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on Utility Models and Prospect Theory |
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Issue of 2016‒10‒09
eighteen papers chosen by |
| By: | Broll, Udo; Welzel, Peter; Wong, Kit Pong |
| Abstract: | We examine risk taking when the bank's preferences exhibit smooth ambiguity aversion. Ambiguity is modeled by a second-order probability distribution that captures the bank's uncertainty about which of the subjective beliefs govern the financial asset return risk. Ambiguity preferences are modeled by the (second-order) expectation of a concave transformation of the (first-order) expected utility of profit conditional on each plausible subjective distribution of the return risk. Within this framework, the banking firm finds it less attractive to take risk in the presence than in the absence of ambiguity. This result extends to the case of greater ambiguity aversion. Given that the competitive bank's smooth ambiguity preferences exhibit non-increasing absolute ambiguity aversion, imposing a more stringent capital requirement to the bank reduces the optimal amount of loans, if the bank's coefficient of relative risk aversion does not exceed unity. Ambiguity and ambiguity aversion as such have adverse effect on the bank's risk taking. |
| Keywords: | Banking firm,Ambiguity,Ambiguity aversion,Capital requirement,Banking,Mehrdeutigkeit,Kapitalbedarf |
| JEL: | D01 D81 G11 G12 |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:tudcep:0116&r=upt |
| By: | Daniel Bartl |
| Abstract: | We consider the robust exponential utility maximization problem in discrete time: An investor maximizes the worst case expected exponential utility with respect to a family of non-dominated probabilistic models of her endowment by dynamically investing in a financial market. We show that, for any measurable random endowment (regardless of whether the problem is finite or not) an optimal strategy exists, a dual representation in terms of martingale measures holds true, and that the problem satisfies the dynamic programming principle. |
| Date: | 2016–10 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1610.00999&r=upt |
| By: | Korn, Olaf; Rieger, Marc Oliver |
| Abstract: | This paper investigates corporate hedging under regret aversion. Regret-averse firms try to avoid deviations of their hedging policy from the ex post best policy, an intuitive consideration if one has to justify one's decisions afterward. The study presents a model of a firm that faces uncertain prices and seeks to hedge both profit risk and regret risk with derivatives. It characterizes optimal hedge positions and shows that regret aversion leads to stronger incentives to hedge downside price risk than standard expected utility theory. In the profit region of the price distribution, however, regret aversion reduces the hedging of price risk to avoid large regret in the case of increasing prices. The results show that regret aversion has a strong effect on the choice of the hedging instrument and provides a preference-based explanation for the use of options in corporate risk management. |
| Keywords: | regret aversion,risk management,hedging,derivatives |
| JEL: | D81 G02 G32 G30 |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:cfrwps:1606&r=upt |
| By: | Stéphane Zuber (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, PSE - 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:journl:halshs-01224145&r=upt |
| By: | Laurence Carassus; Romain Blanchard |
| Abstract: | This paper investigates the problem of maximizing expected terminal utility in a discrete-time financial market model with a finite horizon under non-dominated model uncertainty. We use a dynamic programming framework together with measurable selection arguments to prove that under mild integrability conditions, an optimal portfolio exists for an unbounded utility function defined on the half-real line. |
| Date: | 2016–09 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1609.09205&r=upt |
| By: | Elena L. Del Mercato (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics); Vincenzo Platino (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics) |
| Abstract: | We consider a general equilibrium model of a private ownership economy with consumption and production externalities. Utility functions and production technologies may be affected by the consumption and production activities of all other agents in the economy. We use differential techniques to show that the set of competitive equilibria is non-empty and compact. Fixing the externalities, the assumptions on utility functions and production technologies are standard in a differentiable framework. Competitive equilibria are written in terms first-order conditions associated with agents' behavior and market clearing conditions, following the seminal work by Smale (1974). Adapting differential techniques to economies with externalities is non trivial and it requires some ingenious adjustments, because the production technologies are not required to be convex with respect to the consumption and production activities of all agents. |
| Keywords: | externalities,private ownership economy,competitive equilibrium,differentiable approach |
| Date: | 2015–04 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:halshs-01164015&r=upt |
| By: | T. R. Hurd; Quentin H. Shao; Tuan Tran |
