5. By: Liurui Deng; Traian A. Pirvu
    Abstract: In this article, inspired by Shi, et al. we investigate the optimal portfolio selection with one risk-free asset and one risky asset in a multiple period set- ting under cumulative prospect theory (CPT). Compared with their study, our novelty is that we consider probability distortions, and portfolio constraints. In doing numerical analysis, we test the sensitivity of the optimal CPT-investment strategies to different model parameters.
    Date: 2016–08
  6. By: Roman Inderst (Univ. Frankfurt and Imperial College Lon); Marcus Opp (UC Berkeley, Haas School of Business); Florian Hoffmann (University of Bonn)
    Abstract: Our paper develops a simple principal-agent framework to analyze the equilibrium relationship between risk-taking and the timing of pay. In our setup, the agent's one-time action has persistent effects through affecting the arrival time distribution of a disaster event. While the principal receives informative signals about the agent's action over time, it is costly to rely on this information for incentive pay since the agent is relatively impatient. Optimal compensation contracts resolve the tension between impatience and information with at most two payout dates. Our framework lends itself to analyze recent regulatory interventions mandating minimum deferral periods and clawback provisions in the financial sector. It shows how such regulatory interference in the timing dimension causes the principal to adjust other dimensions of the compensation contract, which may then lead to higher risk-taking. Mandatory deferral requirements are more likely to be effective in reducing risk-taking when competition for agents is high.
    Date: 2016
  7. By: Drichoutis, Andreas C.; Vassilopoulos, Achilleas
    Abstract: Given the importance of risk and time preferences for economics and other disciplines, we seek to examine the intertemporal stability of six related survey-based measures. Using a panel of subjects over a three-year course, between 2013 and 2015, we find aggregate stability of all six measures over the time span of our data. With few exceptions, the measures also show remarkably high individual stability over the examined period. Our results contribute to the wider adoption of survey-based measures, especially considering the ease with which such measures can be incorporated in large-scale surveys.
    Keywords: Delay Discounting; Risk Taking; Risk perception
    JEL: D80 D90
    Date: 2016–08–29

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