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on Utility Models and Prospect Theory |
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Issue of 2017‒01‒08
eighteen papers chosen by |
| By: | Matthew Gentry; Tong Li; Jingfeng Lu |
| Abstract: | In this paper, we study the existence of monotone equilibrium in first price auctions where bidders have a three-dimensional private type, i.e. their private values, degrees of risk aversion and initial wealth. Bidders' utility functions belong to the class of constant relative risk aversion (CRRA) or constant absolute risk aversion (CARA). The bidders' types are independent across bidders, while a bidder's private value, initial wealth and degree of risk aversion are allowed to be correlated. We show that a monotone equilibrium always exists in a general setting allowing for asymmetric bidders. Moreover, with symmetric bidders, a symmetric monotone equilibrium strategy must exist. A bidder's equilibrium strategy increases with bidders' private values and degrees of risk aversion. When bidders have CRRA utility, equilibrium bids decrease with initial wealth; when bidders have CARA utility, equilibrium bids are invariant to initial wealth. |
| Keywords: | constant absolute risk aversion (CARA); constant relative risk aversion (CRRA); auction; initial wealth; monotone equilibrium |
| JEL: | C7 D7 |
| Date: | 2015–11 |
| URL: | http://d.repec.org/n?u=RePEc:ehl:lserod:66100&r=upt |
| By: | von Graevenitz, Kathrine |
| Abstract: | This article reports a complete two stage hedonic analysis for road noise. For the estimation of the hedonic price function I develop a spatial research design which simultaneously reduces the risk of omitted variable bias and the risk of measurement error in the noise measure. The preference parameters are identified following the approach developed in Bajari and Benkard (2005) by using a simple functional form for utility. Preferences are very heterogeneous and observable demographic characteristics explain 30 percent of the variation in taste for quiet. Results are used to discuss willingness to pay for noise reductions from two policy measures. |
| Keywords: | hedonic method,traffic noise,preferences,measurement error |
| JEL: | Q51 Q53 R23 R41 D12 |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:zewdip:16087&r=upt |
| By: | Javier de Frutos; Victor Gaton |
| Abstract: | This paper concerns the numerical solution of the finite-horizon Optimal Investment problem with transaction costs under Potential Utility. The problem is initially posed in terms of an evolutive HJB equation with gradient constraints. In Finite-Horizon Optimal Investment with Transaction Costs: A Parabolic Double Obstacle Problem, Day-Yi, the problem is reformulated as a non-linear parabolic double obstacle problem posed in one spatial variable and defined in an unbounded domain where several explicit properties and formulas are obtained. The restatement of the problem in polar coordinates allows to pose the problem in one spatial variable in a finite domain, avoiding some of the technical difficulties of the numerical solution of the previous statement of the problem. If high precision is required, the spectral numerical method proposed becomes more efficient than simpler methods as finite differences for example. |
| Date: | 2016–12 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1612.09469&r=upt |
| By: | Bruno Bouchard (CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - CNRS - Centre National de la Recherche Scientifique - Université Paris-Dauphine, CREST - Centre de Recherche en Économie et Statistique - INSEE - École Nationale de la Statistique et de l'Administration Économique); Ludovic Moreau (Department of Mathematics, ETH zurich - Swiss Federal Institute of Technology in Zurich (ETH Zurich).); Mete Soner (Department of Mathematics, ETH zurich - Swiss Federal Institute of Technology in Zurich (ETH Zurich).) |
| Abstract: | We consider the problem of option hedging in a market with proportional transaction costs. Since super-replication is very costly in such markets, we replace perfect hedging with an expected loss constraint. Asymptotic analysis for small transactions is used to obtain a tractable model. A general expansion theory is developed using the dynamic programming approach. Explicit formulae are also obtained in the special cases of an exponential or power loss function. As a corollary, we retrieve the asymptotics for the exponential utility indifference price. |
| Keywords: | asymptotic expansion,Expected loss constraint,hedging,transaction cost,asymptotic expansion. |
| Date: | 2016–06–01 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-00863562&r=upt |
| By: | Andrea Carriero; Todd E. Clark; Massimiliano Marcellino |
