
on Utility Models and Prospect Theory 
By:  SPRUMONT, Yves 
Abstract:  The 'beliefweighted Nash social welfare functions' are methods for aggregating Savage preferences defined over a set of acts. Each such method works as follows. Fix a 0normalized subjective expected utility representation of every possible preference and assign a vector of individual weights to each profile of beliefs. To compute the social preference at a given preference profile, rank the acts according to the weighted product of the individual 0normalized subjective expected utilities they yield, where the weights are those associated with the belief profile generated by the preference profile. We show that these social welfare functions are characterized by the weak Pareto principle, a continuity axiom, and the following informational robustness property : the social ranking of two acts is unaffected by the addition of any outcome that every individual deems at least as good as the one she originally found worst. This makes the beliefweighted Nash social welfare functions appealing in contexts where the 'best' relevant outcome for an individual is difficult to identify. 
Keywords:  Preference aggregation; uncertainty; subjective expected utility; Nash product 
JEL:  D63 D71 
Date:  2018 
URL:  http://d.repec.org/n?u=RePEc:mtl:montde:201815&r=upt 
By:  Elena Serfilippi; Michael Carter; Catherine Guirkinger 
Abstract:  In discussing the paradoxical violation of expected utility theory that now bears his name, Maurice Allais noted that individuals tend to “greatly value” payoffs that are certain. Allais' observation would seem to imply that people will undervalue insurance relative to the predictions of expected utility theory because as conventionally constructed, insurance offers an uncertain benefit in exchange for a certain cost that certaintyloving individuals will overvalue. Pursuing this logic, we implemented insurance games with cotton farmers in Burkina Faso. On average, farmer willingness to pay for insurance increases significantly when a premium rebate framing is used to render both costs and benefits of insurance uncertain. We show that the impact of the rebate frame on the willingness to pay for insurance is driven by those farmers who exhibit a welldefined discontinuous preference for certainty, a concept that we adapt from the uv model of utility and measure with a novel behavioral experiment. Given that the potential impacts of insurance for small scale farmers are high, and yet demand for conventionally framed contracts is often low, the insights from this paper suggest welfareenhancing ways of designing insurance for lowincome farmers. 
JEL:  D03 Q12 
Date:  2018–09 
URL:  http://d.repec.org/n?u=RePEc:nbr:nberwo:25026&r=upt 
By:  Fischer, Thomas (Department of Economics, Lund University); Lundtofte , Frederik (Department of Economics, Lund University) 
Abstract:  We apply the Atkinson (1970) inequality index to time series of asset returns to offer a novel measure of financial risk consistent with expectedutility theory. This measure is converted to a certaintyequivalent return serving as a performance measure. We extend the Atkinson index to HARA utility and derive closedform solutions to our measures for a number of preferencereturn combinations. Further, we establish relationships between risk aversion and the weights assigned to the cumulants of the return distribution for our performance measure. Using data from hedge funds and assetpricing anomalies, we find that our performance measure contains additional, economically meaningful information. 
Keywords:  risk; performance; nonGaussian distributions; cumulants; hedge funds 
JEL:  G11 
Date:  2018–10–03 
URL:  http://d.repec.org/n?u=RePEc:hhs:lunewp:2018_025&r=upt 
By:  Brian P Hanley 
Abstract:  This model contains concept, equations, and graphical results for venture banking. A system of 27 equations describes the behavior of the venturebank and underwriter system allowing phasespace type graphs that show where profits and losses occur. These results confirm and expand those obtained from the original spreadsheet based model. An example investment in a castle at a loss is provided to clarify concept. This model requires that all investments are in enterprises that create new utility value. The assessed utility value created is the new money out of which the venture bank and underwriter are paid. The model presented chooses parameters that ensure that the venturebank experiences losses before the underwriter does. Parameters are: DIN Premium, 0.05; Clawback lien fraction, 0.77; Clawback bonds and equity futures discount, 1.5 x (USA 12 month LIBOR); Range of clawback bonds sold, 0 to 100%; Range of equity futures sold 0 to 70%. 
Date:  2018–09 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1810.00516&r=upt 
By:  Jessica Martin (INSA Toulouse, IMT); Anthony R\'eveillac (INSA Toulouse, IMT) 
Abstract:  In this paper we provide a new approach to tackle the PrincipalAgent RiskSharing problem using optimal stochastic control technics. Our analysis relies on an optimal decomposition of the expected utility of the Principal in terms of the reservation utility of the Agent. In particular, this allows us to derive the Borch rule as a necessary optimality condition for this decomposition to hold, which sheds a new light on this economic concept. As a byproduct, this approach provides a class of risksharing plans that satisfy the Borch rule; class to which the optimal plan belongs. 
