|
on Utility Models and Prospect Theory |
|
Issue of 2020‒08‒31
twelve papers chosen by |
| By: | Franz Dietrich (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics, CNRS - Centre National de la Recherche Scientifique) |
| Abstract: | Can a group be a standard rational agent? This would require the group to hold aggregate preferences which maximise expected utility and change only by Bayesian updating. Group rationality is possible, but the only preference aggregation rules which support it (and are minimally Paretian and continuous) are the linear-geometric rules, which combine individual tastes linearly and individual beliefs geometrically. |
| Keywords: | Bayesian aggregation,preference aggregation under uncertainty,expected utility hypothesis for groups,Bayesian revision,rational group agents,linear versus geneometric opinion pooling |
| Date: | 2020–06 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:halshs-02905409&r=all |
| By: | Evan M. Calford |
| Abstract: | We study the use of mixed strategies in games by ambiguity averse agents with a preference for randomization. Applying the decision theoretic model of Saito (2015) to games, we establish that the set of rationalizable strategies grows larger as preferences for randomization weaken. An agent’s preference for randomization is partially observable: given the behavior of an agent in a game, we can determine an upper bound on the strength of randomization preferences for that agent. Notably, data in previous experiments on ambiguity aversion in games is not consistent with a maximal preference for randomization for approximately 30% of subjects. |
| Keywords: | Ambiguity Aversion, Mixed Strategies, Game Theory |
| JEL: | D81 C70 C72 |
| Date: | 2020–08 |
| URL: | http://d.repec.org/n?u=RePEc:acb:cbeeco:2020-675&r=all |
| By: | Matthew Lorig |
| Abstract: | In a market with stochastic interest rates, we consider an investor who can either (i) invest all if his money in a savings account or (ii) purchase zero-coupon bonds and invest the remainder of his wealth in a savings account. The indifference price of the bond is the price for which the investor could achieve the same expected utility under both scenarios. In an affine term structure setting, under the assumption that an investor has a utility function in either exponential or power form, we show that the indifference price of a zero-coupon bond is the root of an integral expression. As an example, we compute bond indifference prices and the corresponding indifference yield curves in the Vasicek setting and interpret the results. |
| Date: | 2020–07 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2007.09201&r=all |
| By: | Ben-Zhang Yang; Xin-Jiang He; Song-Ping Zhu |
| Abstract: | Under mean-variance-utility framework, we propose a new portfolio selection model, which allows wealth and time both have influences on risk aversion in the process of investment. We solved the model under a game theoretic framework and analytically derived the equilibrium investment (consumption) policy. The results conform with the facts that optimal investment strategy heavily depends on the investor's wealth and future income-consumption balance as well as the continuous optimally consumption process is highly dependent on the consumption preference of the investor. |
| Date: | 2020–07 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2007.06510&r=all |
| By: | John Hartwick |
| Abstract: | We re-visit the proposition: utility-change for the translog utility function equals the corresponding Tornqvist quantity index. We observe that the "linear" terms in the translog function must be zero for the result to obtain. We also report on the role of the assumption of homogeneity for the utility function in allowing the result to obtain. |
| Keywords: | translog function, Tornqvist index |
| JEL: | O47 E01 |
| Date: | 2020–07 |
| URL: | http://d.repec.org/n?u=RePEc:qed:wpaper:1434&r=all |
| By: | Rongju Zhang (Monash University [Melbourne]); Nicolas Langrené (CSIRO - Commonwealth Scientific and Industrial Research Organisation [Canberra]); Yu Tian (Monash University [Melbourne]); Zili Zhu (CSIRO - Commonwealth Scientific and Industrial Research Organisation [Canberra]); Fima Klebaner (Monash University [Melbourne]); Kais Hamza (Monash University [Melbourne]) |
| Abstract: | In this paper, we propose a novel investment strategy for portfolio optimization problems. The proposed strategy maximizes the expected portfolio value bounded within a targeted range, composed of a conservative lower target representing a need for capital protection and a desired upper target representing an investment goal. This strategy favorably shapes the entire probability distribution of returns, as it simultaneously seeks a desired expected return, cuts off downside risk and implicitly caps volatility and higher moments. To illustrate the effectiveness of this investment strategy, we study a multiperiod portfolio optimization problem with transaction costs and develop a two-stage regression approach that improves the classical least squares Monte Carlo (LSMC) algorithm when dealing with difficult payoffs, such as highly concave, abruptly changing or discontinuous functions. Our numerical results show substantial improvements over the classical LSMC algorithm for both the constant relative risk-aversion (CRRA) utility approach and the proposed skewed target range strategy (STRS). Our numerical results illustrate the ability of the STRS to contain the portfolio value within the targeted range. When compared with the CRRA utility approach, the STRS achieves a similar mean-variance efficient frontier while delivering a better downside risk-return trade-off. |
| Keywords: | target-based portfolio optimization,alternative performance measure,multiperiod portfolio optimization,least squares Monte Carlo,two-stage regression |
| Date: | 2019 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:hal-02909342&r=all |
| By: | Anastasios G. Karantounias |
| Abstract: | This paper analyzes optimal policy in setups where both the leader and the follower have doubts about the probability model of uncertainty. I illustrate the methodology in two environments: a) an industry populated with a large firm and many small firms in a competitive fringe, where both types of firms doubt the probability model of demand shocks, and b) a general equilibrium economy, where a policymaker taxes linearly the labor income of a representative household in order to finance an exogenous stream of stochastic spending shocks. The policymaker can distrust the probability model of spending shocks more, the same, or less than the household. Whenever there are doubts about the model, cautious agents form endogenous worst-case beliefs by assigning high probability on low profitability or low-utility events. There are two forces that shape optimal policy results: the manipulation of the endogenous beliefs of the follower to the benefit of the leader, and the discrepancy (if any) in the pessimistic beliefs between the leader and the follower. Depending on the application, the leader may amplify or mitigate the worst-case beliefs of the follower. |
