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on Utility Models and Prospect Theory |
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Issue of 2018‒01‒29
twelve papers chosen by |
| By: | Clark, Ephraim; Qiao, Zhuo; Wong, Wing-Keung |
| Abstract: | Investor behavior towards risk lies at the heart of economic decision making in general and modern investment theory and practice in particular. This paper uses both the mean-variance (MV) criterion and stochastic dominance (SD) procedures to analyze the preferences for four of the most widely studied investor types in the Taiwan stock and stock index futures market. We find that risk averters (concave utility function) prefer spot to futures, whereas risk seekers (convex utility function) prefer futures to spot. Our findings also show that investors with S-shaped utility functions prefer spot (futures) to futures (spot) when markets move upward (downward). Finally, our results imply that investors with reverse S-shaped utility functions prefer futures (spot) to spot (futures) when markets move upward (downward). These results are robust with respect to sub-periods, spot returns including dividends and diversification. Although we do not check whether risk averters, risk seekers, and investors with S-shaped and reverse Sshaped utility functions actually exist in the market, we do show that their existence is plausible. The implications of our findings on market efficiency and the existence of arbitrage opportunities are also discussed in this study. |
| Keywords: | stochastic dominance; risk aversion; risk seeking; prospect theory; behavioral economics; stock index futures; |
| JEL: | C14 G12 G15 |
| Date: | 2017–11–23 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:82888&r=upt |
| By: | Shuige Liu |
| Abstract: | We characterize common assumption of rationality of 2-person games within an incomplete information framework. We use the lexicographic model with incomplete information and show that a belief hierarchy expresses common assumption of rationality within a complete information framework if and only if there is a belief hierarchy within the corresponding incomplete information framework that expresses common full belief in caution, rationality, every good choice is supported, and prior belief in the original utility functions. |
| Date: | 2018–01 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1801.04714&r=upt |
| By: | A. Ronald Gallant; Mohammad Jahan-Parvar; Hening Liu |
| Abstract: | We use the Bayesian method introduced by Gallant and McCulloch (2009) to estimate consumption-based asset pricing models featuring smooth ambiguity preferences. We rely on semi-nonparametric estimation of a flexible auxiliary model in our structural estimation. Based on the market and aggregate consumption data, our estimation provides statistical support for asset pricing models with smooth ambiguity. Statistical model comparison shows that models with ambiguity, learning and time-varying volatility are preferred to the long-run risk model. We analyze asset pricing implications of the estimated models. |
| Keywords: | Ambiguity ; Bayesian estimation ; equity premium ; Markov-switching ; long-run risk |
| JEL: | C61 D81 G11 G12 |
| Date: | 2018–01 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedgif:1221&r=upt |
| By: | Mario Le Glatin (CGS i3 - Centre de Gestion Scientifique i3 - MINES ParisTech - École nationale supérieure des mines de Paris - PSL - PSL Research University - CNRS - Centre National de la Recherche Scientifique); Pascal Le Masson (CGS i3 - Centre de Gestion Scientifique i3 - MINES ParisTech - École nationale supérieure des mines de Paris - PSL - PSL Research University - CNRS - Centre National de la Recherche Scientifique); Benoit Weil (CGS i3 - Centre de Gestion Scientifique i3 - MINES ParisTech - École nationale supérieure des mines de Paris - PSL - PSL Research University - CNRS - Centre National de la Recherche Scientifique) |
| Abstract: | Organisations trying to innovate, despite being naturally encouraged to use project management and associated rational theories of choice, will necessarily experiment in some way or another due to the high levels of uncertainty and the unknown to be discovered. Exploratory project management may face situations requiring a constant reconfiguration of beliefs and hypotheses as a reaction to external factors. In this paper, we propose to discuss the existence of a generative rationality breaking away from classical decision theory by deliberately reversing preferences and designing decisions. |
| Keywords: | decision,design,project,innovation,preferences reversal,rationality,generative |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-01674309&r=upt |