| Abstract: | We propose a new framework for measuring uncertainty and its effects on the economy, based on a large VAR model with errors whose stochastic volatility is driven by two common unobservable factors, representing aggregate macroeconomic and financial uncertainty. The uncertainty measures can also influence the levels of the variables so that, contrary to most existing measures, ours reflect changes in both the conditional mean and volatility of the variables, and their impact on the economy can be assessed within the same framework. Moreover, identification of the uncertainty shocks is simplified with respect to standard VAR-based analysis, in line with the FAVAR approach and with heteroskedasticity-based identification. Finally, the model, which is also applicable in other contexts, is estimated with a new Bayesian algorithm, which is computationally efficient and allows for jointly modeling many variables, while previous VAR models with stochastic volatility could only handle a handful of variables. Empirically, we apply the method to estimate uncertainty and its effects using US data, finding that there is indeed substantial commonality in uncertainty, sizable effects of uncertainty on key macroeconomic and financial variables with responses in line with economic theory. |
| Keywords: | Bayesian VARs, stochastic volatility, large datasets |
| JEL: | E44 C11 C13 C33 C55 |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:baf:cbafwp:cbafwp1639&r=upt |
| By: | Venegas-Martínez, Francisco; Avendaño-Vargas, Blanca Lilia; García-Meza, Mario Alberto |
| Abstract: | Resumen En la presente investigación analizamos la demanda de dinero por motivo precautorio como una decisión de un consumidor racional. Siguiendo a Whalen (1966), un consumidor demanda dinero para enfrentar gastos inesperados debido a que no se realizan los ingresos esperados. Dado que el patrón de ingresos y gastos no se conoce con certeza, es posible que los gastos excedan a los ingresos por una cantidad impredecible, durante un periodo determinado. En este caso, es necesario que el consumidor retenga cierta cantidad (óptima) de dinero en efectivo. La incorporación de este tipo de demanda de dinero en el proceso de maximización de utilidad de un consumidor racional implica que la demanda de dinero no sólo depende de la tasa de interés real sino también un parámetro que expresa la ansiedad del consumidor ante la eventualidad de enfrentar gastos inesperados. Abstract This paper analyzes the demand for money for precautionary reasons as a decision from a rational consumer. Following Whalen (1966), a consumer demands money to face unexpected expenses because the expected income is not realized. Since the pattern of income and expenditure is not known with certainty, it is possible that the expenses exceed the income by an unpredictable amount, during a certain period. In this case, it is necessary for the consumer to retain some (optimal) amount of cash. The incorporation of this type of money demand in the process of the utility maximization of a rational consumer implies that the demand for money depends not only on the real interest rate but also on a parameter that expresses consumer anxiety in the event of facing unexpected expenses. |
| Keywords: | Demanda de dinero, motivo precautorio, consumidor racional/Money demand, precautionary motive, rational consumer |
| JEL: | E21 E41 |
| Date: | 2016–12–23 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:75793&r=upt |
| By: | Terzi, Ayse (Tilburg University, School of Economics and Management); Koedijk, Kees (Tilburg University, School of Economics and Management); Noussair, Charles N. (Tilburg University, School of Economics and Management); Pownall, Rachel (Tilburg University, School of Economics and Management) |
| Abstract: | It is well-established that, when confronted with a decision to be taken under risk, individuals use reference payoff levels as important inputs. The purpose of this paper is to study which reference points characterize decisions in a setting in which there are several plausible reference levels of payoff. We report an experiment, in which we investigate which of four potential reference points: (1) a population average payoff level, (2) the announced expected payoff of peers in a similar decision situation, (3) a historical average level of earnings that others have received in the same task, and (4) an announced anticipated individual payoff level, best describes decisions in a decontextualized risky decision making task. We find heterogeneity among individuals in the reference points they employ. The population average payoff level is the modal reference point, followed by experimenter's stated expectation of a participant's individual earnings, followed in turn by the average earnings of other participants in previous sessions of the same experiment. A sizeable share of individuals show multiple reference points simultaneously. The reference point that best fits the choices of the individual is not affected by a shock to her income. |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:tiu:tiutis:9ef0ddbd-8f52-4845-87b3-183ea035c6ef&r=upt |