Date:  2018–09 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1809.07040&r=upt 
By:  Jessica Martin (INSA Toulouse  Institut National des Sciences Appliquées  Toulouse  INSA  Institut National des Sciences Appliquées, IMT  Institut de Mathématiques de Toulouse UMR5219  UT1  Université Toulouse 1 Capitole  UT2J  Université Toulouse  Jean Jaurès  UPS  Université Toulouse III  Paul Sabatier  Université Fédérale Toulouse MidiPyrénées  PRES Université de Toulouse  INSA Toulouse  Institut National des Sciences Appliquées  Toulouse  INSA  Institut National des Sciences Appliquées  CNRS  Centre National de la Recherche Scientifique); Anthony Réveillac (INSA Toulouse  Institut National des Sciences Appliquées  Toulouse  INSA  Institut National des Sciences Appliquées, IMT  Institut de Mathématiques de Toulouse UMR5219  UT1  Université Toulouse 1 Capitole  UT2J  Université Toulouse  Jean Jaurès  UPS  Université Toulouse III  Paul Sabatier  Université Fédérale Toulouse MidiPyrénées  PRES Université de Toulouse  INSA Toulouse  Institut National des Sciences Appliquées  Toulouse  INSA  Institut National des Sciences Appliquées  CNRS  Centre National de la Recherche Scientifique) 
Abstract:  In this paper we provide a new approach to tackle the PrincipalAgent RiskSharing problem using optimal stochastic control technics. Our analysis relies on an optimal decomposition of the expected utility of the Principal in terms of the reservation utility of the Agent. In particular, this allows us to derive the Borch rule as a necessary optimality condition for this decomposition to hold, which sheds a new light on this economic concept. As a byproduct, this approach provides a class of risksharing plans that satisfy the Borch rule; class to which the optimal plan belongs. 
Keywords:  Principal Agent problem,RiskSharing,Borch rule,Reverse Hölder inequality,Optimal Contracting Theory 
Date:  2018–09–14 
URL:  http://d.repec.org/n?u=RePEc:hal:wpaper:hal01874707&r=upt 
By:  MaryAlice Doyle (Reserve Bank of Australia) 
Abstract:  The credit card market offers consumers a wide range of options when choosing a card. While many factors may influence this choice, this paper focuses on the main financial costs and benefits of holding a credit card. I summarise these costs and benefits as the net monetary benefit associated with a card. Theory might suggest that a rational consumer will choose a card that maximises their net monetary benefit. But in reality, consumers' decisions may be systematically biased, leading them to select highercost credit cards when lowercost alternatives are available. To test this possibility, I first estimate the net monetary cost or benefit that individuals in a nationally representative survey obtain from their credit card. I then use these estimates to examine whether principles from behavioural economics – such as optimism bias, bounded rationality and present bias – can help to explain consumers' choice of credit card. I find that approximately 40 per cent of Australian credit card holders receive a positive net monetary benefit from their card (that is, they receive benefits from rewards points and their interestfree period that outweigh annual fees and interest payments). Generally these are higherwealth and higherincome consumers. Of the remaining 60 per cent, around half break even, while half incur a net cost. Moreover, most cardholders, including those who receive a net benefit, appear not to choose cards that best suit their use patterns – for instance, I estimate that consumers who use their card to borrow and pay interest could reduce their annual costs by around $250 by choosing a more appropriate card. Behavioural explanations are consistent with some, but not all, of the patterns observed. Consumers appear to be subject to optimism bias, underestimating how much they will borrow on their card, and a subset of consumers tend to hold inflated estimates of the net monetary benefits that they receive from their card. In contrast, consumers do not appear to be present biased in responding to temporary signup offers. Finally, I find that around half of the respondents who made a net loss held highcost cards, but had not considered switching to a lowercost card; indicative evidence of cognitive, as well as practical, barriers to switching cards. 
Keywords:  bounded rationality; switching behaviour; optimism bias; optimal credit card choice; present bias; retail payments 
JEL:  D12 D30 D90 E42 
Date:  2018–10 
URL:  http://d.repec.org/n?u=RePEc:rba:rbardp:rdp201811&r=upt 
By:  Marcellino Gaudenzi; Michel Vellekoop 
Abstract:  We propose an algorithm to calculate the exact solution for utility optimization problems on finite state spaces under a class of nondifferentiable preferences. We prove that optimal strategies must lie on a discrete grid in the plane, and this allows us to reduce the dimension of the problem and define a very efficient method to obtain those strategies. We also show how fast approximations for the value function can be obtained with an a priori specified error bound and we use these to replicate results for investment problems with a known closedform solution. These results show the efficiency of our approach, which can then be used to obtain numerical solutions for problems for which no explicit formulas are known. 