| By: | Oriol Carbonell-Nicolau (Rutgers University); Humberto Llavador (Universitat Pompeu Fabra and Barcelona GSE) |
| Abstract: | Carbonell-Nicolau and Llavador (forthcoming) extend the classic result of Jakobsson (1976) and Fellman (1976)—according to which average-rate progressive, and only average-rate progressive income taxes, reduce income inequality—to the case of endogenous income. There it is shown that marginal-rate progressivity—in the sense of increasing marginal tax rates on income—is necessary for tax structures to be inequality reducing, and necessary and sufficient conditions on the social utility function are identified under which progressive and only progressive taxes are inequality reducing. This paper takes a further step and furnishes conditions on primitives under which various subclasses of progressive taxes are inequality reducing. The main results in CarbonellNicolau and Llavador (forthcoming) are obtained as particular cases of the more general framework presented here. Restricting the set of taxes allows for larger classes of preferences consistent with inequality reducing income taxation. As an illustration of the results’ practical implications, we provide a precise characterization of the subclass of (progressive) taxes that are inequality reducing for some standard families of preferences. |
| Keywords: | progressive taxation, income inequality, incentive effects of taxation |
| JEL: | D63 D71 |
| Date: | 2018–01–16 |
| URL: | http://d.repec.org/n?u=RePEc:rut:rutres:201801&r=upt |
| By: | Gaspard Dumollard; Stéphane De Cara (ECO-PUB - Economie Publique - INRA - Institut National de la Recherche Agronomique - AgroParisTech) |
| Abstract: | This study aims to characterize steady-state land allocations between a multiple-stand forest and agriculture, when the forest is subject to a storm risk. The landowner is supposed to have recursive preferences, which permits to distinguish between in-tertemporal preferences and risk preferences. Using a stochastic dynamic programming model, we show that both land allocation and forest management depend on the risk and on both types of preferences at the steady-state. Risk aversion is shown to favor land allocation to agriculture and to reduce the forest average harvest age while the preference for a regular income is shown to favor forestry and to reduce the average harvest age. |
| Keywords: | Land allocation,Forest management,Recursive preferences,Stochastic Dynamic Programming |
| Date: | 2017–12–07 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-01671595&r=upt |
| By: | Yasar, Rusen |
| Abstract: | Despite rising popularity of subjective well-being (SWB) as a proxy for utility, its relationship with income is still unresolved. Against the background of debates around the 'Easterlin paradox', this paper seeks a compromise between two positions: one that insists on individual relative income, and one that finds similarity between individual and aggregate levels. Proposing a model which puts the emphasis on the interaction between individual and aggregate-level factors, it argues that the effect of relative income on SWB varies across countries as a function of average income, in addition to a relatively small direct effect of the latter, in partial agreement with the two major positions. The model is tested cross-sectionally on the data from the latest wave of World Values Survey. The results from hierarchical mixed-effect models confirm the main argument. But further examination reveals that there is still unaccounted variation especially in middle-income economies. |
| Keywords: | subjective well-being,Easterlin paradox,relative income,national income |
| JEL: | D31 C31 |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:ifwedp:2017113&r=upt |
| By: | Michał Wiktor Krawczyk (Faculty of Economic Sciences, University of Warsaw); Joanna Rachubik (Faculty of Economic Sciences, University of Warsaw) |
| Abstract: | Despite having the same probability of being drawn, certain number combinations are more popular than others among the lottery players. One explanation of such a preference is the representativeness heuristic (RH). Unlike previous hypothetical experiments, in the present experiment we used real-life lottery tickets, involving a high payout in case of winning to elicit true preferences. To verify if people prefer randomly-looking number combinations, participants were to choose a preferred ticket. To validate if it is likely to be caused by RH, we correlated preference for “random” sequences with the belief in dependence between subsequent coin tosses. We confirm that people strongly prefer random sequences and that a non-trivial fraction believes in dependence between coin tosses. However, there is no correlation between these two tendencies, questioning the RH explanation. By contrast, participants who have an (irrationally) strong preference for number combinations also tend to make (irrationally) specific predictions in the coin task. Unexpectedly, we find that females are considerably more likely to belong to this group than males. |