| By: | Silva-Correa, María de los Ángeles; Martínez-Marca, José Luís; Venegas-Martínez, Francisco |
| Abstract: | This paper examines, through a stochastic volatility model, the relationship between the derivatives market and the inflation rate. It is supposed an economy I which a representative agent allocates his/her wealth in an asset, a derivative, a risk-free bond, and he consumes the rest. The equation of the evolution of real wealth is determined to state the problem of utility maximization that the representative agent faces. In the equilibrium of the economy the inflation rate and the value of the other concerning variables (consumption and real monetary balances) are determined. Subsequently, the Hamilton-Jacobi-Bellman equation (HJB) is solved to determine the optimal decisions of the representative agent. Finally, the impact of the derivatives market on the inflation rate is assessed. / Resumen: En este trabajo se examina, mediante un modelo de volatilidad estocástica, la relación que existe entre el mercado de derivados y la tasa de inflación. Se supone una economía en la que un agente representativo destina su riqueza a la tenencia de un activo, un producto derivado, un bono libre de riesgo, y el resto lo consume. Se determina la ecuación de la evolución de la riqueza real para plantear el problema de maximización de utilidad que enfrenta el agente representativo. En el equilibrio de la economía se determina la tasa de inflación y el valor de las demás variables de interés (consumo y saldos monetarios reales). Posteriormente se resuelve la ecuación Hamilton-Jacobi-Bellman (HJB) para determinar las decisiones óptimas del agente representativo. Por último se evalúa el impacto del mercado de derivados en la tasa de inflación. |
| Keywords: | stochastic volatility, derivatives market, monetary policy, stochastic dynamic optimization. |
| JEL: | E52 G13 |
| Date: | 2016–12–20 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:75705&r=upt |
| By: | Kevin M. Murphy; Ignacio Palacios-Huerta |
| Abstract: | Watching TV and other forms of media consumption represent, after sleeping and working, the main activity that adults perform in developed countries. We present a dynamic theory of commercial broadcasting where the media trade utility-raising goods (programs, information, and services) with audiences in exchange for their exposure to advertisements (utility-decreasing bads), and where goods are otherwise free to the audience except for their opportunity cost of time. Goods and bads are dynamically arranged, and as such traded in an intertemporal bundle. No monetary transfers take place between media and audiences, and this barter exchange is not contractually sustained. We study this dynamic problem in a model that captures the central characteristics of how commercial media markets operate. The model is rich enough to account for a variety of disparate evidence in television, radio, print media and the web. |
| JEL: | D11 D21 L21 L82 |
| Date: | 2016–12 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:22994&r=upt |
| By: | Jacopo Bonan, Jacopo Bonan; Philippe LeMay-Boucher, Philippe LeMay-Boucher; Douglas Scott, Douglas Scott |
| Abstract: | This paper estimates time preference parameters using commonly-applied methodologies, with the aim of investigating the link between these measures and actual economic behaviour. An experiment was conducted in the city of Thies, in Senegal, using the unique reference numbers of banknotes as a means of determining an individual’s willingness to save money. The findings of this experiment provide an innovative comparison between real choices, and choices made in the presence of hypothetical rewards. Our research indicates that individuals display a far greater degree of patience, when the possibility of genuine financial gain is made available to them. Our results show that hypothetical time preferences parameters are poor predictors of actual behaviour, prompting questions over the validity of commonly used measurements. |
| Keywords: | Time Preferences, Randomized Experiment, Senegal, Research Methods/ Statistical Methods, D01, D91, C93, O1, |
| Date: | 2016–12–15 |
| URL: | http://d.repec.org/n?u=RePEc:ags:feemmi:250259&r=upt |
| By: | Duccio Piovani; Vassilis Zachariadis; Michael Batty |
| Abstract: | Newly available data on the spatial distribution of retail activities in cities makes it possible to build models formalized at the level of the single retailer. Current models tackle consumer location choices at an aggregate level and the opportunity new data offers for modeling at the retail unit level lacks a theoretical framework. The model we present here helps to address these issues. It is a particular case of the Cross-Nested Logit model, based on random utility theory built with the idea of quantifying the role of floor space and agglomeration in retail location choice. We test this model on the city of London: the results are consistent with a super linear scaling of a retailer's attractiveness with its floor space, and with an agglomeration effect approximated as the total retail floorspace within a $325m$ radius from each shop. |