Date:  2018–09 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1809.11010&r=upt 
By:  Saad Labyad (University of Oxford [Oxford]); Mehdi Senouci (LGI  Laboratoire Génie Industriel  EA 2606  CentraleSupélec) 
Abstract:  For each production or utility function, we can define the corresponding elasticities of substitution functions; but is the reverse true? This paper shows that yes, and that this link is fruitful. By inverting the system of partial differential equations defining the elasticities of substitution functions, we uncover an analytical formula which encompasses all production and utility functions that are admissible in ArrowDebreu equilibria. We highlight the "Constant Elasticities of Substitution Matrix" (CESM) class of functions which, unlike the CES functions, does not assume uniform substitutability among all pairs of goods. A shortcoming of our method is that it permits only to control for local concavity while it is difficult to control for global concavity. 
Keywords:  Production functions,Utility functions,Elasticity of substitution,Marginal productivity,Marginal utility,Factor shares 
Date:  2018–09–03 
URL:  http://d.repec.org/n?u=RePEc:hal:wpaper:hal01866275&r=upt 
By:  Massimo Guidolin; Alexei G. Orlov 
Abstract:  We report systematic, outofsample evidence on the benefits to an already well diversified investor that may derive from further diversification into various hedge fund strategies. We investigate dynamic strategic asset allocation decisions that take into account investors’ preferences as well as return predictability. Our results suggest that not all hedge fund strategies benefit a longterm investor who is already well diversified across stocks, government and corporate bonds, and REITs. Only strategies whose payoffs are highly nonlinear (e.g., fixed income relative value and convertible arbitrage), and therefore not easily replicable, constitute viable options. Most of the realized economic value fails to result from a meanvariance type of improvement but comes instead from an improvement in realized highermoment properties of optimal portfolios. Medium to highly riskaverse investors benefit the most from this alternative asset class. 
Keywords:  Strategic asset allocation, hedge fund strategies, predictive regressions, outofsample performance, certainty equivalent return 
JEL:  G11 G17 G12 C53 
Date:  2018 
URL:  http://d.repec.org/n?u=RePEc:baf:cbafwp:cbafwp1887&r=upt 
By:  Maria J. Ruiz Martos (Department of Economic Theory and Economic History, University of Granada.) 
Abstract:  Economics calls for monetary incentives to induce participants to exhibit truthful behaviour. This experiment investigates the effect of reducing incentives on dynamic choices, which encompass the individual and chance in a sequence of decisions. This experiment compares choices with the commonly used random lottery incentive system (RLIS) to hypothetical choices in the dynamic choice setting surrounding the common consequence effect (CCE), both horizontal and vertical. In addition, the RLIS is partially controlled for by eliciting with single choice individual preferences over the two horizontal CCE static choice problems. Results suggest that lessening incentives do not induce a systematic shift in preferences when emotional responses are not at stake. 
Keywords:  experiments, monetary incentives, nonexpected utility and risk, dynamic choice principles, common consequence effect 
JEL:  B49 C91 D11 D81 
Date:  2018–07–01 
URL:  http://d.repec.org/n?u=RePEc:gra:wpaper:18/04&r=upt 
By:  Nicole B\"auerle; Sascha Desmettre 
Abstract:  We consider a fractional version of the Heston volatility model which is inspired by [16]. Within this model we treat portfolio optimization problems for power utility functions. Using a suitable representation of the fractional part, followed by a reasonable approximation we show that it is possible to cast the problem into the classical stochastic control framework. This approach is generic for fractional processes. We derive explicit solutions and obtain as a byproduct the Laplace transform of the integrated volatility. In order to get rid of some undesirable features we introduce a new model for the rough path scenario which is based on the Marchaud fractional derivative. We provide a numerical study to underline our results. 
Date:  2018–09 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1809.10716&r=upt 
By:  Ferriani, Fabrizio; Natoli, Filippo; Veronese, Giovanni; Zeni, Federica 
Abstract:  The advent of shale oil in the United States triggered a structural transformation in the oil market. We show, both theoretically and empirically, that this process has relevant consequences on oil risk premia. We construct a consumptionbased model with shale producers interacting with financial speculators in the futures market. Compared to conventionals, shale producers have a more flexible technology, but higher risk aversion and additional costs due to their reliance on external finance. Our model helps to explain the observed pattern of aggregate hedging by US firms in the last decade. The empirical analysis shows that the hedging pressure of shale producers has become more relevant than that of conventional producers in explaining the oil futures risk premium. 
