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on Utility Models and Prospect Theory |
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Issue of 2019‒12‒23
fourteen papers chosen by |
| By: | Johannes G. Jaspersen; Marc A. Ragin; Justin R. Sydnor |
| Abstract: | Can measured risk attitudes and associated structural models predict insurance demand? In an experiment (n = 1,730), we elicit measures of utility curvature, probability weighting, loss aversion, and preference for certainty and use them to parameterize seventeen common structural models (e.g., expected utility, cumulative prospect theory). Subjects also make twelve insurance choices over different loss probabilities and prices. The insurance choices show coherence and some correlation with various risk-attitude measures. Yet all the structural models predict insurance poorly, often less accurately than random predictions. Simpler prediction heuristics show more promise for predicting insurance choices across different conditions. |
| JEL: | D01 D81 G22 |
| Date: | 2019–11 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:26508&r=all |
| By: | Karolis Liaudinskas |
| Abstract: | Can humans achieve rationality, as defined by the expected utility theory, by automating their decision making? We use millisecond-stamped transaction-level data from the Copenhagen Stock Exchange to estimate the disposition effect – the tendency to sell winning but not losing stocks – among algorithmic and human professional day-traders. We find that: (1) the disposition effect is substantial among humans but virtually zero among algorithms; (2) this difference is not fully explained by rational explanations and is, at least partially, attributed to prospect theory, realization utility and beliefs in mean-reversion; (3) the disposition effect harms trading performance, which further deems such behavior irrational. |
| Keywords: | disposition effect, algorithmic trading, financial markets, rationality, automation |
| JEL: | D8 D91 G11 G12 G23 O3 |
| Date: | 2019–11 |
| URL: | http://d.repec.org/n?u=RePEc:bge:wpaper:1133&r=all |
| By: | Gaudeul, A.; Crosetto, P. |
| Abstract: | In this paper we provide choice-process experimental evidence that the attraction effect is a short-term phenomenon, that disappears when individuals are given time and incentives to revise their choices.The attraction (or decoy) effect is the most prominent example of context effects, and it appears when adding a dominated option to a choice set increases the choice share of the now dominant option at the expense of other options. While widely replicated, the attraction effect is usually tested in hypothetical or payoff-irrelevant situations and without following the choice process. We run a laboratory experiment where we incentivize choice, vary the difference in utility between options and track which option participants consider best over time. We find that the effect is a transitory phenomenon that emerges only in the early stages of the choice process to later disappear. Participants are fast then slow: they first choose the dominant option to avoid the dominated decoy and then progressively revise their choices until choice shares come to correspond to price differences only. We expand our analysis by considering differences in utility among options and differences in the presentation of options (numerical or graphical). We also consider differences in the choice processes followed by individuals (intuitive vs. deliberative). This allows us to ascribe more precisely the role of fast and slow cognitive process in the emergence and disappearance of the attraction effect. |
| Keywords: | ASYMMETRIC DOMINANCE;ATTRACTION EFFECT;INDUCED PREFERENCES;CHOICE PROCESS;TIME CONSTRAINT;RATIONALITY;CONTEXT EFFECTS |
| JEL: | C91 D12 D83 |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:gbl:wpaper:2019-06&r=all |
| By: | Garnadi, Agah D.; SYAHRIL, |
| Abstract: | This paper discusses an optimal transaction interval for a consumption and investment decision problem for an~individual who has available a~riskless asset paying fixed interest rate and a~risky asset driven by Brownian motion price fluctuations. The individual observes current wealth when making transactions, that transactions incur costs, and that decisions to transact can be made at any time based on all current information. The transactions costs is fixed for every transaction, regardless of amount transacted. In addition, the investor is charged a fixed fraction of total wealth as management fee. The investor's objective is to maximize the expected utility of consumption over a given horizon. The problem faced by the investor is formulated in a stochastic discrete-continuous-time control problem. An optimal transaction interval for the inverstor is derived. |
| Date: | 2017–12–16 |
| URL: | http://d.repec.org/n?u=RePEc:osf:inarxi:ev7mk&r=all |
| By: | Holzmeister, Felix (University of Innsbruck); Stefan, Matthias |