| Date: | 2016–12 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1612.06441&r=upt |
| By: | Ulrike Malmendier; Demian Pouzo; Vicotria Vanasco |
| Abstract: | How do financial crises and stock-market fluctuations affect investor behavior and the dynamics of financial markets in the long run? Recent evidence suggests that individuals overweight personal experiences of macroeconomic shocks when forming beliefs and making investment decisions. We propose a theoretical foundation for such experience-based learning and derive its dynamic implications in a simple OLG model. Risk averse agents invest in a risky and a risk-free asset. They form beliefs about the payoff of the risky asset based on the two key components of experience effects: (1) they overweight data observed during their lifetimes so far, and (2) they exhibit recency bias. In equilibrium, prices depend on past dividends, but only on those observed by the generations that are alive, and they are more sensitive to more recent dividends. Younger generations react more strongly to recent experiences than older generations, and hence have higher demand for the risky asset in good times, but lower demand in bad times. As a result, a crisis increases the average age of stock market participants, while booms have the opposite effect. The stronger the disagreement across generations (e.g., after a recent shock), the higher is the trade volume. We also show that, vice versa, the demographic composition of markets significantly influences the response to aggregate shocks. We generate empirical results on stock-market participation, stock-market investment, and trade volume from the \emph{Survey of Consumer Finances}, merged with CRSP and historical data on stock-market performance, that are consistent with the model predictions. |
| Date: | 2016–12 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1612.09553&r=upt |
| By: | Olofsson, Sara (The Swedish Institute for Health Economics (IHE), Lund, Sweden); Gerdtham , Ulf-G (Department of Economics, Lund University); Hultkrantz , Lars (Örebro University, School of Business, Sweden); Persson , Ulf (The Swedish Institute for Health Economics (IHE), Lund, Sweden) |
| Abstract: | To decide how much resources to spend on reducing mortality risk, governmental agencies in several countries turn to the value of a statistical life (VSL). VSL has been shown to vary depending on the size of the risk reduction, which indicates that WTP does not increase near-proportional in relation to risk reduction as suggested by standard economic theory. Chained approach (CA) is a stated preference method that was designed to deal with this problem. The objective of this study was to compare CA to the more traditional approach contingent valuation (CV). Data was collected from 500 individuals in the Swedish adult general population using two web-based questionnaires, whereof one based on CA and the other on the CV method. Despite the two different ways of deriving the estimates, the methods showed similar results. The CV result showed scale insensitivity with respect to the size of the risk reduction and disease duration and resulted in more zero and protest response. The CA result did also vary depending on the procedure used, but not when chaining on individual estimates. The CA result was also found to be more sensitive to disease duration and severity. This study provides support for the validity of studies of the WTP for a risk reduction. It also shows that CA is associated with encouraging features for the valuation of non-fatal road traffic accidents, but the result does not support the use of one method over the other. |
| Keywords: | contingent valuation; chained approach; scale sensitivity; risk reduction; willingness-to-pay |
| JEL: | D61 D80 I18 J17 |
| Date: | 2016–12–13 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:lunewp:2016_034&r=upt |
| By: | Federico Favaretto; Donato Masciandaro |
| Abstract: | Behavioral bias – loss aversion – can explain monetary policy inertia in setting interest rates. Economic literature has tended to explain inertia in monetary policymaking in terms of frictions and delays, or has stressed the role of governance rules. We introduce a new driver of inertia, independent from frictions and central bank governance settings: a Monetary Policy Committee (MPC) that takes decisions on interest rates by voting according to a majority rule, in an economy with nominal price rigidities and rational expectations. Central bankers are senior officials, high-ranking bureaucrats who care about their careers and can be divided into three groups, depending on their level of inflation conservatism: doves, pigeons, and hawks. While a conservative stance doesn’t necessarily produce monetary inertia, we show that introducing loss aversion in individual behavior influences the stance of monetary policy under three different but convergent perspectives. First of all, a Moderation Effect can emerge, i.e. the number of pigeons increases. At the same time also a Hysteresis Effect can become relevant, whereby both doves and hawks soften their attitudes. Finally a Smoothing Effect tends to stabilize the number of pigeons. Together, the three effects consistently cause higher monetary policy inertia. |
