
on Utility Models and Prospect Theory 
By:  Rommeswinkel, Hendrik 
Abstract:  This paper provides a representation theorem for procedural mixture spaces. Procedural mixture spaces are mixture spaces in which it is not necessarily true that a mixture of two identical elements yields the same element. Under the remaining standard assumptions of mixture spaces, the following representation theorem is proven; a rational, independent, and continuous preference relation over mixture spaces can be represented either by expected utility plus the Shannon entropy or by expected utility under probability distortions plus the Renyi entropy. The entropy components can be interpreted as the utility or disutility from resolving the mixture and therefore as a procedural as opposed to consequentialist value. 
Keywords:  Risk, decision theory, procedural value, lotteries, mixture spaces 
JEL:  D01 D03 D81 
Date:  2019–03–05 
URL:  http://d.repec.org/n?u=RePEc:pra:mprapa:92535&r=all 
By:  Michael Greinecker (University of Graz, Austria); Christoph Kuzmics (University of Graz, Austria) 
Abstract:  Investors who maximize subjective expected utility will generally trade in an asset unless the market price exactly equals the expected return, but few people participate in the stock market. [Dow and da Costa Werlang, Econometrica 1992] show that an ambiguity averse decision maker might abstain from trading in an asset for a wide interval of prices and use this fact to explain the lack of participation in the stock market. We show that when markets operate via limit orders, all investment behavior will be observationally equivalent to maximizing subjective expected utility; ambiguity aversion has no additional explanatory power. 
Keywords:  Ambiguity; Knightian uncertainty; Dominance; Stock market participation; Limit orders 
JEL:  D81 D83 G11 G12 
Date:  2019–03 
URL:  http://d.repec.org/n?u=RePEc:grz:wpaper:201903&r=all 
By:  Francis W. Ahking (University of Connecticut) 
Abstract:  ucas (1987, 2003) calculates the potential welfare gains to stabilization of business cycles to be surprisingly small. Welfare gain is measured by a compensation parameter which makes a household indifferent between a deterministic lifetime stream and a compensated, risky lifetime stream of consumption. Using a constant relative risk aversion utility function and a coefficient of risk aversion of one, Lucas calculates that the welfare gain in real per capita consumption is in the order of onetwentieth of 1 percent. This is equivalent to an increase of about $18.33 in real per capita consumption per year for 1947 – 2001, stated in 2016 dollars. The main focus of this paper is to examine the welfare cost of business cycles for the 50 states using the same preference function as Lucas (1987, 2003). To our knowledge, this is the first paper that examines the welfare cost of business cycles at the state level. Our results support the findings of Lucas (1987, 2003) and Otrok (2001) that further welfare gain from stabilization of business cycles are very small, ranging from oneeighth of 1 percent for Wyoming to onefortyfifth of 1 percent for Iowa. Further results from additional analysis also suggest that welfare cost of business cycles varies considerably across regions of the country. 
Keywords:  welfare gain, stabilization policy, state business cycles 
JEL:  E32 E63 H80 
Date:  2019–03 
URL:  http://d.repec.org/n?u=RePEc:uct:uconnp:201903&r=all 
By:  Abdelkrim Araar; Yesuf Mohammednur Awel; Jonse Bane Boka; Hiywot Menker; Ajebush Shafi; Eleni Abraham Yitbarek; Mulatu Zerihun 
Abstract:  The attitudes toward risk of women and men entrepreneurs in micro and small enterprises (MSEs) are analyzed, and the factors that influence attitude toward risk of MSE owners are investigated. The empirical analysis first uses the momentbased approach proposed by Antle (1987) to estimate the risk preferences of men and women entrepreneurs. Second, a regression model is employed to understand the correlates of attitude toward risk and to decompose gender differences in risk aversion using the OaxacaBlinder technique. The results clearly indicate that MSE entrepreneurs are riskaverse with a relative risk premium of 1.5%. Women entrepreneurs are slightly more riskaverse than are men entrepreneurs. Regression estimates show that entrepreneursâ€™ attitude toward risk is significantly correlated with age and experience, marital status, education level, financial literacy, wealth, sector, and business type. The gender difference in risk aversion is significantly explained by the predictor variables while the unexplained component is insignificant. This suggests that gender differences in risk preference are the result of disparities in socioeconomic factors rather than of biology. 
