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on Utility Models and Prospect Theory |
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Issue of 2017‒04‒30
fourteen papers chosen by |
| By: | Christophe Courbage (Geneva School of Business Administration, University of Applied SciencesWestern Swizterland (HESSO)); Henri Loubergé (University of Geneva, Geneva School of Economics and Management, Swiss Finance Institute); Béatrice Rey (Univ Lyon, Université Lumière Lyon 2, GATE L-SE UMR 5824, F-69130 Ecully, France) |
| Abstract: | This paper investigates how welfare losses for facing risks change as the risk environment of the decision-maker is altered. To that aim, we define the risk apportionment of order n (RA-n) utility premium as a measure of pain associated with facing the passage from one risk to a riskier one. Changes in risks are expressed through the concept of stochastic dominance of order n. Three configurations of risk exposures are considered. The paper first shows how the RA-n utility premium is modified when initial wealth becomes riskier. Second, the paper provides conditions on individual preferences for superadditivity of the RA-n utility premium. Third, the paper investigates welfare changes of merging increases in risks. These results offer new interpretations of the sign of higher derivatives of the utility function. |
| Keywords: | risk apportionment, superadditivity, RA-n utility premium |
| JEL: | D81 |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:gat:wpaper:1710&r=upt |
| By: | Mihaly Ormos; Dusan Timotity |
| Abstract: | This paper discusses an alternative explanation for the empirical findings contradicting the positive relationship between risk (variance) and reward (expected return). We show that these contradicting results might be due to the false definition of risk-perception, which we correct by introducing Expected Downside Risk (EDR). The EDR parameter, similar to the Expected Shortfall or Conditional Value-at-Risk, measures the tail risk, however, fits and better explains the utility perception of investors. Our results indicate that when using the EDR as risk measure, both the positive and negative relationship between expected return and risk can be derived under standard conditions (e.g. expected utility theory and positive risk-aversion). Therefore, no alternative psychological explanation or additional boundary condition on utility theory is required to explain the phenomenon. Furthermore, we show empirically that it is a more precise linear predictor of expected return than volatility, both for individual assets and portfolios. |
| Date: | 2017–04 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1704.05332&r=upt |
| By: | Polemarchakis, Herakles (Department of Economics, University of Warwick and LabEx MME-DII, University of Paris 2); Selden, Larry (Columbia Business School, Columbia University and University of Pennsylvania); Song, Xinxi (International School of Economics and Management, Capital University of Economics and Business) |
| Abstract: | Individuals behave differently when they know the objective probability of events and when they do not. The smooth ambiguity model accommodates both ambiguity (uncertainty) and risk. For an incomplete, competitive asset market, we develop a revealed preference test for asset demand to be consistent with the maximization of smooth ambiguity preferences ; and we show that ambiguity preferences constructed from finite observations converge to underlying ambiguity preferences as observations become dense. Subsequently, we give sufficient conditions for the asset demand generated by smooth ambiguity preferences to identify the ambiguity and risk indices as well as the ambiguity probability measure. We do not require ambiguity beliefs to be observable : in a generalized specification, they may not even be defined. An ambiguity free asset plays an important role for identification. |
| Keywords: | risk ; uncertainty ; identification JEL classification numbers: D11 ; D80 ; D81 |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:wrk:wcreta:28&r=upt |
| By: | Simonovits Andras (Institute of Economics, Research Centre for Economic and Regional Studies, Hungarian Academy of Sciences, also Mathematical Institute of Budapest University of Technology) |
| Abstract: | We consider three transfer models with a representative individual who discounts the utility of the merit good with respect to the standard one's. In each model, a paternalistic government taxes the consumer and transfers him additional merit goods in return. The private purchase of the merit goods is cheaper than the transfer. Even if the optimal transfer system is welfare superior to the transfer-free system, a system with much lower transfer may be inferior, therefore this welfare gap should be jumped. Various pension modelers (e.g. Feldstein, 1985; van Groezen, Leers and Meijdam, 2003) overlooked this problem and drew wrong conclusions. |
| Keywords: | transfers, pensions, taxes, social welfare, paternalism |
| JEL: | D10 H55 J13 J14 J18 J26 |
| Date: | 2017–03 |
| URL: | http://d.repec.org/n?u=RePEc:has:discpr:1707&r=upt |
| By: | José Renato Haas Ornelas; Roberto Baltieri Mauad |
| Abstract: | This paper extends the empirical literature on volatility risk premium (VRP) and future returns by analyzing the predictive ability of commodity currency VRP and commodity VRP. The empirical evidence throughout this paper provides support for a positive relationship of commodity currency VRP and future commodity returns, but only for the period after the 2008 global financial crisis. This predictability survives the inclusion of control variables such as equity VRP and past currency returns. Furthermore, we find a negative relationship between gold VRP and future commodity and currency returns. This result corroborates the view of gold as a safe haven asset |