| Abstract: | This paper investigates the investment behaviour of a large unregulated financial institution (FI) with CARA risk preferences. It shows how the FI optimizes its trading to account for market illiquidity using an extension of the Almgren-Chriss market impact model of multiple risky assets. This expected utility optimization problem over the set of adapted strategies turns out to have the same solutions as a mean-variance optimization over deterministic trading strategies. That means the optimal adapted trading strategy is both deterministic and time-consistent. It is also found to have an explicit closed form that clearly displays interesting properties. For example, the classic constant Merton portfolio strategy, a particular solution of the frictionless limit of the problem, behaves like an attractor in the space of more general solutions. The main effect of temporary market impact is to slow down the speed of convergence to this constant Merton portfolio. The effect of permanent market impact is to incentivize the FI to buy additional risky assets near the end of the period. This property, that we name the Ponzi property, is related to the creation and bursting of bubbles in the market. The proposed model can be used as a stylized dynamic model of a typical FI in the study of the asset fire sale channel relevant to understanding systemic risk and financial stability. |
| Date: | 2016–10 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1610.00395&r=upt |
| By: | Alain Chateauneuf (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics, IPAG - Business School); Michèle Cohen (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics); Mina Mostoufi (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics); Jean-Christophe Vergnaud (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, PSE - 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:journl:halshs-01224502&r=upt |
| By: | Okay Gunes (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique); Armagan Tuna Aktuna-Gunes (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics) |
| Abstract: | In this article, the satisfactory consumption and labor supply elasticities of demand are measured through a model of time allocation that includes eight time assignment equations by using the full time use (the temporal values of the monetary expenditure plus time spent) concept obtained by matching the Classic Family Budget survey with the Time Use survey for Turkey. The cross-sectional data covers the period of 2003-2006 in Turkey. The elasticity results show a clear picture of the relationship between satisfactory consumption and working with commodity demands for Turkey. As a contribution to the literature, we explore the reasons behind the demand for satisfactory consumption through working decisions by measuring well-being inequality for each consumption group. In order to increase the robustness of our result, overall well-being inequality is measured by introducing the axiom of superposed utility of preferences. As expected, overall well-being inequality declines to 0.26, which is 119 percentage points lower than the average rate of well-being inequality (0.57) in Turkey. |
| Abstract: | Dans cet article, les élasticités de consommation satisfaisante et de l'offre de travail de demande sont mesurées par un modèle d'allocation du temps qui comprend huit équations en utilisant du temps complet (les valeurs temporelles des dépenses monétaires plus les dépenses temporelles) obtenu par l'appariement statistique des enquêtes turques sur le Budget des Familles avec l'enquête sur l'Emploi du Temps. Les données transversales couvrent les années 2003-2006 en Turquie. Les résultats des élasticités montrent une image claire de la relation entre la consommation satisfaisante et l'offre du travail avec les demandes de bien pour la Turquie. Comme contribution à la littérature, nous explorons les raisons derrière de la demande de consommation satisfaisante grâce à la décision de travail en mesurant l'inégalité de bien-être dans chaque groupe de consommation. Afin d'augmenter la robustesse de nos résultats, l'inégalité du bien-être général est mesurée en introduisant l'axiome d'utilité superposée de préférences. Comme prévu, l'inégalité de bien-être général diminue à 0,26 qui est de 119 points de pourcentage moins que le taux moyen de l'inégalité de bien-être général (0,57) en Turquie. |
| Keywords: | time use,life satisfaction,well-being inequality,superposed utilities |
| Date: | 2015–02 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:halshs-01161880&r=upt |
| By: | Jose Apesteguia; Miguel Ángel Ballester |
| Abstract: | Consider the aggregation of a collection of individual stochastic behaviors that fit a given stochastic choice model. We say that such a model has a representative agent if their aggregate stochastic behaviour also fits the model. We show that the Luce model and several prominent extensions thereof do not have a representative agent. On the positive side, we show that the random utility model and several domain-specific restrictions thereof do have a representative agent. |
| Keywords: | representative agent, stochastic choice. |
| JEL: | D0 D7 E1 |
| Date: | 2016–09 |
| URL: | http://d.repec.org/n?u=RePEc:bge:wpaper:928&r=upt |
| By: | Giesecke, Matthias; Yang, Guanzhong |
