
on Utility Models and Prospect Theory 
By:  Stanislaus MaierPaape; Qiji Jim Zhu 
Abstract:  Utility and risk are two often competing measurements on the investment success. We show that efficient tradeoff between these two measurements for investment portfolios happens, in general, on a convex curve in the two dimensional space of utility and risk. This is a rather general pattern. The modern portfolio theory of Markowitz [H. Markowitz, Portfolio Selection, 1959] and its natural generalization, the capital market pricing model, [W. F. Sharpe, Mutual fund performance , 1966] are special cases of our general framework when the risk measure is taken to be the standard deviation and the utility function is the identity mapping. Using our general framework, we also recover the results in [R. T. Rockafellar, S. Uryasev and M. Zabarankin, Master funds in portfolio analysis with general deviation measures, 2006] that extends the capital market pricing model to allow for the use of more general deviation measures. This generalized capital asset pricing model also applies to e.g. when an approximation of the maximum drawdown is considered as a risk measure. Furthermore, the consideration of a general utility function allows to go beyond the "additive" performance measure to a "multiplicative" one of cumulative returns by using the log utility. As a result, the growth optimal portfolio theory [J. Lintner, The valuation of risk assets and the selection of risky investments in stock portfolios and capital budgets, 1965] and the leverage space portfolio theory [R. Vince, The Leverage Space Trading Model, 2009] can also be understood under our general framework. Thus, this general framework allows a unification of several important existing portfolio theories and goes much beyond. 
Date:  2017–10 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1710.04579&r=upt 
By:  Geoffrey Heal, Anthony Millner 
Abstract:  Uncertainty is ubiquitous in Environmental Economics. This is inevitable: we study the interactions between socioeconomic systems and biogeochemical systems, and in general neither of these is fully understood. Climate change is a good example: the scientific community understands some aspects of the behaviour of the climate system well, but others poorly. We are certainly no better off, and often worse off, when it comes to our understanding of economic systems. And we are particularly weak at the interactions between the two. Biodiversity loss is another important problem for which our lack of knowledge is striking. We are in the midst of a mass extinction comparable to those of prehistory, yet we have little formal understanding of why biodiversity matters to us or how to model the economic consequences of its loss. In this paper, the authors' treatment of uncertainty in environmental applications is motivated by two leading examples: climate change and biodiversity loss. They argue that in these cases uncertainty is sufficiently farreaching that standard decisionmaking tools such as expected utility theory may no longer capture important aspects of our uncertainty preferences. Richer models of decisionmaking, which allow us to express lack of confidence in our information, may be more desirable. 
Date:  2017–09 
URL:  http://d.repec.org/n?u=RePEc:lsg:lsgwps:wp278&r=upt 
By:  Ian DewBecker; Charles G. Nathanson 
Abstract:  We study an ambiguityaverse agent with uncertainty about income dynamics who chooses what aspects of the income process to learn about. The agent chooses to learn most about income dynamics at the very lowest frequencies, which have the greatest effect on utility. Deviations of consumption from the fullinformation benchmark are then largest at high frequencies, so consumption responds strongly to predictable changes in income in the shortrun but is closer to a random walk in the longrun. Whereas ambiguity aversion typically leads agents to act as though shocks are more persistent than the truth, endogenous learning here eliminates that effect. 
JEL:  C14 D83 E21 
Date:  2017–10 
URL:  http://d.repec.org/n?u=RePEc:nbr:nberwo:23917&r=upt 
By:  Lingqi Gu; Yiqing Lin; Junjian Yang 
Abstract:  This paper discusses the num\'erairebased utility maximization problem in markets with proportional transaction costs. In particular, the investor is required to liquidate all her position in stock at the terminal time. We first observe the stability of the primal and dual value functions as well as the convergence of the primal and dual optimizers when perturbations occur on the utility function and on the physical probability. We then study the properties of the optimal dual process (ODP), that is, a process from the dual domain that induces the optimality of the dual problem. When the market is driven by a continuous process, we construct the ODP for the problem in the limiting market by a sequence of ODPs corresponding to the problems with small misspecificated parameters. Moreover, we prove that this limiting ODP defines a shadow price. 
