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on Utility Models and Prospect Theory |
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Issue of 2019‒03‒25
twenty papers chosen by |
| By: | Joshua Aurand; Yu-Jui Huang |
| Abstract: | This paper solves the consumption-investment problem with Epstein-Zin utility on a random horizon. In an incomplete market, we take the random horizon to be a stopping time adapted to the market filtration, generated by all observable, but not necessarily tradable, state processes. Contrary to prior studies, we do not impose any fixed upper bound for the random horizon, allowing for truly unbounded ones. Focusing on the empirically relevant case where the risk aversion and the elasticity of intertemporal substitution are both larger than one, we characterize optimal consumption and investment strategies through backward stochastic differential equations (BSDEs). Compared with classical results on a fixed horizon, our characterization involves an additional stochastic process to account for the uncertainty of the horizon. As demonstrated in a Markovian setting, this added uncertainty drastically alters optimal strategies from the fixed-horizon case. The main results are obtained through developing new techniques for BSDEs with superlinear growth on an unbounded random horizon. |
| Date: | 2019–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1903.08782&r=all |
| By: | Koumou, Gilles Boevi (HEC Montreal, Canada Research Chair in Risk Management); Dionne, Georges (HEC Montreal, Canada Research Chair in Risk Management) |
| Abstract: | This paper provides an axiomatic foundation of the measurement of diversification in a one-period portfolio theory under the assumption that the investor has complete information about the joint distribution of asset returns. Four categories of portfolio diversification measures can be distinguished: the law of large numbers diversification measures, the correlation diversification measures, the market portfolio diversification measures and the risk contribution diversification measures. We offer the first step towards a rigorous theory of correlation diversification measures. We propose a set of nine desirable axioms for this class of diversification measures, and name the measures satisfying these axioms coherent diversification measures that we distinguish from the notion of coherent risk measures. We provide the decision-theoretic foundations of our axioms by studying their compatibility with investors’ preference for diversification in two important decision theories under risk: the expected utility theory and Yaari’s dual theory. We explore whether useful methods of measuring portfolio diversification satisfy our axioms. We also investigate whether or not our axioms have forms of representation. |
| Keywords: | Portfolio theory; portfolio diversification; preference for diversification; correlation diversification; expected utility theory; dual theory. |
| JEL: | D81 G01 G11 |
| Date: | 2019–03–12 |
| URL: | http://d.repec.org/n?u=RePEc:ris:crcrmw:2019_002&r=all |
| By: | Hiroaki Hata; Shuenn-Jyi Sheu; Li-Hsien Sun |
| Abstract: | In this paper, we consider the problem of optimal investment by an insurer. The insurer invests in a market consisting of a bank account and $m$ risky assets. The mean returns and volatilities of the risky assets depend nonlinearly on economic factors that are formulated as the solutions of general stochastic differential equations. The wealth of the insurer is described by a Cram\'er--Lundberg process, and the insurer preferences are exponential. Adapting a dynamic programming approach, we derive Hamilton--Jacobi--Bellman (HJB) equation. And, we prove the unique solvability of HJB equation. In addition, the optimal strategy is also obtained using the coupled forward and backward stochastic differential equations (FBSDEs). Finally, proving the verification theorem, we construct the optimal strategy. |
| Date: | 2019–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1903.08957&r=all |
| By: | Thomas Greve (Faculty of Economics, University of Cambridge); Fei Teng (Imperial College London, MINES ParisTech, PSL Research University); Michael Pollitt (Faculty of Economics, University of Cambridge); Goran Strbac (Imperial College London) |
| Keywords: | Utility function, ancillary services, system operator, energy storage, VCG mechanism |
| JEL: | D44 L94 |
| Date: | 2017–07 |
| URL: | http://d.repec.org/n?u=RePEc:enp:wpaper:eprg1713&r=all |
| By: | Simone Manganelli |
| Abstract: | A decision maker starts from a judgmental decision and moves to the closest boundary of the confidence interval. This statistical decision rule is admissible and does not perform worse than the judgmental decision with a probability equal to the confidence level, which is interpreted as a coefficient of statistical risk aversion. The confidence level is related to the decision maker's aversion to uncertainty and can be elicited with laboratory experiments using urns a la Ellsberg. The decision rule is applied to a problem of asset allocation for an investor whose judgmental decision is to keep all her wealth in cash. |
| Date: | 2019–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1903.06980&r=all |