| Abstract: | With the rise of experimental methods in the social sciences, numerous methods to elicit and classify people's risk attitudes in the laboratory have evolved. However, evidence suggests that people's attitudes towards risk may change considerably when measured with different methods. Based on a with-subject design using four widespread risk elicitation methods, we find that different procedures indeed give rise to considerably varying estimates of individual and aggregate level risk preferences. Conducting simulation exercises to obtain benchmarks for subjects' behavior, we find that the observed heterogeneity in risk preference estimates across methods is qualitatively similar to the heterogeneity arising from independent random draws from choices in the experimental tasks. Our study, however, provides evidence that subjects are surprisingly well aware of the variation in the riskiness of their choices. We argue that this calls into question the common interpretation of variation in revealed risk preferences being inconsistent. |
| Date: | 2019–03–29 |
| URL: | http://d.repec.org/n?u=RePEc:osf:osfxxx:pj9u2&r=all |
| By: | Robert W. Dimand (Department of Economics, Brock University) |
| Abstract: | Commitment to the behaviorist approach to utility theory, to the usefulness of mathematics in economic analysis and to equalization of the marginal utility of income as a principle of just taxation brought Irving Fisher and Ragnar Frisch to attempt to measure the marginal utility of income, and led them to collaborate in forming the Econometric Society and sponsoring the establishment of the Cowles Commission, institutions advancing economic theory in connection to mathematics and statistics. To be presented at a symposium at the University of Oslo, December 3, 2019, honoring the 50th anniversary of the award to Ragnar Frisch of the Royal Bank of Sweden Prize in Economic Science in Memory of Alfred Nobel and the 30th anniversary of the award of that prize to Trygve Haavelmo. |
| Keywords: | Irving Fisher, Ragnar Frisch, Measurable utility, Axiomatic approach to utility |
| JEL: | B1 B23 B31 |
| Date: | 2019–11 |
| URL: | http://d.repec.org/n?u=RePEc:cwl:cwldpp:2206&r=all |
| By: | Tanaka, Yasuhito |
| Abstract: | We show the existence of involuntary unemployment without assuming wage rigidity. Key points of our analysis are indivisibility of labor supply and increasing returns to scale. We derive involuntary unemployment by considering utility maximization of consumers and profit maximization of firms in an overlapping generations model under monopolistic competition with indivisibility of labor supply and increasing returns to scale technology. |
| Keywords: | involuntary unemployment, monopolistic competition, indivisible labor supply, increasing returns to scale |
| JEL: | E12 E24 |
| Date: | 2019–12–03 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:97378&r=all |
| By: | Georgios Gerasimou |
| Abstract: | We propose a general and applicable model of simple preference intensity comparisons. The model encompasses those that belong to the utility-difference class, has transparent behavioural underpinnings and features purely ordinal uniqueness properties. Three applications are analysed. First, the model's empirical content is characterized by an easily testable condition on behavioural data that include choices and additional observables with intensity-revealing potential that are often elicited in experimental/empirical work, such as survey ratings, response times or willingness to pay. Second, a special case of the model is argued to facilitate interpersonal comparisons of (strict) intensity relations without requiring interpersonally comparable utilities. Building on this, the novel notion of intensity efficiency is introduced in a single-profile social choice setting and is shown to be well-defined and to refine Pareto efficiency by discarding allocations that are dominated on intensity-difference grounds. Finally, the house allocation problem in one-sided matching is revisited when agents have intensity relations of this kind, and a simple algorithm is shown to yield an intensity-efficient allocation in every such market. |
| Keywords: | Preference intensity functions; revealed preference intensity; intensity-efficient allocations |
| JEL: | B21 C88 D11 D63 D70 D90 |
| Date: | 2019–06–01 |
| URL: | http://d.repec.org/n?u=RePEc:san:wpecon:1905&r=all |
| By: | Chulyoung Kim (Yonsei Univ); Miho Hong (Yale Univ); Sang-Hyun Kim (Yonsei Univ); Sangyoon Nam (U of Southern California) |
| Abstract: | Using a modified ultimatum game experiment, we tested the hypothesis that greater “observability†of responders’ actions leads to a higher rejection rate. Our experimental data on participants’ rejection behavior rejected this hypothesis but confirmed the theory of reference-dependent preferences. |
| Keywords: | Ultimatum game experiment, audience effect, signaling, loss aversion |
| JEL: | C91 |
| Date: | 2019–12 |
| URL: | http://d.repec.org/n?u=RePEc:yon:wpaper:2019rwp-155&r=all |
| By: | Christoph Görtz; Mallory Yeromonahos |
| Abstract: | A large literature suggests that the expected equity risk premium is countercyclical. Using a variety of different measures for this risk premium, we document that it also exhibits growth asymmetry, i.e. the risk premium rises sharply in recessions and declines much more gradually during the following recoveries. We show that a model with recursive preferences, in which agents cannot perfectly observe the state of current productivity, can generate the observed asymmetry in the risk premium. Key for this result are endogenous fluctuations in uncertainty which induce procyclical variations in agent’s nowcast accuracy. In addition to matching moments of the risk premium, the model is also successful in generating the growth asymmetry in macroeconomic aggregates observed in the data, and in matching the cyclical relation between quantities and the risk premium. |