| Keywords: | Monetary Policy, Behavioral Economics |
| JEL: | E5 |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:baf:cbafwp:cbafwp1621&r=upt |
| By: | Breaban, Adriana (Tilburg University, School of Economics and Management); Van De Kuilen, Gijs (Tilburg University, School of Economics and Management); Noussair, Charles N. (Tilburg University, School of Economics and Management) |
| Abstract: | We report an experiment to consider the emotional correlates of prudent decision making. In the experiment, we present subjects with lotteries and measure their emotional response with facial recognition software. They then make binary choices between risky lotteries that distinguish prudent from imprudent individuals. They also perform tasks to measure their cognitive ability and a number of personality characteristics. We find that a more negative emotional state correlates with greater prudence. Higher cognitive ability and less conscientiousness is also associated with greater prudence. |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:tiu:tiutis:0ac205ac-aee3-4df2-82ee-6aa62b7e3114&r=upt |
| By: | Rezai, Armon; Van der Ploeg, Frederick |
| Abstract: | A new IAM is used to calculate the optimal tradeoff between, on the one hand,locking up fossil fuel and curbing global warming, and, on the other hand,sacrificing consumption now and in the near future. This IAM uses the Oxford carbon cycle, which differs from DICE, FUND and PAGE in that cumulative emissions are the key driving force of changes in temperature. We highlight how time impatience, intergenerational inequality aversion and expected trend growth affect the time paths of the optimal global carbon tax and the optimal amount of fossil fuel reserves to leave untapped. We also compare these with the adverse and deleterious global warming trajectories that occur if no policy actions are taken. (authors' abstract) |
| Keywords: | unburnable fossil fuel; cumulative emissions; optimal carbon tax; Oxford carbon cycle; trend growth; intergenerational inequality aversion; time impatience |
| Date: | 2016 |
| URL: | http://d.repec.org/n?u=RePEc:wiw:wus045:4795&r=upt |
| By: | Ibhagui, Oyakhilome |
| Abstract: | In this paper, we incorporate regret into the decision-making process of a pension fund and derive the optimal asset allocation of a final-wealth-maximizing pension fund in the accumulation and decumulation phases. We find that the optimal asset allocation must be congruent in both phases if and only if the pension fund is upside regret-averse. In particular, our results suggest that allocation to risky assets must increase through time in the accumulation and decumulation phases so that the pension fund can realize gains from any upsides in the risky asset market, thereby maximizing final wealth and limiting the feeling of regret ex-post. Although decisions in both phases are congruent, we find that the optimal asset allocation generally depends on wealth levels. This evidence implies that separate management of the accumulation and decumulation phases of a pension fund decreases available wealth levels and is not an optimal strategy. |
| Keywords: | Financial markets. Asset allocation. Log-logistic. Modified utility. Mortality. Pension fund. Regret aversion |
| JEL: | G1 G11 |
| Date: | 2016–11–19 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:75802&r=upt |
| By: | Brown, Sarah (University of Sheffield); Gray, Daniel (University of Sheffield); Harris, Mark N. (Curtin University); Spencer, Christopher (Loughborough University) |
| Abstract: | Analysing the US Panel Study of Income Dynamics, we present a new empirical method to investigate the extent to which households reduce their financial risk exposure when confronted with background risk. Our novel modelling approach – termed a deflated fractional ordered probit model – quantifies how the overall asset composition in a portfolio adjusts with background risk, and is unique in recovering for, any given risky asset class, the shares that are reallocated to a safer asset category. Background risk exerts a significant impact on household portfolios, resulting in a 'flight from risk', away from riskier to safe assets. |
| Keywords: | asset allocation, background risk, flight from risk, fractional models |
| JEL: | C33 C35 D14 G11 |
| Date: | 2016–12 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp10408&r=upt |