| By: | Chia-Lin Chang (Department of Applied Economics and Department of Finance National Chung Hsing University, Taiwan.); Michael McAleer (Department of Quantitative Finance National Tsing Hua University, Taiwan and Econometric Institute Erasmus School of Economics Erasmus University Rotterdam, The Netherlands and Department of Quantitative Economics Complutense University of Madrid, Spain And Institute of Advanced Sciences Yokohama National University, Japan.); Wing-Keung Wong (Department of Finance, Fintech Center, and Big Data Research Center Asia University, Taiwan and Department of Medical Research, China Medical University Hospital, Taiwan And Department of Economics and Finance, Hang Seng Management College Hong Kong, China and Department of Economics, Lingnan University, Hong Kong, China.) |
| Abstract: | This note is concerned with an editorial statement of intent for Advances in Decision Sciences (ADS), which was founded in 1997, so that 2918 marks the 22nd Anniversary of the journal. The note discusses the aims and scope of ADS in Section 1, innovative topics in all fields of optimal decision making in Section 2, invitation to submit papers to ADS in Section 3, editors and members of the editorial board in Section 4, and acknowledgements in Section 5. |
| Keywords: | Decision making, Aims and scope, Innovative topics, Optimality, Areas and topics of interest. |
| JEL: | C44 D81 D91 G11 M51 |
| URL: | http://d.repec.org/n?u=RePEc:ucm:doicae:1903&r=all |
| By: | Ginés de Rus; Per-Olov Johansson |
| Abstract: | The measurement of the economic effects of transport improvements is generally based on the rule of a half. Virtually all the projects have in common the reduction of the generalized cost of transport. The basic rule is derived from a simple indirect utility function, illustrating its use to measure changes in the main components of the generalized price of transport. The paper also addresses the issue of the indirect effects and the so-called wider economic benefits, and briefly discuss the content of these additional impacts with the aim of assessing the role of these impacts on the economic appraisal of transport projects. |
| Date: | 2019–01 |
| URL: | http://d.repec.org/n?u=RePEc:fda:fdaddt:2019-01&r=all |
| By: | Dietzenbacher, Bas (Tilburg University, Center For Economic Research) |
| Abstract: | This paper studies the procedural egalitarian solution on the class of egalitarian stable games. By deriving several axiomatic characterizations involving consistency and monotonicity, we show that the procedural egalitarian solution satisfies various desirable properties and unites many egalitarian concepts defined in the literature. Moreover, we illustrate the computational implications of these characterizations and relate the class of egalitarian stable games to other well-known classes. |
| Keywords: | egalitarianism; transferable utility games; procedural egalitarian solution; egalitarian stability |
| JEL: | C71 |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:tiu:tiucen:6caea8c0-1dcd-4038-88da-bbf034bd65b6&r=all |
| By: | Chia-Lin Chang (Department of Applied Economics and Department of Finance National Chung Hsing University, Taiwan.); Michael McAleer (Department of Quantitative Finance National Tsing Hua University, Taiwan and Econometric Institute Erasmus School of Economics Erasmus University Rotterdam, The Netherlands and Department of Quantitative Economics Complutense University of Madrid, Spain And Institute of Advanced Sciences Yokohama National University, Japan.); Wing-Keung Wong (Department of Finance, Fintech Center, and Big Data Research Center Asia University, Taiwan and Department of Medical Research, China Medical University Hospital, Taiwan And Department of Economics and Finance, Hang Seng Management College Hong Kong, China and Department of Economics, Lingnan University, Hong Kong, China.) |
| Abstract: | This note is concerned with an editorial statement of intent for Advances in Decision Sciences (ADS), which was founded in 1997, so that 2918 marks the 22nd Anniversary of the journal. The note discusses the aims and scope of ADS in Section 1, innovative topics in all fields of optimal decision making in Section 2, research areas of interest to ADS in Section 3, invitation to submit papers to ADS in Section 4, editors and members of the editorial board in Section 5, and acknowledgements in Section 6. |
| Keywords: | Decision making, Aims and scope, Innovative topics, Optimality, Areas and topics of interest. |
| JEL: | C44 D81 D91 G11 M51 |
| URL: | http://d.repec.org/n?u=RePEc:ucm:doicae:1905&r=all |
| By: | Adams, Abigail |
| Abstract: | Revealed preference restrictions are increasingly used to predict demand behaviour at new budgets of interest and as shape restrictions in nonparametric estimation exercises. However, the restrictions imposed are not sufficient for rationality when predictions are made at multiple budgets. I highlight the nonconvexities in the set of predictions that arise when making multiple predictions. I develop a mixed integer programming characterisation of the problem that can be used to impose rationality on multiple predictions. The approach is applied to the UK Family Expenditure Survey to recover rational demand predictions with substantially reduced computational resources compared to known alternatives. |
| Keywords: | Demand estimation; mixed integer programming; Revealed Preference |
| JEL: | C60 D11 D12 |
| Date: | 2019–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:13580&r=all |
| By: | Òscar Jordà; Moritz Schularick; Alan M. Taylor |