Keywords:  risk aversion, gender, micro and small enterprises 
JEL:  D14 J16 M21 
Date:  2019 
URL:  http://d.repec.org/n?u=RePEc:lvl:pmmacr:201905&r=all 
By:  Emmanouil Platanakis (School of Management, University of Bath); Athanasios Sakkas (Southampton Business School, University of Southampton); Charles Sutcliffe (ICMA Centre, Henley Business School, University of Reading) 
Abstract:  Estimation errors in the inputs are the main problem when applying portfolio analysis. Markov regime switching models are used to reduce these errors, but they do not always improve outofsample portfolio performance. We investigate the levels of transaction costs and risk aversion below which the use of two regimes is superior to one regime for an investor with a CRRA utility function, allowing for skewed and kurtic returns. Our results suggest that, due to differences in risk and transactions costs, most retail investors should use one regime models, while investment banks should use two regime models. 
Keywords:  finance, portfolio theory, regime shifting, transaction costs, risk aversion, constant relative risk aversion 
JEL:  G11 
Date:  2017–09 
URL:  http://d.repec.org/n?u=RePEc:rdg:icmadp:icmadp201707&r=all 
By:  JiunHua Su 
Abstract:  The semiparametric maximum utility estimation proposed by Elliott and Lieli (2013) can be viewed as costsensitive binary classification; thus, its insample overfitting issue is similar to that of perceptron learning in the machine learning literature. Based on structural risk minimization, a utilitymaximizing prediction rule (UMPR) is constructed to alleviate the insample overfitting of the maximum utility estimation. We establish nonasymptotic upper bounds on the difference between the maximal expected utility and the generalized expected utility of the UMPR. Simulation results show that the UMPR with an appropriate datadependent penalty outweighs some common estimators in binary classification if the conditional probability of the binary outcome is misspecified, or a decision maker's preference is ignored. 
Date:  2019–03 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1903.00716&r=all 
By:  Niklas Potrafke 
Abstract:  Using the new macro data on risk aversion and patience by Falk et al. (2018), I show that risk aversion and patience are related to intelligence: highIQ populations are more patient and more risk averse than lowIQ populations. The correlation between patience and intelligence corroborates previous results based on micro data. Intelligent people tend to be patient because they have long time horizons. The correlation between risk aversion and intelligence supports new micro data studies based on dynamically optimized sequential experimentation (Chapman et al. 2018). 
Keywords:  Risk aversion, patience, intelligence 
JEL:  D00 D81 D90 
Date:  2019 
URL:  http://d.repec.org/n?u=RePEc:ces:ifowps:_295&r=all 
By:  Arthur Attema (Erasmus School of Economics  Erasmus University Rotterdam); Olivier L’haridon (CREM  Centre de recherche en économie et management  UNICAEN  Université de Caen Normandie  NU  Normandie Université  UR1  Université de Rennes 1  UNIVRENNES  Université de Rennes  CNRS  Centre National de la Recherche Scientifique); Gijs Van de Kuilen (TiSEM  Tilburg School of Economics and Management  Tilburg University [Netherlands]) 
Abstract:  We investigate univariate and multivariate risk preferences for health (longevity) and wealth. We measure attitudes toward correlation and attitudes toward higher order dependence structures such as crossprudence and crosstemperance, making use of the risk apportionment technique proposed by Eeckhoudt et al. (2007). For multivariate gains, we find correlation aversion and crossprudence in longevity and wealth. For losses, we observe correlation seeking and crossimprudence. We do not find clear evidence for crosstemperance. Our results indicate that longevity and wealth are considered to be substitutes for gains, but not for losses. Second, univariate (higher order) risk preferences are comparable for longevity and wealth, although somewhat closer to linearity for wealth. Third, we find evidence that attitudes toward dependence structures in the health domain are signdependent. 