| Abstract: | We elicit preferences for retirement timing in a laboratory experiment. Subjects make retirement choices under different payoff schemes that introduce variation in financial incentives. Testing ceteris paribus conditions of the financial incentive alone shows a considerable delay of retirement once early retirement becomes financially less attractive. However, varying available information as another treatment parameter reveals considerable heterogeneity in the functioning of these incentives. Subjects who are explicitly informed about the expected pension wealth respond more strongly to financial incentives compared to those who only know their pension annuity. We conclude that the financial consequences of retirement choices become more salient to the decision maker once being informed on a forward-looking measure of pension benefits. |
| Abstract: | Wir untersuchen die Wirkung finanzieller Anreize auf das Rentenalter im Rahmen eines Laborexperiments. Die Teilnehmer wählen ein Renteneintrittsalter, wobei sich die Auszahlungsstruktur hinsichtlich des erwarteten Rentenbarwerts als Funktion des Rentenalters unterscheidet. Konsistent mit der quasi-experimentellen Literatur zeigt sich zunächst eine deutliche Verschiebung des Rentenalters, wenn Frühverrentung finanziell relativ weniger attraktiv ist. Allerdings offenbart sich substantielle Heterogenität in der Wirkungsweise des finanziellen Anreizes, wenn die Menge an verfügbarer Information variiert. Teilnehmer, die explizit über den erwarteten Rentenbarwert für ein entsprechendes Rentenalter informiert sind, reagieren deutlich stärker auf finanzielle Anreize als diejenigen, die lediglich die jeweilige Annuität kennen. Das Ergebnis macht deutlich, dass die finanziellen Konsequenzen von Renteneintrittsentscheidungen in relevantem Ausmaß offensichtlicher werden, wenn Entscheidungsträger über den Barwert als vorausschauendes Maß von periodischen Rentenbezügen informiert sind. |
| Keywords: | retirement age,financial incentives,information treatment,pension knowledge,financial literacy |
| JEL: | C91 H55 J26 |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:rwirep:641&r=upt |
| By: | Hiroki Nishimura (Department of Economics, University of California Riverside); Efe A. Ok; John K.-H. Quah |
| Date: | 2016–10 |
| URL: | http://d.repec.org/n?u=RePEc:ucr:wpaper:201614&r=upt |
| By: | Joao Pedro Jerico; Renato Vicente |
| Abstract: | We study the effects of introducing information inefficiency in a model for a random linear economy with a representative consumer. This is done by considering statistical, instead of classical, economic general equilibria. Employing two different approaches we show that inefficiency increases the consumption set of a consumer but decreases her expected utility. In this scenario economic activity grows while welfare shrinks, that is the opposite of the behavior obtained by considering a rational consumer. |
| Date: | 2016–10 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1610.01270&r=upt |
| By: | Vincenzo Platino (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique); Elena L. Del Mercato (PSE - Paris School of Economics, CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique) |
| Abstract: | We consider a general equilibrium model of a private ownership economy with consumption and production externalities. The choices of all agents (households and firms) may affect utility functions and production technologies. The equilibrium notion blends Arrow-Debreu with Nash, that is, agents (households and firms) maximize their goals by taking as given both commodity prices and choices of every other agent in the economy. We provide an example showing that under standard assumptions, such economies may have infinitely many equilibria. We present our model with firms' endowments following Geanakoplos, Magill, Quinzii and Drèze (1990). Firms' endowments consist of amounts of commodities held by the firms to generate receipts from sales of initially-held stocks of commodities and claims from debts, subsidies and taxes expressible in terms of them. We prove that almost all economies are regular in the space of endowments of households and firms. |
| Keywords: | regular economies,competitive equilibrium à la Nash,externalities,private ownership economies |
| Date: | 2015–05 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:halshs-01162039&r=upt |
| By: | Aronsson, Thomas (Department of Economics, Umeå School of Business and Economics, Umeå University); Johansson-Stenman, Olof (Department of Economics, School of Business, Economics and Law, Göteborg University) |
| Abstract: | This paper deals with tax policy responses to inequality aversion by examining the first-best Pareto-efficient marginal tax structure when people are inequality averse. In doing so, we distinguish between four different and widely used models of inequality aversion. The results show that empirically and experimentally quantified degrees of inequality aversion have potentially very strong implications for Pareto-efficient marginal income taxation. It also turns out that the exact type of inequality aversion (self-centered vs. non-self-centered), and the measures of inequality used, matter a great deal. For example, based on simulation results mimicking the disposable income distribution in the US in 2013, the preferences suggested by Fehr and Schmidt (1999) imply monotonically increasing marginal income taxes, with large negative marginal tax rates for low-income individuals and large positive marginal tax rates for high-income individuals. In contrast, the often considered similar model by Bolton and Ockenfels (2000) implies close to zero marginal income tax rates for all. |