| Abstract: | The risk premium puzzle is worse than you think. Using a new database for the U.S. and 15 other advanced economies from 1870 to the present that includes housing as well as equity returns (to capture the full risky capital portfolio of the representative agent), standard calculations using returns to total wealth and consumption show that: housing returns in the long run are comparable to those of equities, and yet housing returns have lower volatility and lower covariance with consumption growth than equities. The same applies to a weighted total-wealth portfolio, and over a range of horizons. As a result, the implied risk aversion parameters for housing wealth and total wealth are even larger than those for equities, often by a factor of 2 or more. We find that more exotic models cannot resolve these even bigger puzzles, and we see little role for limited participation, idiosyncratic housing risk, transaction costs, or liquidity premiums. |
| JEL: | E44 G12 G15 N20 |
| Date: | 2019–03 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:25653&r=all |
| By: | Gauthier de Maere d'Aertrycke (CEEME - Engie); Andreas Ehrenmann (CEEME - Engie); Daniel Ralph (Cambridge Judge Business School, University of Cambridge); Yves Smeers (Center for Operations Research and Econometrics, Universit´e catholique de Louvain) |
| Keywords: | Capacity expansion, spot market, perfect or Cournot competition, risk aversion, risk trading, complete or incomplete risk market, coherent risk measure, risky capacity equilibria |
| JEL: | C62 C72 L94 C73 G32 |
| Date: | 2018–01 |
| URL: | http://d.repec.org/n?u=RePEc:enp:wpaper:eprg1720&r=all |
| By: | Irenaeus Wolff |
| Abstract: | Simple game structures like discoordination, hide-and-seek, or Colonel-Blotto games have been used to model a wide range of economically relevant situations. Yet, Nash-equilibrium and its alternatives notoriously fail to explain observed behaviour in these games when alternatives carry descriptive labels. This paper shows that throughout the different games, behavioural patterns resemble `lucky-number' patterns: the choice patterns in related lotteries. Starting from this observation, I adjust standard models to account for the data. The adjusted models outperform the existing models, but they do not outperform a simple benchmark model. In the benchmark model, agents pick according to the `lucky numbers' or, under certain circumstances, choose any of the other options with equal probabilities. Interestingly, this benchmark model predicts two additional general regularities that bear out on the existing data and new data from two additional games: hide-and-seek seekers rely on `lucky numbers' more heavily than any other player role; and the stronger the `lucky-number' pattern deviates from a uniform distribution, the more likely it is observed also in the game data. |
| Keywords: | Bounded Rationality, Level-k, Salience, Heuristic, Hide and Seek, Discoordination, Rock-Paper-Scissors, Colonel Blotto, Representativeness |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:twi:respas:0115&r=all |
| By: | Huy N. Chau; Miklos Rasonyi |
| Abstract: | We treat a fairly broad class of financial models which includes markets with proportional transaction costs. We consider an investor with cumulative prospect theory preferences and a non-negativity constraint on portfolio wealth. The existence of an optimal strategy is shown in this context in a class of generalized strategies. |
| Date: | 2019–03 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1903.08156&r=all |
| By: | Löfgren, Åsa (Department of Economics, School of Business, Economics and Law, Göteborg University); Nordblom, Katarina (Department of Economics, School of Business, Economics and Law, Göteborg University) |
| Abstract: | In this paper we develop a theoretical model to clarify the underlying mechanisms that drive individual decision making and responses to behavioral interventions, such as nudges. The contribution of the paper is three-fold: First, the model provides a theoretical framework that comprehensively structures the individual decision-making process applicable to a wide range of choice situations. Second, we reduce the confusion regarding what should be called a nudge by offering a clear classification of behavioral interventions. We distinguish among what we label as pure nudges, preference nudges, and other behavioral interventions. Third, we identify the mechanisms behind the effectiveness of behavioral interventions based on the structured decision-making process. Hence, the model can be used to predict under which circumstances, and in which choice situations, a nudge is likely to be effective. |
| Keywords: | Nudge; decision making; behavioral intervention |
| JEL: | D11 D91 |
| Date: | 2019–03 |
| URL: | http://d.repec.org/n?u=RePEc:hhs:gunwpe:0754&r=all |
| By: | Mario R. Pascoa (University of Surrey); Abdelkrim Seghir (Ajman University) |
| Abstract: | When loans are secured but subject to utility penalties on default, notrade equilibria induced by unduly low repayment beliefs can be trivially found for nite horizon economies but not for in nite horizon ones. We illustrate this fact and propose also a re nement of equilibrium that gets rid of spurious no-trade outcomes when they do occur. Known existence results pass this re nement criterion. |
| JEL: | D52 D53 G33 |
| Date: | 2019–03 |
| URL: | http://d.repec.org/n?u=RePEc:sur:surrec:0919&r=all |