Keywords:  shale oil, futures, risk premium, hedging, speculation, limits to arbitrage 
JEL:  G00 G13 G32 Q43 
Date:  2018–08 
URL:  http://d.repec.org/n?u=RePEc:pra:mprapa:89097&r=upt 
By:  Serhat Basdogan; Hilde Remøy; Ruud Binnekamp 
Abstract:  With the rapid development of real estate markets under globalization and exponential competitive market conditions, risk evaluation has been one of the most important tasks in the process of real estate investment valuation. This paper describes the relationship between construction permit uncertainties and real estate development projects by using the Decision Tree Analysis (DTA) approach together with Monte Carlo simulations. Expected Value (EV) criterion for an office development project proposed and incorporated into conventional Discounted Cash Flow (DCF) analysis which is determined by stochastic DTA. This will help utility function to come closer to the real world, so that decision making and risk analysis can be done based on the real and possible data providing better conditions for investors. The results are consistent with the results calculated by conventional DCF analysis. However research demonstrates that is of application Monte Carlo Simulation (MCS) and DTA obviate the deficiencies of conventional DCF analysis under construction permit delays and scheduling uncertainties. Results also emphasize the importance of applying EV and DTA for the construction permit delays generate a significant change in NPV and also investment decisions of real estate development projects. 
Keywords:  Decision Tree Analysis; Expected Value; Monte Carlo Simulation; Real Estate Development; Valuation 
JEL:  R3 
Date:  2018–01–01 
URL:  http://d.repec.org/n?u=RePEc:arz:wpaper:eres2018_265&r=upt 
By:  Van Tassel, Peter (Federal Reserve Bank of New York) 
Abstract:  This paper provides empirical evidence that volatility markets are integrated through the timevarying term structure of variance risk premia. These risk premia predict the returns from selling volatility for different horizons, maturities, and products, including variance swaps, straddles, and VIX futures. In addition, the paper derives a closedform relationship between the prices of variance swaps and VIX futures. While tightly linked, VIX futures exhibit deviations of varying significance from the noarbitrage prices and bounds implied by the variance swap market. The paper examines these pricing errors and their relationship to VIX futures’ return predictability. 
Keywords:  variance swaps; term structure; variance risk premium; VIX futures; options; return predictability 
JEL:  C58 G12 G13 
Date:  2018–09–01 
URL:  http://d.repec.org/n?u=RePEc:fip:fednsr:867&r=upt 
By:  Vasilev, Aleksandar 
Abstract:  We introduce consumption habits into an exogenous growth model augmented with a detailed government sector, and calibrate the model to Bulgarian data for the period following the introduction of the currency board arrangement (19992016). We show that in contrast to the case without habits, e.g., Vasilev (2009), when the economy features saddlepath stability, the habit motive alone leads to equilibrium indeterminacy in the model. When habits enter multiplicatively in the representative agent's utility function, the setup exhibits "sink" dynamics, and equilibrium paths are determined by "animal spirits." These results are in line with the findings in the literature, e.g., Benhabib and Farmer (1994, 1996) and Farmer (1999), and have major implications for policymaking and welfare. 
Keywords:  Equilibrium indeterminacy,animal spirits,multiplicative consumption habits,Bulgaria 
JEL:  E32 E37 
Date:  2018 
URL:  http://d.repec.org/n?u=RePEc:zbw:esprep:182499&r=upt 
By:  Inés MachoStadler; David PérezCastrillo; David Wettstein 
Abstract:  Shapley (1953a) formulates his proposal of a value for cooperative games with transferable utility in characteristic function form, that is, for games where the resources every group of players has available to distribute among its members only depend on the members of the group. However, the worth of a coalition of agents often depends on the organization of the rest of the players. The existence of externalities is one of the key ingredients in most interesting economic, social, or political environments. Thrall and Lucas (1963) provide the first formal description of settings with externalities by introducing the games in partition function form. In this chapter, we present the extensions of the Shapley value to this larger set of games. The different approaches that lead to the Shapley value in characteristic function form games (axiomatic, marginalistic, potential, dividends, noncooperative) provide alternative routes for addressing the question of the most suitable extension of the Shapley value for the set of games in partition function form. 
Keywords:  shapley value, Externalities 
JEL:  C71 D62 
Date:  2018–10 
URL:  http://d.repec.org/n?u=RePEc:bge:wpaper:1056&r=upt 