|
on Utility Models and Prospect Theory |
|
Issue of 2018‒07‒16
thirty-one papers chosen by |
| By: | Echenique, Federico (California Institute of Technology); Imai, Taisuke (LMU Munich); Saito, Kota (California Institute of Technology) |
| Abstract: | We propose a new measure of deviations from expected utility, given data on economic choices under risk and uncertainty. In a revealed preference setup, and given a positive number e, we provide a characterization of the datasets whose deviation (in beliefs, utility, or perceived prices) is within e of expected utility theory. The number e can then be used as a distance to the theory. We apply our methodology to three recent large-scale experiments. Many subjects in those experiments are consistent with utility maximization, but not expected utility maximization. The correlation of our measure with demographics is also interesting, and provides new and intuitive findings on expected utility. |
| Keywords: | expected utility; revealed preference; |
| JEL: | D01 D81 |
| Date: | 2018–06–26 |
| URL: | http://d.repec.org/n?u=RePEc:rco:dpaper:103&r=upt |
| By: | Attanasi, Giuseppe Marco; D'Albis, Hippolyte; Thibault, Emmanuel |
| Abstract: | In a life-cycle model with a bequest motive, we study the impact of smooth ambiguity aversion to uncertain survival probabilities on the optimal demand for annuities. We implement a theory-driven laboratory experiment. First, a subject's ambiguity attitude is elicited in a simple experimental setting able to make the smooth ambiguity model operational. Then, in a two-period annuity-bequest decision problem, the subject's bequest in the second period is presented as a donation to a previously chosen charity, contingent to the subject being active after the first period. In line with the theoretical predictions, we find that ambiguity-averse (resp., loving) subjects invest less (resp., more) in annuities than ambiguity-neutral ones. Furthermore, subjects'contingent donation to the chosen charity increases in their investment in annuities only for sufficiently high levels of warm-glow altruism. |
| Keywords: | Self-insurance; annuity; uncertain survival probabilities; smooth ambiguity aversion; charity; experiment |
| JEL: | C91 D81 G22 |
| Date: | 2018–07 |
| URL: | http://d.repec.org/n?u=RePEc:tse:wpaper:32756&r=upt |
| By: | TAKAMIZAWA, Hideyuki |
| Abstract: | This study proposes an equilibrium model of term structures of bonds and equities, which has a similar descriptive ability to a reduced-form model proposed by Lettau and Wachter (LW) (J. Financial Economics, 2011), and yet offers economic implications about preferences and consumption dynamics. The ability is obtained by letting parameters of recursive utility depend on state variables of the economy. The model is calibrated by matching it with the LW model, showing that it can produce the term structure of real interest rates with either a positive or negative slope and the term structure of dividend risk premiums with a negative slope, both of which stand as challenges to any pricing models. It also shows that while an implied behavior of state-dependent time preference is reasonable, modifications of parameter values and cash flow processes are necessary for state-dependent risk aversion to behave reasonably. |
| Keywords: | Term structure, Interest rate, Dividend strip, Risk premium, Sharpe ration, Recursive utility, State-dependent preference |
| Date: | 2018–07–01 |
| URL: | http://d.repec.org/n?u=RePEc:hit:hcfrwp:g-1-19&r=upt |
| By: | Kerem Ugurlu |
| Abstract: | We consider a continuous time Principal-Agent model on a finite time horizon, where we look for the existence of an optimal contract both parties agreed on. Contrary to the main stream, where the principal is modelled as risk-neutral, we assume that both the principal and the agent have exponential utility, and are risk averse with same risk awareness level. Moreover, the agent's quality is unknown and modelled as a filtering term in the problem, which is revealed as time passes by. The principal can not observe the agent's real action, but can only recommend action levels to the agent. Hence, we have a \textit{moral hazard} problem. In this setting, we give an explicit solution to the optimal contract problem. |
| Date: | 2018–06 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1806.01495&r=upt |
| By: | Ronald Schettkat |
| Abstract: | Behavioral economics, the analysis of economic decisions, has made enormous progress over the last decades and become accepted as a major field in economics. How is behavioral economics to be compared to the neoclassical model? As a revision of the neoclassical model enhancing the set of variables for motivation such as fairness in the utility function which is then to be maximized? Or is behavioral economics a revolution, a departure from the neoclassical axioms, a new model? This paper argues that many of the findings in behavioral economics are incompatible with the neoclassical model and have paved the way for a revolution in economics. |