| By: | Baldwin, Elizabeth; Klemperer, Paul |
| Abstract: | An Equivalence Theorem between geometric structures and utility functions allows new methods for understanding preferences. Our classification of valuations into "Demand Types" incorporates existing definitions (substitutes, complements, "strong substitutes", etc.) and permits new ones. Our Unimodularity Theorem generalises previous results about when competitive equilibrium exists for any set of agents whose valuations are all of a "demand type". Contrary to popular belief, equilibrium is guaranteed for more classes of purely-complements, than of purely-substitutes, preferences. Our Intersection Count Theorem checks equilibrium existence for combinations of agents with specific valuations by counting the intersection points of geometric objects. Applications include matching and coalition-formation, and the "Product-Mix Auction" introduced by the Bank of England in response to the financial crisis. |
| Keywords: | Competitive Equilibrium; consumer theory; demand type; equilibrium existence; geometry; indivisible goods; Matching; product mix auction; product-mix auction; tropical geometry |
| JEL: | C62 D44 D50 D51 |
| Date: | 2019–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:13586&r=all |
| By: | Edilio Valentini (Department of Economics, University of Chieti-Pescara); Paolo Vitale (Department of Economics, University of Chieti-Pescara) |
| Abstract: | In this paper we present a dynamic discrete-time model that allows to investigate the impact of risk-aversion in an oligopoly characterized by a homogeneous non-storable good, sticky prices and uncertainty. Our model nests the classical dynamic oligopoly model with sticky prices by Fershtman and Kamien (Fershtman and Kamien, 1987), which can be viewed as the continuous-time limit of our model with no uncertainty and no risk-aversion. Focusing on the continuous-time limit of the infinite horizon formulation we show that the optimal production strategy and the consequent equilibrium price are, respectively, directly and inversely related to the degrees of uncertainty and risk-aversion. However, the effect of uncertainty and risk-aversion crucially depends on price stickiness since, when prices can adjust instantaneously, the steady state equilibrium in our model with uncertainty and risk aversion collapses to Fershtman and Kamien’s analogue. |
| Keywords: | Uncertainty, Risk-aversion, Dynamic Oligopoly |
| JEL: | D8 D81 L13 |
| Date: | 2019–03 |
| URL: | http://d.repec.org/n?u=RePEc:fem:femwpa:2019.03&r=all |
| By: | Booth, Alison L. (Australian National University); Lee, Jungmin (Seoul National University) |
| Abstract: | We compare the performance of high-ability adolescent girls and boys who participated in a a long-running Korean television quiz show. We find there is a gender gap in performance – in favour of boys – across episodes of the quiz show. To investigate underlying mechanisms that might explain this, we explore how male and female performance varies under different rules of the game. We find that there are no gender gaps when stress is kept to a minimum – that is, in games without fastest-finger buzzer, knock-outs or penalties. However, in games with these features, there are significant gender gaps. In addition, we examine performance in Round 2 of the shows, where we find larger gender gaps. These are consistent with girls being increasingly hindered by psychological stress and risk aversion as competition is higher. Finally, we use panel data to estimate performance in the games in which players stay in for 25 questions. Here we find that girls are less likely to respond faster especially when their winning probability is higher. Further, the gender gap is more salient at the end of the game. The results are also consistent with gendered behavioural responses to psychological pressure. |
| Keywords: | gender and competition, tournaments, psychological pressure, risk aversion |
| JEL: | J16 I21 D9 L83 M5 |
| Date: | 2019–02 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp12182&r=all |
| By: | Masoud Fekri; Babak Barazandeh |
| Abstract: | Optimal capital allocation between different assets is an important financial problem, which is generally framed as the portfolio optimization problem. General models include the single-period and multi-period cases. The traditional Mean-Variance model introduced by Harry Markowitz has been the basis of many models used to solve the portfolio optimization problem. The overall goal is to achieve the highest return and lowest risk in portfolio optimization problems. In this paper, we will present an optimal portfolio based the Markowitz Mean-Variance-Skewness with weight constraints model for short-term investment opportunities in Iran's stock market. We will use a neural network based predictor to predict the stock returns and measure the risk of stocks based on the prediction errors in the neural network. We will perform a series of experiments on our portfolio optimization model with the real data from Iran's stock market indices including Bank, Insurance, Investment, Petroleum Products and Chemicals indices. Finally, 8 different portfolios with low, medium and high risks for different type of investors (risk-averse or risk taker) using genetic algorithm will be designed and analyzed. |
| Date: | 2019–02 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1903.06632&r=all |