| Keywords: | model uncertainty; ambiguity aversion; multiplier preferences; misspecification; robustness; martingale; monopolist; competitive fringe; demand uncertainty; Ramsey taxation |
| JEL: | D80 E62 H21 H63 |
| Date: | 2020–07–31 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedawp:88478&r=all |
| By: | Franz Dietrich (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics, CNRS - Centre National de la Recherche Scientifique); Antonios Staras (Cardiff University); Robert Sugden (UEA - University of East Anglia [Norwich]) |
| Abstract: | Leonard Savage famously contravened his own theory when first confronting the Allais Paradox, but then convinced himself that the had made an error. We examine the formal structure of Savage's ‘error-correcting' reasoning in the light of (i) behavioural economists' claims to identify the latent preferences of individuals who violate conventional rationality requirements and (ii) John Broome's critique of arguments which presuppose that rationality requirements can be achieved through reasoning. We argue that Savage's reasoning is not vulnerable to Broome's critique, but does not provide support for the view that behavioural scientists can identify and counteract errors in people's choices. |
| Keywords: | Savage,Allais Paradox,Broome,rationality,reasoning,behavioural economics |
| Date: | 2020–05 |
| URL: | http://d.repec.org/n?u=RePEc:hal:journl:halshs-02905466&r=all |
| By: | Georgios Gerasimou |
| Abstract: | We study two random non-forced choice models that explain behavioural patterns suggesting that the no-choice outside option is often selected when people find it hard to decide between the market alternatives available to them, even when these are few and desirable. The decision-conflict logit extends the logit model with an outside option by assigning a menu-dependent value to that option. This value captures the degree of complexity/decision difficulty at the relevant menu and allows for the choice probability of the outside option to either increase or decrease when the menu is expanded, depending on how many as well as on how attractive options are added to it. The multicriteria logit is a special case of this model and introduces multiple utility functions that jointly predict behaviour in a multiplicative-logit way. Every multicriteria logit admits a tractable discrete-choice formulation. |
| Date: | 2020–08 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2008.04229&r=all |
| By: | Dylan Possama\"i; Nizar Touzi |
| Abstract: | This paper provides a complete review of the continuous-time optimal contracting problem introduced by Sannikov, in the extended context allowing for possibly different discount rates of both parties. The agent's problem is to seek for optimal effort, given the compensation scheme proposed by the principal over a random horizon. Then, given the optimal agent's response, the principal determines the best compensation scheme in terms of running payment, retirement, and lump-sum payment at retirement. A Golden Parachute is a situation where the agent ceases any effort at some positive stopping time, and receives a payment afterwards, possibly under the form of a lump-sum payment, or of a continuous stream of payments. We show that a Golden Parachute only exists in certain specific circumstances. This is in contrast with the results claimed by Sannikov, where the only requirement is a positive agent's marginal cost of effort at zero. Namely, we show that there is no Golden Parachute if this parameter is too large. Similarly, in the context of a concave marginal utility, there is no Golden Parachute if the agent's utility function has a too negative curvature at zero. In the general case, we provide a rigorous analysis of this problem, and we prove that an agent with positive reservation utility is either never retired by the principal, or retired above some given threshold (as in Sannikov's solution). In particular, different discount factors induce naturally a face-lifted utility function, which allows to reduce the whole analysis to a setting similar to the equal-discount rates one. Finally, we also confirm that an agent with small reservation utility does have an informational rent, meaning that the principal optimally offers him a contract with strictly higher utility value. |
| Date: | 2020–07 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2007.05529&r=all |
| By: | Szekeres, Szabolcs |
| Abstract: | A numerical model is used to experimentally compute certainty equivalent discount rates (CERs) of risk neutral and risk-averse decision makers. Investors are characterized by utility functions of the constant-intertemporal-elasticity-of-substitution (CIES) type. Stochastic interest rates are generated using a Cox, Ingersoll & Ross (CIR) type model, calibrated to 1992-2017 US three-month Treasury Bill rates. The paper replicates empirical studies providing evidence for declining discount rates (DDRs) and tests claims regarding risk averse CERs in a descriptive discounting context. It is shown that DDRs as proposed by Weitzman are based on a fallacy. The reviewed papers seeking empirical evidence of DDRs repeat the mistake. Risk averse CERs can be decline with time because of portfolio effects. If these are low, risk averse CERs are slightly lower than risk neutral ones but not secularly declining. |
| Keywords: | Weitzman-Gollier puzzle; declining discount rates; discounting |
| JEL: | D61 H43 |
| Date: | 2020–08–04 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:102233&r=all |
| By: | Drew Fudenberg; Wayne Gao; Annie Liang |
| Abstract: | We propose a new way to quantify the restrictiveness of an economic model, based on how well the model fits simulated, hypothetical data sets. The data sets are drawn at random from a distribution that satisfies some application-dependent content restrictions (such as that people prefer more money to less). Models that can fit almost all hypothetical data well are not restrictive. To illustrate our approach, we evaluate the restrictiveness of two widely-used behavioral models, Cumulative Prospect Theory and the Poisson Cognitive Hierarchy Model, and explain how restrictiveness reveals new insights about them. |
| Date: | 2020–07 |
| URL: | http://d.repec.org/n?u=RePEc:arx:papers:2007.09213&r=all |