| Date: | 2018–06 |
| URL: | http://d.repec.org/n?u=RePEc:bwu:schdps:sdp18005&r=upt |
| By: | Noemí Herranz-Zarzoso (LEE and Department of Economics, Universitat Jaume I, Castellón, Spain); Gerardo Sabater-Grande (LEE and Department of Economics, Universitat Jaume I, Castellón, Spain) |
| Abstract: | In this study we analyze framing effects caused by two versions of the choice (multiple price) list procedure used to elicitate individual risk preferences. In the probability equivalence (PE) version, subjects face pairwise choices between lotteries within a choice list. In the certainty equivalence (CE) version, subjects are asked to state a minimum selling price to give up the lottery they cope to. We implement a within-subjects experiment allowing for preference imprecision and preference for compound lotteries, by means of repetition of identical risk tasks. Introducing different variations in the number of lottery options offered with and without decreasing their range, we find that changes in the framework disturb subject’s risk preferences only in the CE version. |
| Keywords: | risk aversion, framing effects, risk task repetition, preference imprecision, preference for compound lotteries, choice list procedure |
| JEL: | C93 D03 D81 |
| Date: | 2018 |
| URL: | http://d.repec.org/n?u=RePEc:jau:wpaper:2018/04&r=upt |
| By: | Tom D. Holden; Paul Levine; Jonathan M. Swarbrick |
| Abstract: | This note studies a form of a utility function of consumption with habit and leisure that (a) is compatible with long-run balanced growth, (b) hits a steady-state observed target for hours worked and (c) is consistent with micro-econometric evidence for the inter-temporal elasticity of substitution and the Frisch elasticity of labor supply. We employ Jaimovich- Rebello preferences, and our results highlight a constraint on the preference parameter needed to target the steady-state Frisch elasticity. This leads to a lower bound for the latter that cannot be reconciled empirically with external habit, but the introduction of a labor wedge solves the problem. We also propose a dynamic Frisch inverse elasticity measure and examine its business cycle properties. |
| Keywords: | Econometric and statistical methods, Inflation and prices |
| JEL: | E21 E24 |
| Date: | 2018 |
| URL: | http://d.repec.org/n?u=RePEc:bca:bocawp:18-26&r=upt |
| By: | Argenziano, Rossella; Gilboa, Itzhak |
| Abstract: | Relying on a literal interpretation of Weber's law in psychophysics, we show that a simple condition of independence across good categories implies the Cobb-Douglas preferences. |
| Keywords: | Cobb-Douglas; Webers Law; Semi-Order |
| JEL: | D11 |
| Date: | 2017–03–01 |
| URL: | http://d.repec.org/n?u=RePEc:ebg:heccah:1269&r=upt |
| By: | Strobl, Renate; Wunsch, Conny |
| Abstract: | Negative income shocks can either be the consequence of risky choices or random events. A growing literature analyzes the role of responsibility for neediness for informal financial support of individuals facing negative income shocks based on randomized experiments. In this paper, we show that studying this question involves a number of challenges that existing studies either have not been aware of, or have been unable to address satisfactorily. We show that the average effect of free choice of risk on sharing, i.e.\ the comparison of mean sharing across randomized treatments, is not informative about the behavioural effects and that it is not possible to ensure by the experimental design that the average treatment effect equals the behavioural effect. Instead, isolating the behavioural effect requires conditioning on risk exposure. We show that a design that measures subjects preferred level of risk in all treatments allows isolating this effect without additional assumptions. Another advantage of our design is that it allows disentangling changes in giving behaviour due to attributions of responsibility for neediness from other explanations. We implement our design in a lab experiment we conducted with slum dwellers in Nairobi that measures subjects' transfers to a worse-off partner both in a setting where participants could either deliberately choose or were randomly assigned to a safe or a risky project. We find that free choice matters for giving and that the effects depend on donors' risk preferences but that attributions of responsibility play a negligible role in this context. |
| Keywords: | experimental design; Risk Taking; Solidarity |
| JEL: | C91 D63 D81 O12 |
| Date: | 2018–06 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:12995&r=upt |
| By: | Senda Ounaies (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, Department of Mathematics - College of Science - University of Tunis El Manar); Jean-Marc Bonnisseau (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics); Souhail Chebbi (King Saud University - Department of Mathematics - College of Science) |