| Date: | 2017–04 |
| URL: | http://d.repec.org/n?u=RePEc:bcb:wpaper:455&r=upt |
| By: | Job Harms; S. Rosenkranz; M.W.J.L. Sanders |
| Abstract: | In this study we investigate how two types of information interventions, providing a benchmark and providing costly information on option ranking, can improve decision-making in complex choices. In our experiment subjects made a series of incentivized choices between four hypothetical financial products with multiple cost components. In the benchmark treatments one product was revealed as the average for all cost components, either in relative or absolute terms. In the costly information treatment subjects were given the option to pay a flat fee in order to have two products revealed as being suboptimal. Our results indicate that benchmarks affect decision quality, but only when presented in relative terms. In addition, we find that the effect of relative benchmarks on decision-quality increases as options become more dissimilar in terms of the number of optimal and suboptimal features. This result suggests that benchmarks make these differences between products more salient. Furthermore, we find that decision-quality is improved by providing costly information, specifically for more similar options. Finally, we find that absolute – but not relative – benchmarks increase demand for costly information. In sum, these results suggest that relative benchmarks can improve decision-making in complex choice environments. |
| Keywords: | experimental economics, complex choices, benchmarks, advice, choice architecture |
| Date: | 2017–03 |
| URL: | http://d.repec.org/n?u=RePEc:use:tkiwps:1707&r=upt |
| By: | Utteeyo Dasgupta; Subha Mani; Smriti Sharma; Saurabh Singhal |
| Abstract: | We design an experiment to examine whether egalitarian preferences, and in particular, behindness aversion as well as preference for favourable inequality affect competitive choices differently among males and females. We find that selection into competitive environments is: (a) negatively related to egalitarian preferences, with smaller negative impacts of being egalitarian on females’ choice of the tournament wage scheme, and (b) negatively associated with behindness aversion and positively related to preference for favourable inequality, with significant gender differences in the impact of these distributional preferences. Once we allow for the impact of distributional preferences, behavioural, personality, and socioeconomic characteristics to vary by gender, the pure gender effect is explained away. We find that gender gaps in distributional preferences along with selected personality traits are the most relevant explanations for gender differences in willingness to compete. This is an important result as these characteristics are per se malleable and amenable to policy interventions. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:unu:wpaper:wp2017-90&r=upt |
| By: | Maya Shaton |
| Abstract: | I exploit a natural experiment to show that household investment decisions depend on the manner in which information is displayed. Israeli retirement funds were prohibited from displaying returns for periods shorter than twelve months. In this setting, the information displayed was altered but the accessible information remained the same. Using differences-in-differences design, I find that this change caused reduction in fund flow sensitivity to past returns, decline in trade volume, and increased asset allocation toward riskier funds. These results are consistent with models of limited attention and myopic loss aversion, and have important implications for households' accumulated wealth at retirement. |
| Keywords: | Attention ; Household Finance ; Information Display ; Myopic Loss Aversion ; Salience |
| JEL: | D14 G02 G11 |
| Date: | 2017–04 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgfe:2017-43&r=upt |
| By: | Maria J. Ruiz Martos (Department of Economic Theory and Economic History, University of Granada.) |
| Abstract: | Cubitt, Starmer and Sugden [TheEconomic Journal, 108, 1362-80, (1998)] pose a dynamic choice argument against the random lottery incentive (RLIS) mechanism. To wit, the RLIS relies on principles of dynamic choice. Thus, experimental research on the dynamic choice principles should be conducted ina single choice design. This study attempts to evaluate the empirical validity of their argument by quasi-replicating their single choice experiment in a RLIS design. Results suggest that one may use the RLISin dynamic choice experiments. |
| Keywords: | experiments, payment approaches,non-expected utility and risk, dynamic choice principles |
| JEL: | B49 C91 D11 D81 |
| Date: | 2017–04–25 |
| URL: | http://d.repec.org/n?u=RePEc:gra:wpaper:17/02&r=upt |
| By: | van Veldhuizen, Roel (WZB Berlin Social Science Center) |
| Abstract: | A large number of recent experimental studies show that women are less likely to sort into competitive environments. While part of this effect may be explained by gender differences in risk attitudes and overconfidence, previous studies have attributed the majority of the gender gap to gender differences in a separate \\\'competitiveness\\\' trait. We re-examine this result using a novel experimental technique that allows us to separate competitiveness from alternative explanations by experimental design. In contrast to the literature, our results imply that the whole gender gap is driven by risk attitudes and overconfidence, which has important implications for future research. |