Date:  2017–10 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1710.04363&r=upt 
By:  JeanMichel Grandmont (Department of Economics, University Of Venice Cà Foscari; CREST (EXCESS, UMR CNRS 9194), University of ParisSaclay, France; and RIEB Fellow, University of Kobe, Japan) 
Abstract:  We evaluate the income elasticity of the aggregate budget share spent on a subgroup of commodities, in a competitive framework, by a continuum of agents having the same income, but heterogeneous behavior described by an "homothetic preferences scaling factor" having a bounded Pareto distribution in the population. If individual budget share increases globally significantly in the limit from low to large incomes, aggregate budget share is locally increasing with medium range incomes when the logarithm of the heterogeneity factor has an increasing (exponential) density with a large support. Aggregate income elasticity converges to that exponential density parameter when its support becomes infinitely large. Symmetric results hold in the decreasing case. Applications are made to market expenditures, wealth effects on portfolio choice with many risky assets, concave expenditures, that are compatible with standard (expected) utility maximization or other "behavioral" decision making processes. 
Keywords:  ICEF, Department of Economics, Ca' Foscari University Venice Italy; CREST (EXCESS, UMR CNRS 9194), University of ParisSaclay, France; and RIEB Fellow, University of Kobe, Japan 
JEL:  D01 D03 D11 D14 D30 D41 D53 E10 E20 G02 G11 
Date:  2017 
URL:  http://d.repec.org/n?u=RePEc:ven:wpaper:2017:22&r=upt 
By:  Topi Miettinen; Michael Kosfeld; Ernst Fehr; Jörgen W. Weibull 
Abstract:  We experimentally investigate behavior and beliefs in a sequential prisonerâ€™s dilemma. Each subject had to choose an action as firstmover and a conditional action as secondmover. All subjects also had to state their beliefs about othersâ€™ secondmover choices. We find that subjectsâ€™ beliefs about othersâ€™ choices are fairly accurate on average. Using the elicited beliefs, we compare the explanatory power of a few current models of social and moral preferences. The data show clear differences in explanatory power between the preference models, both without and with control for the number of free parameters. The bestperforming models explain about 80% of observed behavior. We use the estimated preference parameters to identify biases in subjectsâ€™ expectations. We find a consensus bias (whereby subjects believe others behave like themselves) and a certain optimism (whereby subjects overestimate probabilities for favorable outcomes), the former being about twice as strong as the second. 
Keywords:  cooperation, prisonersâ€™ dilemma, otherregarding preferences, categorical imperative, consensus effect, optimism 
JEL:  C72 C90 D03 D84 
Date:  2017 
URL:  http://d.repec.org/n?u=RePEc:ces:ceswps:_6358&r=upt 
By:  Jessen, Robin; Metzing, Maria; RostamAfschar, Davud 
Abstract:  A common assumption in the optimal taxation literature is that the social planner maximizes a welfarist social welfare function with weights decreasing with income. However, high transfer withdrawal rates in many countries imply very low weights for the working poor in practice. We reconcile this puzzle by generalizing the optimal taxation framework by Saez (2002) to allow for alternatives to welfarism. We calculate weights of a social planner's function as implied by the German tax and transfer system based on the concepts of welfarism, minimum absolute and relative sacrifice, as well as subjective justness. For the latter we use a novel question from the German SocioEconomic Panel. We find that the minimum absolute sacrifice principle is in line with social weights that decline with net income. Absolute subjective justness is roughly in line with decreasing social weights, which is reflected by preferences of men, West Germans, and supporters of the grand coalition parties. 