| Abstract: | In this paper, we consider a production economy with an unbounded attainable set where the consumers may have non-complete non-transitive preferences. To get the existence of an equilibrium, we provide an asymptotic property on preferences for the attainable consumptions and we use a combination of nonlinear optimization and fixed point theorem on truncated economies together with an asymptotic argument. We show that this condition holds true if the set of attainable allocations is compact or, when preferences are representable by utility functions, if the set of attainable individually rational utility levels is compact. This assumption generalizes the CPP condition of Allouch (2002) and covers the example of Page et al. (2000) when the attainable utility levels set is not compact. So we extend the previous existence results with non compact attainable sets in two ways by adding a production sector and considering general preferences. |
| Keywords: | production economy,non compact attainable allocations,Quasi-equilibrium,nonlinear optimization |
| Date: | 2017–10 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:halshs-01382539&r=upt |
| By: | Simon Schopohl (EDEEM - Université Paris 1 - EDEEM - European Doctorate in Economics Erasmus Mundus, Universität Bielefeld (GERMANY), CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, UCL - Université Catholique de Louvain) |
| Abstract: | We consider a Sender-Receiver game in which the Sender can choose between sending a cheap-talk message, which is costless, but also not verified and a costly verified message. While the Sender knows the true state of the world, the Receiver does not have this information, but has to choose an action depending on the message he receives. The action then yields to some utility for Sender and Receiver. We only make a few assumptions about the utility functions of both players, so situations may arise where the Sender's preferences are such that she sends a message trying to convince the Receiver about a certain state of the world, which is not the true one. In a finite setting we state conditons for full revelation, i.e. when the Receiver always learns the truth. Furthermore we describe the player's behavior if only partial revelation is possible. For a continuous setting we show that additional conditions have to hold and that these do not hold for "smooth" preferences and utility, e.g. in the classic example of quadratic loss utilities. |
| Keywords: | verifiable information,cheap-talk,communication,costly disclosure,full revelation,increasing differences,Sender-Receiver game |
| Date: | 2017–01 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:halshs-01490688&r=upt |
| By: | Vladimir Novak; Tim Willems |
| Abstract: | This paper solves the two-armed bandit problem when decision makers are risk averse. It shows, counterintuitively, that a more risk-averse decision maker might be more willing to take risky actions. The reason relates to the fact that pulling the risky arm in bandit models produces information on the environment – thereby reducing the risk that a decision maker will face in the future. This finding gives reason for caution when inferring risk preferences from observed actions: in a bandit setup, observing a greater appetite for risky actions can actually be indicative of more risk aversion, not less. Studies which do not take this into account may produce biased estimates. |
| Keywords: | experimentation; learning; risk aversion; |
| JEL: | D81 D83 |
| Date: | 2018–06 |
| URL: | http://d.repec.org/n?u=RePEc:cer:papers:wp618&r=upt |
| By: | Zbigniew Palmowski; {\L}ukasz Stettner; Anna Sulima |
| Abstract: | We study a portfolio selection problem in a continuous-time It\^o-Markov additive market with prices of financial assets described by Markov additive processes which combine L\'evy processes and regime switching models. Thus the model takes into account two sources of risk: the jump diffusion risk and the regime switching risk. For this reason the market is incomplete. We complete the market by enlarging it with the use of a set of Markovian jump securities, Markovian power-jump securities and impulse regime switching securities. Moreover, we give conditions under which the market is asymptotic-arbitrage-free. We solve the portfolio selection problem in the It\^o-Markov additive market for the power utility and the logarithmic utility. |
| Date: | 2018–06 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1806.03496&r=upt |
| By: | Thai Ha-Huy (EPEE - Centre d'Etudes des Politiques Economiques - UEVE - Université d'Évry-Val-d'Essonne); Cuong Le Van (PSE - Paris School of Economics, CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, IPAG Business School - IPAG BUSINESS SCHOOL PARIS); Frank Page (Department of Economics, Indiana University - Indiana University [Bloomington]); Myrna Wooders (Vanderbilt University - Department of Economics) |