| Keywords: | decision bias, gambler’s fallacy, gender difference, hot hand fallacy, lottery choice, misperception of randomness, number preference in lotteries, representativeness heuristic |
| JEL: | C93 D01 D81 D91 |
| Date: | 2018 |
| URL: | http://d.repec.org/n?u=RePEc:war:wpaper:2018-03&r=upt |
| By: | Jörn Richstein |
| Abstract: | Low and uncertain carbon prices are often stated as a major obstacle for industrial sector investments in technologies to deliver deep emissions reductions. Project-based carbon contracts underwritten by national governments could addressregulatory risk, lower financing costs and strengthen incentives for emission reductions at investment and operation stage. In this paper design options for project-based carbon contracts are assessed using an analytical model capturing risk aversion of investors with a meanvariance utility function. The model is also used to assess how a combination with grant support for innovative projects can minimize overall costs of innovation policy. Savings in financing costs are quantified using a stylized project finance cash flow analysis. |
| Keywords: | Emission trading systems, carbon contract, innovation support |
| JEL: | D81 Q48 Q54 Q55 Q58 O38 |
| Date: | 2017 |
| URL: | http://d.repec.org/n?u=RePEc:diw:diwwpp:dp1714&r=upt |
| By: | Uschi Backes-Gellner (University of Zurich); Holger Herz (University of Fribourg); Michael Kosfeld (Goethe University Frankfurt); Yvonne Oswald (University of Zurich) |
| Abstract: | Evidence suggests that acquiring human capital is related to better life outcomes, yet young peoples' decisions to invest in or stop acquiring human capital are still poorly understood. We investigate the role of time and reference-dependent preferences in such decisions. Using a data set that is unique in its combination of real-world observations on student outcomes and experimental data on economic preferences, we find that a low degree of long-run patience is a key determinant of dropping out of upper-secondary education. Further, for students who finish education we show that one month before termination of their program, present-biased students are less likely to have concrete continuation plans while loss averse students are more likely to have a definite job offer already. Our findings provide fresh evidence on students' decision-making about human capital acquisition and labor market transition with important implications for education and labor market policy. |
| Keywords: | Economic preferences, education, dropout, human capital, job search |
| JEL: | D01 D03 D91 I21 J64 |
| Date: | 2018–01 |
| URL: | http://d.repec.org/n?u=RePEc:iso:educat:0144&r=upt |
| By: | Alejandro Martínez-Marquina; Muriel Niederle; Emanuel Vespa |
| Abstract: | We propose a new hypothesis, the Power of Certainty, to help explain agents' difficulties in making choices when there are multiple possible payoff-relevant states. In the probabilistic ‘Acquiring-a-Company’ problem an agent submits a price to a firm before knowing whether the firm is of low or high value. We construct a deterministic problem with a low and high value firm, where the agent submits a price that is sent to each firm separately. Subjects are much more likely to use dominant strategies in deterministic than in probabilistic problems, even though computations for profit maximization are identical for risk-neutral agents. |
| JEL: | C90 D81 |
| Date: | 2017–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:24030&r=upt |
| By: | Jun Sakamoto (Graduate School of Economics, Osaka University) |
| Abstract: | This paper analyzes the impact of the disclosure on the equity premium. We also investigate whether or not the effect of the disclosure on the premium depends on market uncertainty. We obtain the following empirical results. In the case that the market uncertainty is low, the equity premium and the level of disclosure have the insignificant negative relationship. In contrast, when the market uncertainty is high, the negative relationship between the level of the disclosure and the equity premium is strongly supported. |
| Keywords: | Disclosure, Risk premium, Fama-French 3factor model |
| JEL: | G12 |
| Date: | 2017–04 |
| URL: | http://d.repec.org/n?u=RePEc:osk:wpaper:1711r&r=upt |