Keywords:  Justness,Optimal Taxation,Income Redistribution,Equal Sacrifice,Inequality,Subjective Preferences 
JEL:  D63 D60 H21 H23 I38 
Date:  2017 
URL:  http://d.repec.org/n?u=RePEc:zbw:hohdps:272017&r=upt 
By:  Lionel Ragot; Michel Beine; Marco Delogu 
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 from a Random Utility Maximization model of location choice for international students in the presence of capacity constraints of the hosting institutions. The last layer of the model is estimated using new data on student migration flows at the university level for Italy. We control for the potential endogeneity of tuition fees through a classical IV approach based on the status of the university. We obtain evidence for a clear and negative effect of fees on international student mobility and confirm the positive impact of the quality of the education. The estimations also support the important role of additional destinationspecific variables such as host capacity, the expected return of education and the cost of living in the vicinity of the university. 
Keywords:  Foreign students; Tuition fees; Location choice; University Quality. 
JEL:  F22 H52 I23 O15 
Date:  2017 
URL:  http://d.repec.org/n?u=RePEc:drm:wpaper:201744&r=upt 
By:  Chris Kenyon; Mourad Berrahoui; Benjamin Poncet 
Abstract:  The utility of Potential Future Exposure (PFE) for counterparty trading limits is being challenged by new market developments, notably widespread regulatory Initial Margin (using 99% 10day exposure), and netting of trade and collateral flows. However PFE has preexisting challenges w.r.t. portfolios/distributions, collateralization, netting set seniority, and overlaps with CVA. We introduce Potential Future Loss (PFL) which combines expected shortfall (ES) and loss given default (LGD) as a replacement for PFE. With two additional variants Adjusted PFL (aPFL) and Protected Adjusted PFL (paPFL) these deal with both new and preexisting challenges. We provide a theoretical background and numerical examples. 
Date:  2017–10 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1710.03161&r=upt 
By:  Svetlozar Rachev; Stoyan Stoyanov; Stefan Mittnik; Frank J. Fabozzi 
Abstract:  In this paper we address three main objections of behavioral finance to the theory of rational finance, considered as anomalies the theory of rational finance cannot explain: Predictability of asset returns, The Equity Premium, (The Volatility Puzzle. We offer resolutions of those objections within the rational finance. We do not claim that those are the only possible explanations of the anomalies, but offer statistical models within the rational theory of finance which can be used without relying on behavioral finance assumptions when searching for explanations of those anomalies. 
Date:  2017–10 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1710.03211&r=upt 
By:  Burak Can (Department of Economics, School of Business and Economics, Maastricht University); Ali Ihsan Ozkes (AixMarseille Univ. (AixMarseille School of Economics), CNRS, EHESS and Centrale Marseille); Ton Storcken (Department of Quantitative Economics, Maastricht University) 
Abstract:  We provide axiomatic characterizations for measures of polarization in profiles of preferences that are represented as rankings of alternatives. Polarization is seen as the extent to which opinions are opposed. We provide characterizations for an extension of this simple intuition on the pairs of alternatives to the cases with more than two alternatives. Our primary generalization allows for different treatment among issues, i.e., pairs of alternatives. Secondly, we show that the characterization result continues to hold when preferences are allowed to attain indifferences. Finally, we show that we can also impose a domain restriction that only allows for singlepeaked preferences and retain our characterization. Our results point to a fundamental feature of measures on profile of preferences that are based on pairwise comparisons of alternatives. 
Keywords:  polarization, measurement, Social Choice, singlepeaked preferences 
JEL:  D63 D71 D72 D74 
Date:  2017–09 
URL:  http://d.repec.org/n?u=RePEc:aim:wpaimx:1734&r=upt 
By:  Jaroslav Borovicka; John Stachurski 
Abstract:  We study existence, uniqueness and computability of solutions for a class of discrete time recursive utilities models. By combining two streams of the recent literature on recursive preferencesone that analyzes principal eigenvalues of valuation operators and another that exploits the theory of monotone concave operatorswe obtain conditions that are both necessary and sufficient for existence and uniqueness of solutions. We also show that the natural iterative algorithm is convergent if and only if a solution exists. Consumption processes are allowed to be nonstationary. 
Date:  2017–10 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1710.06526&r=upt 