| Keywords: | risk premium, business cycles, Bayesian learning, asymmetry, uncertainty, nowcasting |
| JEL: | E20 E30 G10 |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:ces:ceswps:_7959&r=all |
| By: | Maria Arvaniti (Chair of Economics/Resource Economics, ETH, Zurich and Center for Environmental and Resource Economics (CERE), Umea, Sweden.); Chandra K. Krishnamurthy (Beijer Institute for Ecological Economics, The Royal Swedish Academy of Sciences, Stockholm, Department of Forest Economics, Swedish Agricultural University, SLU, Umea and Center for Environmental and Resource Economics (CERE), Umea, Sweden.); Anne-Sophie Crépin (Beijer Institute for Ecological Economics, The Royal Swedish Academy of Sciences, Stockholm and Stockholm Resilience Centre, Stockholm University, Stockholm.) |
| Abstract: | We investigate how a resource user who is present-biased manages a renewable resource stock with variable growth that could undergo a reversible regime shift (an abrupt, persistent change in structure and function of the ecosystem supplying the resource). In a discrete-time quasihyperbolic discounting framework with no commitment device, and using only generic utility functions and stock transition with regime shifts, we show that there is a unique, time-consistent stationary Markov-Nash equilibrium extraction policy. Further, we find that the optimal extraction policy is increasing in the resource stock and in the degree of present bias. Overall, our results suggest that for characteristics of ecosystems commonly considered in the literature, presentbiased resource users will increase extraction when faced with regime shifts. |
| Keywords: | Renewable resources, Regime shifts, Hyperbolic Discounting, Present bias, Uncertainty, Markov Equilibrium |
| JEL: | Q20 C61 C73 |
| Date: | 2019–12 |
| URL: | http://d.repec.org/n?u=RePEc:eth:wpswif:19-329&r=all |
| By: | Maruyama, Yuuki |
| Abstract: | In this model, the stock price is determined by two variables: the fundamental value and the current risk preference of people. Suppose that the fundamental value follows Geometric Brownian motion and the function of the risk preference of people follows Ornstein-Uhlenbeck process. There are only two types of asset: money (safe asset) and stocks (risk asset). In this case, the profit rate of equity investment is mean reverting, and long-term investment is more advantageous than short-term investment. The market is arbitrage-free. Also, based on this model, I suggest a solution to the Equity Premium Puzzle. |
| Date: | 2019–10–07 |
| URL: | http://d.repec.org/n?u=RePEc:osf:osfxxx:6gwjq&r=all |
| By: | David Alary (LERNA - Laboratoire d'Economie des ressources Naturelles - INRA - Institut National de la Recherche Agronomique); Franck Bien (LEDa - Laboratoire d'Economie de Dauphine - CNRS - Centre National de la Recherche Scientifique - IRD - Institut de Recherche pour le Développement - Université Paris-Dauphine) |
| Abstract: | In this note, we consider an adverse selection problem involving an insurance market à la Rothschild-Stiglitz. We assume that part of the loss is uninsurable as in the case with health care or environmental risk. We characterize sufficient conditions such that adverse selection by itself does not distort competitive insurance contracts. A sufficiently large uninsurable loss provides an incentive to high-risk policy holders not to mimic low-risk policy holders without distorting the optimal coverage. |
| Keywords: | Adverse Selection,Background risk,Optimal Contract |
| Date: | 2019–12–02 |
| URL: | http://d.repec.org/n?u=RePEc:hal:wpaper:hal-02390017&r=all |
| By: | Girshina, Anastasia; Mathä, Thomas Y.; Ziegelmeyer, Michael |
| Abstract: | This paper studies how peers’ financial behaviour affects individuals’ own investment choices. To identify the peer effect, we exploit the unique composition of the Luxembourg population and use the differences in stock market participation across various immigrant groups to study how they affect stock market participation of natives. We solve the reflection problem by instrumenting immigrants’ stock market participation with lagged participation rates in their countries of birth. We separate the peer effect from the contextual and correlated effects by controlling for neighbourhood and individual characteristics. We find that stock market participation of immigrant peers has sizeable effects on that of natives. We also provide evidence that social learning is one of the channels through which the peer effect is transmitted. However, social learning alone does not account for the entire effect and we conclude that social utility might also play an important role in peer effects transmission. JEL Classification: G5, D14, D83, G11, I22 |
| Keywords: | peer effects, social learning, social utility, stock market participation |
| Date: | 2019–12 |
| URL: | http://d.repec.org/n?u=RePEc:ecb:ecbwps:20192340&r=all |