| Abstract: | We consider an exchange economy with a finite number of assets and a finite number of agents. The utility functions of the agents are concave, strictly increasing and their suprema equal infity. We use weak no-arbitrage prices a la Dana and Le Van [5]. Our main result is: an equilibrium exists if, and only if, their exists a weak no-arbitrage price common to all the agents. |
| Keywords: | asset market equilibrium,individually rational attainable allocations,individually rational utility set,no-arbitrage prices,weak no-arbitrage prices,no-arbitrage condition |
| Date: | 2017–05 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:halshs-01529663&r=upt |
| By: | Jorgen-Vitting Andersen (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique); Roy Cerqueti (University of Macerata); Giulia Rotundo (Sapienza University [Rome]) |
| Abstract: | This paper proposes a stochastic model for describing rational expectations. The context is systemic risk, with interconnected components of a unified system. The evolution dynamics leading to the failure of the system is explored either under a theoretical point of view as well as through an extensive scenario analysis. |
| Keywords: | Rational expectation,stochastic system,systemic risk,evolutionary economics |
| Date: | 2017–12 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:halshs-01673338&r=upt |
| By: | Colonnello, Stefano; Curatola, Giuliano; Gioffré, Alessandro |
| Abstract: | We develop a model that reproduces the average return and volatility spread between sin and non-sin stocks. Our investors do not necessarily boycott sin companies. Rather, they are open to invest in any company while trading off dividends against ethicalness. We show that when dividends and ethicalness are complementary goods and investors are sufficiently risk averse, the model predicts that the dividend share of sin companies exhibits a positive relation with the future return and volatility spreads. Our empirical analysis supports the model's predictions. |
| Keywords: | Asset Pricing,General Equilibrium,Sin Stocks |
| JEL: | D51 D91 E20 G12 |
| Date: | 2018 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:safewp:216&r=upt |
| By: | Anne Amar-Sabbah (CERGAM - Centre d'Études et de Recherche en Gestion d'Aix-Marseille - AMU - Aix Marseille Université - UTLN - Université de Toulon); Pierre Batteau (CERGAM - Centre d'Études et de Recherche en Gestion d'Aix-Marseille - AMU - Aix Marseille Université - UTLN - Université de Toulon) |
| Abstract: | Often criticized in the civil society for its magnitude, though considered with mixed appreciations by academics, CEO pay has been objects of many contributions. Reviewing key papers that have raised controversies, we discuss divergent viewpoints with simple game theoretic models in the neoclassical spirit. We assert the complete inadequacy of the agency and asymmetry of information models for explaining CEO compensation, but we diverge from those who reject the optimal contracting approach and show how reasoning with the classical tools of utility maximization, rationality, freedom to participate, and price sets on markets, competitive or not, can model a broad range of situations, including those put forward as arguments against the microeconomic approaches of compensation. The CEO-Board relationship should not be studied as a delegation issue within a hierarchical organization with the shareholders sitting at the top, but rather as a market bargain in search of optimal contracting with symmetrical position and information of both parties, but with asymmetrical reservation utility because the distribution of talent to manage is itself highly asymmetrical, expressing the game power of each side. |
| Keywords: | rationality,CEO compensation,agency theory,bargaining,optimal contracting,utility maximization,CEO power,game theory,Neo-classical economics |
| Date: | 2018–06–19 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:halshs-01818600&r=upt |
| By: | Strobl, Renate; Wunsch, Conny |
| Abstract: | In this study we experimentally investigate whether solidarity, which is a crucial base for informal insurance arrangements in developing countries, is sensitive to the extent to which individuals can influence their risk exposure. With slum dwellers of Nairobi our design measures subjects' willingness to share income with a worse-off partner both in a setting where participants could either deliberately choose or were randomly assigned to a safe or a risky project. We find that only a subgroup of subjects reduces willingness to give when risk exposure is a choice. Responses are limited to donors in the risky project, whereas donors in the safe project do not adjust their willingness to give. This difference in behaviour can be explained by differential giving in the absence of choice. Lucky winners with the risky project show a particularly high degree of solidarity with unlucky losers compared to donors and partners assigned to the safe project when they face risk for exogenous reasons. The possibility of free project choice removes these differences in generosity and we show that this is driven by attributions of responsibility for neediness. Our results suggest that crowding out of informal support might be less severe than suggested by the studies from Western countries and the evidence on formal insurance from developing countries. |