Keywords:  multivariate risk attitudes,health,prudence,temperance 
Date:  2019–03 
URL:  http://d.repec.org/n?u=RePEc:hal:journl:halshs01970236&r=all 
By:  Larry G. Epstein (Department of Economics, Boston University); Shaolin Ji (Institute of Financial Studies, Shandong University) 
Abstract:  We consider the dynamics of learning under ambiguity when learning is costly and is chosen optimally. The setting is Ellsbergâ€™s twourn thought experiment modified by allowing the agent to postpone her choice between bets so that she can learn about the composition of the ambiguous urn. Signals are modeled by a diffusion process whose drift is equal to the true bias of the ambiguous urn and they are observed at a constant cost per unit time. The resulting optimal stopping problem is solved and the effect of ambiguity on the extent of learning is determined. It is shown that rejection of learning opportunities can be optimal for an ambiguity averse agent even given a small cost. 
Keywords:  ambiguity, learning, partial information, optimal stopping, driftdiffusion model 
Date:  2017–08 
URL:  http://d.repec.org/n?u=RePEc:bos:wpaper:wp2017010&r=all 
By:  Roberto Iacono (NTNU  Norwegian University of Science and Technology [Trondheim]); Marco Ranaldi (UP1  Université PanthéonSorbonne, PSE  Paris School of Economics) 
Abstract:  This paper shows that perceptions of inequality are a key factor in the formation of preferences for redistribution and thereby in the determination of the equilibrium redistribution level. We build on the novel stylized facts provided by the recent empirical and experimental literature on perceptions of income inequality. In brief, the emerging consensus is that agents incorrectly estimate the shape of the income distribution because of limited information. Agents with income above the mean believe they are poorer than they actually are, and agents with income below the mean believe themselves to be richer. We revisit the standard framework on the political economy of redistribution and extend it in two ways. First, we assume a more general twosided inequality aversion. Second, we incorporate perceptions of income inequality in the model. We show analytically that the equilibrium redistribution level is crucially determined by the interplay between the information treatment correcting the bias in perceptions of inequality and fairness considerations specified by the degree of inequality aversion. By doing this, we add (biased) perceptions of inequality to the list of potential factors explaining why, notwithstanding high levels of inequality, in many countries, an increase in the desire for redistribution has not been observed. 
Keywords:  MeltzerRichard Model,Perceived Inequality,Inequality Aversion,Redistributive Preferences 
Date:  2019–01 
URL:  http://d.repec.org/n?u=RePEc:hal:journl:halshs02042330&r=all 
By:  Lambert, Thomas 
Abstract:  In the field of philosophy of mind, the concepts of rational behavior, rational choice theory, and instrumental rationality (the “practical reasoning” version of rationality) are important in trying to make statements and conclusions about human thinking and behavior in general. Rational choice theory is also considered a normative but not a descriptive or positive theory. Much of economic theory is based on the principle that economic agents usually or always behave rationally in maximizing the benefits and/or minimizing the costs of their decisions. Developments in behavioral economics over the last several decades have begun to question this principle with much of the questioning about rationality and rational behavior centering on whether individuals can correctly and adequately assess probabilities and risk/reward. The inability to correctly assess risk/reward limits rational behavior and can yield suboptimal outcomes for economic agents. This exploratory paper examines the linkages between schooling in a capitalist society and limits on rationality in a monopoly capital economic system. 
Keywords:  behavioral economics, capitalist schooling, monopoly capital, rationality, rational choice 
JEL:  B51 I24 
Date:  2019–03–05 
URL:  http://d.repec.org/n?u=RePEc:pra:mprapa:92594&r=all 
By:  Jin Sun; Ryle S. Perera; Pavel V. Shevchenko 
Abstract:  We investigate an optimal investmentconsumption and optimal level of insurance on durable consumption goods with a positive loading in a continuoustime economy. We assume that the economic agent invests in the financial market and in durable as well as perishable consumption goods to derive utilities from consumption over time in a jumpdiffusion market. Assuming that the financial assets and durable consumption goods can be traded without transaction costs, we provide a semiexplicit solution for the optimal insurance coverage for durable goods and financial asset. With transaction costs for trading the durable good proportional to the total value of the durable good, we formulate the agent's optimization problem as a combined stochastic and impulse control problem, with an implicit intervention value function. We solve this problem numerically using stopping time iteration, and analyze the numerical results using illustrative examples. 
Date:  2019–03 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1903.00631&r=all 
By:  Yu Feng 
Abstract:  Understanding and measuring model risk is important to financial practitioners. However, there lacks a nonparametric approach to model risk quantification in a dynamic setting and with pathdependent losses. We propose a complete theory generalizing the relativeentropic approach by Glasserman and Xu to the dynamic case under any $f$divergence. It provides an unified treatment for measuring both the worstcase risk and the $f$divergence budget that originate from the model uncertainty of an underlying state process. 