| Keywords: | Pareto-efficient taxation; Inequality aversion; Inequity aversion; Self-centered inequality aversion; Non-self-centered inequality aversion; Fehr and Schmidt preferences; Bolton and Ockenfels preferences |
| JEL: | D03 D62 H23 |
| Date: | 2016–10 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:gunwpe:0673&r=upt |
| By: | DeMarzo, Peter; Kaniel, Ron |
| Abstract: | We consider a multi-agent contracting setting when agents derive utility based in part on their pay relative to their peers. Because agents' productivity is affected by common as well as idiosyncratic shocks, it is optimal to base pay on the agent's performance relative to a benchmark of his peers. But when agents have "keeping up with the Joneses" (KUJ) preferences and care about how their pay compares to that of others, relative performance evaluation also increases agents' perceived risk. We show that when a single principal (or social planner) can commit to a public contract, the optimal contract hedges the risk of the agent's relative wage without sacrificing efficiency. While output is unchanged, however, hedging makes the contracts appear inefficient in the sense that performance is inadequately benchmarked. We also show that when there are multiple principals, or the principal is unable to commit, efficiency is undermined. In particular, KUJ effects induce agents to be more productive, but average wages increase even more, reducing firm profits. We also show that if the principal cannot commit not to privately renegotiate contracts, then wages and effort are increased when KUJ effects are weak, but are reduced, enhancing efficiency, when KUJ effects are sufficiently strong. Finally, public disclosure of contracts across firms can cause output to collapse. |
| Keywords: | contract; Joneses; manager; pay performance; relative |
| Date: | 2016–09 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:11538&r=upt |
| By: | Farah Said; Giovanna d'Adda; Marcel Fafchamps; Uzma Afzal |
| Abstract: | Theoretical and empirical work on intra-household decision making capture empowerment through bargaining weights given to individual preferences, and infer such weights from household consumption allocations. In this paper we test two key hypotheses underlying this work: first, that spousal influence is the same for all private consumption goods; and second, that women have pent up demand for pure agency. We use data from a survey and a novel laboratory experiment implemented with adult couples in Pakistan. We find that women's influence on household decisions is decreasing in the importance of the decision. We find no evidence that women have pent up demand for agency. Instead, women are less willing to pay for agency when facing an unknown man. We interpret this evidence as suggesting that women in our study population have internalized gender norms, and that these norms regulate interactions between genders most strongly outside of the household. We also find little evidence, within our experimental setting, that willingness to pay for agency is affected by the instrumental value of agency. |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:feb:framed:00555&r=upt |
| By: | Daniel Ray (ESC Grenoble - Ecole Supérieure de Commerce de Grenoble - Grenoble École de Management (GEM)); William Sabadie (Centre de Recherche Magellan - Université Jean Moulin - Lyon III - Institut d'Administration des Entreprises (IAE) - Lyon); David Gotteland (ESC Grenoble - Ecole Supérieure de Commerce de Grenoble - Grenoble École de Management (GEM)) |
| Abstract: | This communication addresses how customer orientation can prevent defensive organizational behaviors towards complaints. We argue that prospect theory offers a relevant theoretical framework to address that question. When managers and employees view complaints nega-tively, they are likely to exhibit defensive behaviors towards complaints, which results in an ineffective complaint management. A study conducted with 137 complaint managers show that investments into complaint management do not yield returns if customer orientation does not result in a firm’s orientation toward complaints. Senior management as a critical to play in implementing a complaint orientation of corporate culture. |
| Abstract: | Nous avons recours à la théorie des perspectives pour expliquer comment l’orientation client peut éviter les comportements organisationnels défensifs vis-à-vis des réclamations. Lorsque les managers et les employés ont une conception négative des réclamations, ils développent des comportements défensifs, et cela se traduit par un management inefficace des réclama-tions. Les résultats d’une étude menée auprès de 137 responsables marketing montrent que des efforts en termes de gestion des réclamations sont efficaces si l’orientation client se traduit par une orientation envers les réclamations. Le rôle des managers est important pour favoriser une orientation réclamation dans la culture organisationnelle. |
| Keywords: | customer orientation,complaint,orientation client,réclamation,orientation réclamation |
| Date: | 2015–05–13 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-01222209&r=upt |