| Keywords: | Kenya; Risk Taking; Solidarity |
| JEL: | C91 D63 D81 O12 |
| Date: | 2018–06 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:12996&r=upt |
| By: | Bahman Angoshtari; Erhan Bayraktar; Virginia R. Young |
| Abstract: | We consider the optimal dividend problem under a habit formation constraint that prevents the dividend rate to fall below a certain proportion of its historical maximum, the so-called drawdown constraint. This is an extension of the optimal Duesenberry's ratcheting consumption problem, studied by Dybvig (1995) [Review of Economic Studies 62(2), 287-313], in which consumption is assumed to be nondecreasing. Our problem differs from Dybvig's also in that the time of ruin could be finite in our setting, whereas ruin was impossible in Dybvig's work. We formulate our problem as a stochastic control problem with the objective of maximizing the expected discounted utility of the dividend stream until bankruptcy, in which risk preferences are embodied by power utility. We semi-explicitly solve the corresponding Hamilton-Jacobi-Bellman variational inequality, which is a nonlinear free-boundary problem. The optimal (excess) dividend rate $c^*_t$ - as a function of the company's current surplus $X_t$ and its historical running maximum of the (excess) dividend rate $z_t$ - is as follows: There are constants $0 w^* z_t$, it is optimal to increase the dividend rate above $z_t$, and (5) it is optimal to increase $z_t$ via singular control as needed to keep $X_t \le w^* z_t$. Because, the maximum (excess) dividend rate will eventually be proportional to the running maximum of the surplus, "mountains will have to move" before we increase the dividend rate beyond its historical maximum. |
| Date: | 2018–06 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1806.07499&r=upt |
| By: | Aaberge, Rolf (Statistics Norway); Colombino, Ugo (University of Turin) |
| Abstract: | The purpose of the paper is to provide a discussion of the various approaches for accounting for labour supply responses in microsimulation models. The paper focuses attention on two methodologies for modelling labour supply: the discrete choice model and the random utility – random opportunities model. The paper then describes approaches to utilising these models for policy simulation in terms of producing and interpreting simulation outcomes, outlining an extensive literature of policy analyses utilising these approach. Labour supply models are not only central for analyzing behavioural labour supply responses but also for identifying optimal tax-benefit systems, given some of the challenges of the theoretical approach. Combining labour supply results with individual and social welfare functions enables the social evaluation of policy simulations. Combining welfare functions and labour supply functions, the paper discusses how to model socially optimal income taxation. |
| Keywords: | behavioural microsimulation, labour supply, discrete choice, tax reforms |
| JEL: | C50 D10 D31 H21 H24 H31 J20 |
| Date: | 2018–05 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp11562&r=upt |
| By: | Ilke Aydogan (Department of Economics, Bocconi University); Lo?c Berger (IESEG School of Management and Bocconi University); Valentina Bosetti (Department of Economics, Bocconi University and Fondazione Eni Enrico Mattei (FEEM)); Ning Liu (Department of Economics, Bocconi University) |
| Abstract: | We experimentally explore decision-making under uncertainty using a framework that decomposes uncertainty into three distinct layers: (1) physical uncertainty, entailing inherent randomness within a given probability model, (2) model uncertainty, entailing subjective uncertainty about the probability model to be used and (3) model misspecification, entailing uncertainty about the presence of the true probability model among the set of models considered. Using a new experimental design, we measure individual attitudes towards these different layers of uncertainty and study the distinct role of each of them in characterizing ambiguity attitudes. In addition to providing new insights into the underlying processes behind ambiguity aversion -failure to reduce compound probabilities or distinct attitudes towards unknown probabilities- our study provides the first empirical evidence for the intermediate role of model misspecification between model uncertainty and Ellsberg in decision-making under uncertainty. |