| Keywords: | gender; competitiveness; lab experiment; experimental design; |
| JEL: | C90 J16 D03 |
| Date: | 2017–03–25 |
| URL: | http://d.repec.org/n?u=RePEc:rco:dpaper:14&r=upt |
| By: | Jang, Tae-Seok; Sacht, Stephen |
| Abstract: | The notion of bounded rationality has received a considerable attention in the midst of debate over the usefulness of various macroeconomic models. In this paper we empirically seek to analyze the baseline New-Keynesian model with heterogeneous agents who may adopt various heuristics used to forecast future movements in consumption. Agents could exhibit an optimistic or pessimistic view or act as fundamentalists or chartists when forming expectations on future consumption based on discrete choice. Our empirical results via the Simulated Method of Moment Approach show that consumer confidence in the US is heavily grounded on consumers' emotional state (with respect to optimism and pessimism), while for the Euro Area it is most likely technical in nature (with respect to fundamentalists and chartists). These heuristics lead to an equivalent or even better fit to the data compared to the hybrid version of the baseline New-Keynesian model. We argue that this study could open up new possibilities for estimating bounded rationality models and policy analysis. |
| Keywords: | Bounded Rationality,Consumer Confidence,New-Keynesian Model,Forecast Heuristics,Simulated Method of Moments |
| JEL: | C53 D83 E12 E32 |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:cauewp:201704&r=upt |
| By: | Thomas Garcia (Univ Lyon, Université Lumière Lyon 2, GATE L-SE UMR 5824, F-69130 Ecully, France; QuBE - School of Economics and Finance, QUT, Brisbane, Australia); Sébastien Massoni (QuBE - School of Economics and Finance, QUT, Brisbane, Australia; Australian Centre for Entrepreneurship Research, QUT, Brisbane, Australia) |
| Abstract: | When making a decision under uncertainty, individuals aim to achieve opti- mality. In general, an accurate decision is optimal. However, in real life situations asymmetric stakes induce an unusual divergence between optimality and accuracy. We highlight this optimality-accuracy trade-off and study its origins using two experiments on perceptual decision making. We use Signal Detection Theory as a normative benchmark. The first experiment confirms the existence of an optimality-accuracy trade-off with a leading role of accuracy. The second experiment explains this trade-off by the concern of people for being right. |
| Keywords: | optimality, accuracy, signal detection theory, incentives, experiment |
| JEL: | D81 D83 |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:gat:wpaper:1714&r=upt |
| By: | Sinaiko, Anna (Harvard University); Zeckhauser, Richard (Harvard University) |
| Abstract: | Behavioral economic research has established that defaults, one form of nudge, powerfully influence choices. In most policy contexts, all individuals receive the same nudge. We present a model that analyzes the optimal universal nudge when individuals differ in their preferences, different individuals should make different choices, and there is a cost to resist a nudge. Our empirical focus is on terminated choosers, individuals whose prior choice becomes no longer available. Specifically, we examine the power of defaults for individuals who had enrolled in Medicare Advantage with drug coverage and had their plans discountinued. Should these terminated choosers fail to actively choose another Medicare Advantage plan, they are automatically defaulted into fee-for-service Medicare absent drug coverage. Overall, the rate of transition for TCs to FFS Medicare is low, implying that original preferences and status quo bias overpowered the default. Black TCs were more susceptible to the default than non-blacks. Increasing numbers of Americans are choosing plans in health insurance exchange settings such as Medicare, the Affordable Care Act (ACA), and private exchanges. Plan exits and large numbers of TCs are inevitable, along with other forms of turmoil. Any guidance and defaults provided for TCs should attend to their past revealed preferences. |
| Date: | 2016–12 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:harjfk:rwp16-055&r=upt |
| By: | Fuhai Hong; Tanjim Hossain; John List; Migiwa Tanaka |
| Abstract: | Using a natural field experiment with factory workers where we introduce a quantity-based performance-pay scheme in addition to their base salary, we quantify the impact of one-dimensional monetary incentives on both incentivized (quantity) and non-incentivized (quality) dimensions of output. While the management typically observes only quantity, we also observe quality by hiring quality-inspectors unbeknownst to the workers. While some workers receive a flat-rate base salary, others receive a piece-rate base salary. We find sharp evidence that workers under a flat-rate base salary trade off quality for quantity. Interestingly, this quantity-quality trade-off is statistically insignificant for workers under a piece-rate base salary. This variation in the treatment effect is consistent with a simple theoretical model that predicts that when agents are already incented at the margin, the quantity-quality trade-off resulting from additional incentives will be less prominent. |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:feb:natura:00609&r=upt |