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on Utility Models and Prospect Theory |
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Issue of 2019‒12‒02
twelve papers chosen by |
| By: | Stark, Oded (University of Bonn) |
| Abstract: | Combining a standard measure of concern about low relative wealth and a standard measure of relative risk aversion leads to a novel explanation of variation in risk-taking behavior identified and documented by social psychologists and economists. We obtain two results: (1) Holding individual i's wealth and his rank in the wealth distribution constant, the individual's relative risk aversion decreases when he becomes more relatively deprived as a result of an increase in the average wealth of the individuals who are wealthier than he is. (2) If relative deprivation enters the individual's utility function approximately linearly then, holding constant individual i's wealth and the average wealth of the individuals who are wealthier than he is, the individual's relative risk aversion decreases when he becomes more relatively deprived as a result of a decline in his rank. Our findings provide a theoretical support for evidence about the propensity of relatively deprived individuals to gamble and resort to other risky behaviors. |
| Keywords: | social preferences, relative deprivation, concern about low relative wealth, risk aversion |
| JEL: | D01 D81 D91 I12 |
| Date: | 2019–11 |
| URL: | http://d.repec.org/n?u=RePEc:iza:izadps:dp12756&r=all |
| By: | Nevin Cavusoglu (James Madison University); Michael D. Goldberg (University of New Hampshire); Joshua Stillwagon (Babson College) |
| Abstract: | This paper re-examines the empirical performance of the portfolio balance approach to currency returns. It considers the implications of two alternative specifications of preferences: one based on expected utility theory and the other on prospect theory. It also uses survey data to estimate models of ex-ante rather than ex-post returns. The empirical analysis relies on the co-integrated VAR framework, which is well suited for testing competing models and dealing with unit roots. Like earlier studies, we find little support for the expected utility theory model. By contrast, the prospect theory model`s predictions are largely borne out in the data, including those about sign reversals. We find the strongest support for a hybrid model that incorporates the risk factors of both portfolio balance specifications. |
| Keywords: | International CAPM, Prospect Theory, Risk Premium, Co-integrated VAR, Survey Expectations |
| JEL: | F31 D81 D84 G10 |
| Date: | 2019–01 |
| URL: | http://d.repec.org/n?u=RePEc:thk:wpaper:89&r=all |
| By: | Immanuel Lampe; Daniel Würtenberger |
| Abstract: | This work analyzes if reference dependence and loss aversion can explainthe puzzling low adoption rates of rainfall index insurance. We present a model that predicts the impact of loss aversion on index insurance demand to vary with different levels of insurance understanding. Index insurance demand of farmers who are unaware of the loss-hedging benefit that insurance provides decreases with loss aversion. In contrast, insurance demand of farmers who are aware of the loss-hedging benefit increases with loss aversion. The model further predicts that farmers who are unaware of the loss-hedging benefit will not demand an even highly subsidized index insurance. Using data from a randomized controlled trial involving a sample of Indian farmers we provide empirical support for our core conjecture that insurance understanding mitigates the negative impact of loss aversion on index insurance adoption. |
| Keywords: | Prospect Theory, Reference Dependence, Microinsurance, Farm Household |
| JEL: | D91 G22 Q12 |
| Date: | 2019–06 |
| URL: | http://d.repec.org/n?u=RePEc:usg:sfwpfi:2019:07&r=all |
| By: | Antoine Billot (Lemma, Université Panthéon-Assas); Sujoy Mukerji (Queen Mary University of London); Jean-Marc Tallon (Paris School of Economics, CNRS) |
| Abstract: | We review some of the (theoretical) economic implications of David Schmeidler's models of decision under uncertainty (Choquet expected utility and maxmin expected utility) in competitive market settings. We start with the portfolio inertia result of Dow and Werlang (1992), show how it does or does not generalize in an equilibrium setting. We further explore the equilibrium implications (indeterminacies, non revelation of information) of these decision models. A section is then devoted to the studies of Pareto optimal arrangements under these models. We conclude with a discussion of experimental evidence for these models that relate, in particular, to the implications for market behaviour discussed in the preceding sections. |
| Keywords: | Choquet Expected Utility; Maxmin Expected Utility; No-trade; Risk Sharing; Indeterminacy; Experimental evidence |
| JEL: | D81 |
| Date: | 2019–10–24 |
| URL: | http://d.repec.org/n?u=RePEc:qmw:qmwecw:897&r=all |
| By: | Dmytro Ivasiuk |
| Abstract: | This work presents an approximate solution of the portfolio choice problem for the investor with a power utility function and the predictable returns. Assuming that asset returns follow the vector autoregressive process with the normally distributed error terms (what is a popular choice in financial literature to model the return path) it comes up with the fact that portfolio gross returns appear to be normally distributed as a linear combination of normal variables. As it was shown, the log-normal distribution seems to be a good proxy of the normal distribution in case if the standard deviation of the last one is way much smaller than the mean. Thus, this fact is exploited to derive the optimal weights. Besides, the paper provides a simulation study comparing the derived result to the well-know numerical solution obtained by using a Taylor series expansion of the value function. |
| Date: | 2019–11 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1911.06552&r=all |
| By: | Philippe Jehiel (PJSE - Paris Jourdan Sciences Economiques - UP1 - Université Panthéon-Sorbonne - ENS Paris - École normale supérieure - Paris - INRA - Institut National de la Recherche Agronomique - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics, UCL - University College of London [London]); Juni Singh (PSE - Paris School of Economics, PJSE - Paris Jourdan Sciences Economiques - UP1 - Université Panthéon-Sorbonne - ENS Paris - École normale supérieure - Paris - INRA - Institut National de la Recherche Agronomique - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique) |