| Keywords: | Ambiguity Aversion, Reduction of Compound Lotteries, Non-expected Utility, Model Uncertainty, Model Misspecification |
| JEL: | D81 |
| Date: | 2018–07 |
| URL: | http://d.repec.org/n?u=RePEc:fem:femwpa:2018.24&r=upt |
| By: | Weiwei Tasch (Interdisciplinary Center for Economic Science and Department of Economics, George Mason University); Daniel Houser (Interdisciplinary Center for Economic Science and Department of Economics, George Mason University) |
| Abstract: | Over the last two decades social preferences have been implicated in a wide variety of key economic behaviors. Here we investigate connections between social preferences and the demand for information about others’ economic decisions and outcomes, which we denote “social curiosity.†Our analysis is within the context of the inequality aversion model of Fehr and Schmidt (1999). Using data from laboratory experiments with sequential public goods games, we estimate social preferences at the individual level, and then correlate social preferences with one’s willingness to pay to make visible others’ contribution decisions. Our investigation enables us to shed light on how costs to knowing others’ economic decisions and outcomes impact decisions among people with different social preferences, and in particular the extent to which such costs impact the willingness for groups to cooperate. |
| Keywords: | Laboratory Experiment, Inequality Aversion, Social Curiosity, Information, Sequential Public Goods Game |
| JEL: | C91 D83 D91 H41 |
| Date: | 2018–07 |
| URL: | http://d.repec.org/n?u=RePEc:gms:wpaper:1067&r=upt |
| By: | Kremena Bachmann (University of Zurich); Thorsten Hens (University of Zurich, Norwegian School of Economics and Business Administration (NHH), and Swiss Finance Institute); Remo Stössel (University of Zurich) |
| Abstract: | We assess the ability of different risk profiling measures to predict risk taking along a multi-stage decision process. The latter involves decisions under ambiguity, decisions under risk, decisions after gaining experience and decisions after receiving outcome information on previous decisions. We find that in all decisions risk taking can be predicted by some questions on individuals’ risk tolerance but it is not related to self-reported investment experience. Although simulated experience as part of our study design improves the risk awareness and leads to higher risk taking, it cannot substitute the assessment of risk tolerance and in particular the assessment of individual’s loss aversion. In contrast, self-assessed risk tolerance measures are not suitable for predicting risk taking in any stage of the decision process. Among the socioeconomic characteristics only the gender has some predictive power. |
| Keywords: | investment advice, risk profiling, experience sampling, risk attitude, risk perception, risk preferences |
| JEL: | D81 G11 |
| Date: | 2017–12 |
| URL: | http://d.repec.org/n?u=RePEc:chf:rpseri:rp1751&r=upt |
| By: | Lijun Bo; Agostino Capponi |
| Abstract: | We study an optimal investment/consumption problem in a model capturing market and credit risk dependencies. Stochastic factors drive both the default intensity and the volatility of the stocks in the portfolio. We use the martingale approach and analyze the recursive system of nonlinear Hamilton-Jacobi-Bellman equations associated with the dual problem. We transform such a system into an equivalent system of semi-linear PDEs, for which we establish existence and uniqueness of a bounded global classical solution. We obtain explicit representations for the optimal strategy, consumption path and wealth process, in terms of the solution to the recursive system of semi-linear PDEs. We numerically analyze the sensitivity of the optimal investment strategies to risk aversion, default risk and volatility. |
| Date: | 2018–06 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1806.07175&r=upt |
| By: | Elisabeth Pröhl (University of Geneva and Swiss Finance Institute) |
| Abstract: | Dynamic stochastic general equilibrium models with ex-post heterogeneity due to idiosyncratic risk have to be solved numerically. This is a nontrivial task as the cross-sectional distribution of endogenous variables becomes an element of the state space due to aggregate risk. Existing global solution methods have assumed bounded rationality in terms of a parametric law of motion of aggregate variables in order to reduce dimensionality. In this paper, we remove that assumption and compute a fully rational equilibrium dependent on the whole cross-sectional distribution. Dimensionality is tackled by polynomial chaos expansions, a projection technique for square-integrable random variables, resulting in a nonparametric law of motion. We establish conditions under which our method converges and approximation error bounds. Economically, we find that the bounded rationality assumption leads to significantly more inequality than in a fully rational equilibrium. Furthermore, more risk sharing in form of redistribution can lead to higher systemic risk. |