Date:  2019–03 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:1903.00590&r=all 
By:  Troug, Haytem 
Abstract:  To show how fiscal policy affects the transmission mechanism of monetary policy, we extend a standard new Keynesian model for a small open economy to allow for the presence of nonseparable government consumption in the utility function. We show how monetary policy should optimally respond to demand and supply shocks when the government sector is incorporated into the model. The introduction of government consumption affects the transmission of monetary policy. When government consumption has a crowding in effect on private consumption, it will dampen the transmission mechanism of monetary policy, and vice versa. Nevertheless, the degree of openness will minimise the effect of the introduction of government consumption in a nonseparable form. Data for 35 OECD countries empirically support these findings, and the empirical results are robust to the zero lower bound period. The theoretical model also shows that, once we model the rest of the world economy, domestic government consumption and foreign government consumption will have opposing effects on private consumption, which contradicts with the existing literature. 
Keywords:  New Keynesian models, Business Cycle, Monetary Policy, Open Economy Macroeconomics, Joint Analysis of Fiscal and Monetary Policy. 
JEL:  E12 E32 E52 E63 F41 
Date:  2019–03–02 
URL:  http://d.repec.org/n?u=RePEc:pra:mprapa:92511&r=all 
By:  Hitoshi Matsushima (University of Tokyo) 
Abstract:  This study investigates the unique implementation of a social choice function in iterative dominance in the expost term. We assume partial expost verifiability; that is, after determining an allocation, the central planner can only observe partial information about the state as verifiable. We demonstrate a condition of the state space, termed â€œfull detection,â€ under which any social choice function is uniquely implementable even if the range of the playersâ€™ lies, which the expost verifiable information directly detects, is quite narrow. To prove this, we construct a dynamic mechanism according to which each player announces his (or her) private signal before the other players observe this signal at an earlier stage, and each player also announces the state at a later stage. In this construction, we can impose several severe restrictions, such as boundedness, permission of only tiny transfers off the equilibrium path, and no permission of transfers on the equilibrium path. This study does not assume either expected utility or quasilinearity. 
Date:  2019–02 
URL:  http://d.repec.org/n?u=RePEc:cfi:fseres:cf453&r=all 
By:  de Oliveira Souza, Thiago (Department of Business and Economics) 
Abstract:  This paper offers theoretical, empirical, and simulated evidence that momentum regularities in asset prices are not anomalies. Within a general, frictionless, rational expectations, riskbased asset pricing framework, riskier assets tend to be in the loser portfolios after (large) increases in the price of risk. Hence, the risk of momentum portfolios usually decreases with the prevailing price of risk, and their risk premiums are approximately negative quadratic functions of the price of risk (and the market premium) theoretically truncated at zero. The best linear (CAPM) function describing this relation unconditionally has exactly the negative slope and positive intercept documented empirically. 
Keywords:  Momentum; risk; puzzle; ranking; conditional 
JEL:  G11 G12 G14 
Date:  2019–02–20 
URL:  http://d.repec.org/n?u=RePEc:hhs:sdueko:2019_005&r=all 
By:  Sokic, Alexandre 
Abstract:  This paper is deeply motivated by the need to explore the impressive Bitcoin price development by addressing Bitcoin as money in its essential attribute as a medium of exchange. We adopt a monetary economics viewpoint and resort to a representative agent modelling strategy within a moneyintheutility function (MIUF) framework. First, we show that the impressive Bitcoin price development observed since its inception can be interpreted as a hyperdeflation when we focus on Bitcoin role as a medium of exchange. Second, we show that specific monetary features of Bitcoin, its asymptotical fixed nominal stock and divisibility down to eight decimal places, account for a strong possibility of speculative hyperdeflationary paths. It is shown that those paths are fully consistent with the medium of exchange monetary role of Bitcoin and the representative agent optimizing behavior. 
Keywords:  Cryptocurrencies, Bitcoin, hyperdeflation, medium of exchange 
JEL:  E31 E41 E42 
Date:  2018–11 
URL:  http://d.repec.org/n?u=RePEc:pra:mprapa:90603&r=all 