| Keywords: | Ambiguity,Bounded Rationality,Experiment,Learning,Coarse feedback,Valuation equilibrium |
| Date: | 2019–07 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:halshs-02183444&r=all |
| By: | Walid Matar (King Abdullah Petroleum Studies and Research Center) |
| Abstract: | Energy economists are interested in how a change in electricity prices prompts a response by way of end-user power demand. It is difficult to estimate price elasticities statistically if historical prices are low and change infrequently, especially in the short run. This paper extends a previous analysis by Matar (2018) that explored the merger of a residential building energy model and a utility maximization component by incorporating more demand-reducing measures within a utility-maximization framework for households. The framework is informed by the physical equations that govern how electricity is consumed. |
| Keywords: | Electricity demand, Consumer Energy Use, Electricity consumption, Electricity prices |
| Date: | 2019–02 |
| URL: | http://d.repec.org/n?u=RePEc:prc:dpaper:ks-2019-dp51&r=all |
| By: | Philipp Galkin; Carlo Andrea Bollino; Rami Shabaneh (King Abdullah Petroleum Studies and Research Center) |
| Abstract: | Energy economists are interested in how a change in electricity prices prompts a response by way of end-user power demand. It is difficult to estimate price elasticities statistically if historical prices are low and change infrequently, especially in the short run. This paper extends a previous analysis by Matar (2018) that explored the merger of a residential building energy model and a utility maximization component by incorporating more demand-reducing measures within a utility-maximization framework for households. The framework is informed by the physical equations that govern how electricity is consumed. |
| Keywords: | Consumer Behavior, Consumer Energy Use, Domestic energy consumption, Electricity |
| Date: | 2018–06 |
| URL: | http://d.repec.org/n?u=RePEc:prc:dpaper:ks-2018-dp34&r=all |
| By: | Roland Füss; Massimo Guidolin; Christian Koeppel |
| Abstract: | This paper introduces a new sentiment-augmented asset pricing model in order to provide a comprehensive understanding of the role of non-fundamental risk factors. We find that news and social media search-based indicators are significantly related to excess returns across different asset classes and markets. Adding sentiment factors to both classical and more recent pricing models leads to a significant increase in model performance. Following the Fama-MacBeth procedure, our modified pricing model obtains positive estimates of the risk premium for negative sentiment for global equity markets. Our results contribute to the explanation of the cross-section of average, international excess returns. |
| Keywords: | Asset pricing, behavioral finance, financial markets, investor sentiment, sentiment risk premium |
| JEL: | C53 G12 |
| Date: | 2019–08 |
| URL: | http://d.repec.org/n?u=RePEc:usg:sfwpfi:2019:13&r=all |
| By: | Engzell, Per; Ichou, Mathieu |
| Abstract: | Immigrants experience an ambiguous social position: on the one hand, they tend to be positively selected on resources from the origin country; on the other, they often occupy the lower rungs of the status ladder in receiving countries. This study explores the implications of this ambiguity for two important individual outcomes: subjective social status and perceived financial situation. We study the diverse sample of immigrants in the European Social Survey and use the fact that, due to country differences in educational distributions, a given education level can entail a very different rank in the sending and receiving countries. We document a robust relationship whereby immigrants who ranked higher in the origin than in the destination country see themselves as being comparatively worse off. This finding suggests that the social position before migration provides an important reference point by which immigrants judge their success in the new country. |
| Date: | 2019–04–23 |
| URL: | http://d.repec.org/n?u=RePEc:osf:socarx:qr5h7&r=all |
| By: | Anastasia Stepanova (National Research University Higher School of Economics); Anastasia Suraeva (National Research University Higher School of Economics) |
| Abstract: | Bank risk-taking behavior is of significant interest for researches and policy makers because financial failures due to excessive risk in this sector can have severe consequences for the bank’s numerous stakeholders and for the macroeconomic system overall. A growing literature investigates the main factors contributing to “well above average” risk. In particular, this study explains risk strategies in firms taking into account the bounded rationality of corporate governance agents. On a panel dataset of 110 listed US banks in the period of 2011-2016 empirical evidence is provided that excessive risk-taking in banks arises from the cognitive bias of the overconfidence of CEO decision-making. The study also presents how the impact of an overconfident CEO on risk-taking is affected considering the interaction of CEO overconfidence with the board of directors. It was revealed that the CEO's positive influence on risk is moderated if the board is an effective monitoring mechanism with the presence of independent directors who are experts in the financial sphere |
| Keywords: | bank risk-taking, CEO overconfidence, board of directors, behavioral finance, behavioral biases |
| JEL: | G21 G39 |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:hig:wpaper:78/fe/2019&r=all |
| By: | Yeon-Koo Che; Jinwoo Kim; Fuhito Kojima |
| Abstract: | We develop a theory of monotone comparative statics based on weak set order, or in short weak monotone comparative statics, and identify the enabling conditions in the context of individual choices, Pareto optimal choices for a coalition of agents, and Nash equilibria of games. Compared with the existing theory based on strong set order, the conditions for weak monotone comparative statics are weaker, sometimes considerably, in terms of the structure of the choice environment and underlying preferences of agents. We apply the theory to establish existence and monotone comparative statics of Nash equilibria in games with strategic complementarities and of stable many-to-one matchings in two-sided matching problems, allowing for general preferences that accommodate indifferences and incomplete preferences. |
| Date: | 2019–11 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:1911.06442&r=all |