| Keywords: | Dynamic stochastic general equilibrium, Incomplete markets, Heterogeneous agents, Aggregate uncertainty, Convergence, Numerical solutions, Polynomial chaos |
| JEL: | C62 C63 D31 D52 E21 |
| Date: | 2017–12 |
| URL: | http://d.repec.org/n?u=RePEc:chf:rpseri:rp1763&r=upt |
| By: | Tomohiko Konno; Yannis M. Ioannides |
| Abstract: | This paper proposes a logit response game with a spatial social structure and solves it exactly. We derive closed-form solutions for the strategy choice probabilities, the spatial correlation function of strategies of distant players, and the expected utility. We study how the prob- ability of adopting a cooperative strategy in a prisoner's dilemma game and the probability of adopting Pareto efficient strategies in a cooperation game are affected by changes in the parameter that expresses payoff-responsiveness. |
| Keywords: | Spatial Logit Game, Exact solution, Network,Logit Local Interaction, Competi- tion with Spatial Structure, Spatial coordination game |
| JEL: | R00 R30 R32 R39 D21 |
| Date: | 2018 |
| URL: | http://d.repec.org/n?u=RePEc:tuf:tuftec:0827&r=upt |
| By: | Kremena Bachmann (University of Zurich); Thorsten Hens (University of Zurich, Norwegian School of Economics and Business Administration (NHH), and Swiss Finance Institute) |
| Abstract: | This paper studies the earnings management behavior of a manager in a strategic game in which the manager may have incentives to avoid earnings below the analysts’ consensus forecast and the analysts aiming to provide accurate forecasts behave as rational Bayesians. Our analysis reveals the existence of equilibria in which the manager who is compensated with stocks manipulates earnings to meet the consensus forecasts and the earnings manipulation is not detected. When the manager holds stock options, these non-revealing equilibria do not exist. The manager exhausts his reporting discretion as earnings manipulation becomes costless once the price of firm’s shares falls below the exercise price of the options. Our model provides a set of implications for observing opportunistic earnings management in dependence of managerial compensation and investors’ aversion to negative earnings surprises. In addition, the model’s predictions regarding the relationship between earnings management and executive compensation are consistent with empirical observations. |
| Keywords: | earnings management, disclosure policy, loss aversion |
| JEL: | G38 J33 M41 |
| Date: | 2017–12 |
| URL: | http://d.repec.org/n?u=RePEc:chf:rpseri:rp1777&r=upt |
| By: | Cormac O'Dea (Institute for Fiscal Studies); David Sturrock (Institute for Fiscal Studies and Institute for Fiscal Studies) |
| Abstract: | This paper investigates individuals’ expectations about their own survival to older ages and compares these to projected and actual survival rates. The extent to which individuals have, on average, reasonable expectations about survival to older ages is important in a context of increasing personal responsibility for, and control over, the accumulation and use of retirement savings. We use data from the English Longitudinal Study of Ageing, which surveyed a representative sample of the English household population aged 50 and over between 2002–03 and 2014–15, and the ONS 2014-based life tables for England and Wales. Subjective expectations of survival Modern surveys ask individuals about their probability of survival to specific older ages. In only a small proportion of cases is there clear evidence that these questions are not understood. 98% of individuals gave an answer to a question asking their chances of surviving to older ages and of these just 14% – i.e. fewer than one-in-six – showed clear evidence of misunderstanding (e.g. by reporting no chance of death in the coming 10-year period). Individuals’ stated beliefs about their probability of survival are correlated with known risk factors such as smoking and the age that their parents died. Those who currently smoke report on average 6–8 percentage points lower chance of surviving to an age 11–15 years ahead than do people who have never smoked. Those whose mother died at age 85 or older report on average 5-7 percentage points higher chance of surviving to an age 11–15 years ahead than do those whose mother died aged 60-64. Beliefs about probability of survival are also correlated with the individual’s actual age of death and respond to new diagnoses of health conditions. Those reporting a 10% or less chance of survival to an age 11–15 years ahead were more than twice as likely to die in the following 10 years than those who reported a 50% or greater chance of survival. A new cancer diagnosis was associated with a 5 percentage point reduction in the stated probability of surviving to an age 11–15 years ahead. Comparing subjective expectations with life table estimates and mortality data Relative to life tables, individuals from a range of ages and birth cohorts underestimate their chances of survival to ages 75, 80 and 85, on average. Those in their 50s and 60s underestimate their chances of survival to age 75 by around 20 percentage points and to 85 by around 5 to 10 percentage For example, men born in the 1940s who were interviewed at age 65 reported a 65% chance of making it to age 75, whereas the official estimate was 83%. For women, the equivalent figures were 65% and 89%. Individuals in their late 70s and 80s are, on average, optimistic about surviving to ages 90, 95 and above. This optimism becomes larger at older ages (10–15 percentage points when looking at age 95) and is larger for men than for women, amongst those born in the 1920s and 1930 For example, men born in the 1930s who were interviewed at age 80 reported a 32% chance of making it to age 95, whereas the official estimate was 17%. For women, the equivalent figures were 37% and 24%. Figure 1.1. Comparing subjective reports and “objective” life table estimates of survival probabilities (for men born 1930-39) |
| Keywords: | Survival expectations, savings, wealth accumulation, annuitisation |
| JEL: | D14 D84 D91 J14 |
| Date: | 2018–04–16 |
| URL: | http://d.repec.org/n?u=RePEc:ifs:ifsewp:18/14&r=upt |
| By: | Álvaro Riascos; Juan David Martín; Natalia Serna |
| Abstract: | During 2014, the Comisión de Regulación de Comunicaciones in Colombia enacted a Resolution by which permanence clauses or fixed-length terms in mobile telecommunications contracts were prohibited for network operators offering bundled mobile terminals and voice plans. Prohibition was enacted under the argument permanence clauses create switching costs, reduce competition, and generate information asymmetries. In this study we measure the impact of the Resolution on consumer, firm, and social welfare by estimating the structural demand for mobile terminals and conducting two counterfactual scenarios. We show switching costs by means of permanence clauses reduce consumer utility and increase the variance of the utility distribution. We also show the Colombian market for mobile terminals has been better off without permanence clauses, with both consumers and firms experiencing gains from the prohibition. However, variation in firm surplus is explained mostly by the variation in profits of incumbent network operators than by the variation in profits of firms selling terminals at cash price. Our study contributes to the literature of bundled sales and switching costs and is crucial from the perspective of regulation and industrial policy in the telecommunications sector. |
| Keywords: | switching costs; permanence clauses; structural demand; telecommunications; fixed-length contracts |
| JEL: | L50 L13 L11 |
| Date: | 2017–07–03 |
| URL: | http://d.repec.org/n?u=RePEc:col:000508:016418&r=upt |
| By: | Hill, Brian |
| Abstract: | The standard, Bayesian account of rational belief and decision is often argued to be unable to cope properly with severe uncertainty, of the sort ubiquitous in some areas of policy making. This paper tackles the question of what should replace it as a guide for rational decision making. It defends a recent proposal, which reserves a role for the decision maker’s confidence in beliefs. Beyond being able to cope with severe uncertainty, the account has strong normative credentials on the main fronts typically evoked as relevant for rational belief and decision. It fares particularly well, we argue, in comparison to other prominent non-Bayesian models in the literature. |
| Keywords: | Confidence; Decision Under Uncertainty; Belief; Rationality |
| JEL: | D81 H00 |
| Date: | 2017–10–03 |
| URL: | http://d.repec.org/n?u=RePEc:ebg:heccah:1258&r=upt |
| By: | Zhao, Feng; Gao, Jianwei; Gu, Yundong |
| Abstract: | Almost stochastic dominance is a relaxation of stochastic dominance, which allows small violations of stochastic dominance rules to avoid situations where most decision makers prefer one alternative to another but stochastic dominance cannot rank them. The authors first discuss the relations between almost first-degree stochastic dominance (AFSD) and the second-degree stochastic dominance (SSD), and demonstrate that the AFSD criterion is helpful to narrow down the SSD efficient set. Since the existing AFSD criterion is not convenient to rank transformations of random variables due to its relying heavily on cumulative distribution functions, the authors propose the AFSD criterion for transformations of random variables by means of transformation functions and the probability function of the original random variable. Moreover, they employ this method to analyze the transformations resulting from insurance and option strategy. |
| Keywords: | stochastic dominance,almost stochastic dominance,transformation,utility theory |
| JEL: | C51 D81 |
| Date: | 2018 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:ifwedp:201846&r=upt |