
on Utility Models and Prospect Theory 
By:  Takashi Nishiwaki (Graduate School of Economics,Waseda University. 161, NishiWaseda, Shinjukuku, Tokyo 1698050, Japan.) 
Abstract:  This study examines the optimal investment strategies for riskandambiguityaverse investors and characterizes conditions under which ambiguity induces investors to buy or sell options. Under identical hyperbolic absolute risk aversion (HARA) utility functions, we illustrate that ambiguityaverse investors should sell portfolio insurance if their preferences exhibit constant relative risk aversion (CRRA). In particular, when investors f relative risk aversion is less than or equal to two, ambiguityaverse investors should sell options at any realization values of a reference asset. Further, if the relative risk aversion is greater than two, we demonstrate that ambiguityaverse investors should sell and buy options at smaller and higher realization values of the reference asset, respectively. Furthermore, if the utility functions display constant absolute risk aversion (CARA), then an ambiguityaverse investor should buy options at any realization values of the reference asset. 
Keywords:  Ambiguity; Multiple prior model; Options demand; Kullback? Leibler divergence 
JEL:  G11 G12 
Date:  2021–04 
URL:  http://d.repec.org/n?u=RePEc:wap:wpaper:2102&r= 
By:  Xi Zhi "RC" Lim 
Abstract:  We study how violations of structural assumptions like expected utility and exponential discounting can be connected to reference dependent preferences with setdependent reference points, even if behavior conforms with these assumptions when the reference is fixed. An axiomatic framework jointly and systematically relaxes general rationality (WARP) and structural assumptions to capture reference dependence across domains. It gives rise to a linear order that determines references points, which in turn determines the preference parameters for a choice problem. This allows us to study risk, time, and social preferences collectively, where seemingly independent anomalies are interconnected through the lens of referencedependent choice. 
Date:  2021–05 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:2105.12915&r= 
By:  Olkhov, Victor 
Abstract:  We make three remarks to the main CAPM equation presented in the wellknown textbook by John Cochrane (2001). First, we believe that any economic averaging procedure implies aggregation of corresponding time series during certain time interval Δ and explain the necessity to use math expectation for both sides of the main CAPM equation. Second, the firstorder condition of utility max used to derive main CAPM equation should be complemented by the second one that requires negative utility second derivative. Both define the amount of assets ξmax that delivers max to utility. Expansions of the utility in a Taylor series by price and payoff variations give approximations for ξmax and uncover equations on price, payoff, volatility, skewness, their covariance’s and etc. We discuss why market pricevolume positive correlations may prohibit existence of ξmax and main CAPM equation. Third, we argue that the economic sense of the conventional frequencybased price probability may be poor. To overcome this trouble we propose new price probability measure based on widely used volume weighted average price (VWAP). To forecast price volatility one should predict evolution of squares of the value and the volume of market trades aggregated during averaging interval Δ. The forecast of the new price probability measure may be the main tough puzzle for CAPM and finance. However investors are free to chose any probability measure they prefer as ground for their investment strategies but should be ready for unexpected losses due to possible distinctions with real market trade price dynamics. 
Keywords:  asset pricing, volatility, price probability, market trades 
JEL:  C02 D40 D53 G10 G12 
Date:  2021–05–24 
URL:  http://d.repec.org/n?u=RePEc:pra:mprapa:107938&r= 
By:  Patrick Reinwald; Stephan Leitner; Friederike Wall 
Abstract:  Limited memory of decisionmakers is often neglected in economic models, although it is reasonable to assume that it significantly influences the models' outcomes. The hiddenaction model introduced by Holmstr\"om also includes this assumption. In delegation relationships between a principal and an agent, this model provides the optimal sharing rule for the outcome that optimizes both parties' utilities. This paper introduces an agentbased model of the hiddenaction problem that includes limitations in the cognitive capacity of contracting parties. Our analysis mainly focuses on the sensitivity of the principal's and the agent's utilities to the relaxed assumptions. The results indicate that the agent's utility drops with limitations in the principal's cognitive capacity. Also, we find that the agent's cognitive capacity limitations affect neither his nor the principal's utility. Thus, the agent bears all adverse effects resulting from limitations in cognitive capacity. 
Date:  2021–05 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:2105.12469&r= 
By:  Marcelo Bérgolo (Universidad de la República (Uruguay). Facultad de Ciencias Económicas y de Administración. Instituto de Economía); Gabriel Burdín (University of Leeds); Santiago Burone (Universidad de la República (Uruguay). Facultad de Ciencias Económicas y de Administración. Instituto de Economía); Mauricio de Rosa (Universidad de la República (Uruguay). Facultad de Ciencias Económicas y de Administración. Instituto de Economía); Matías Giaccobasso (University of California. Anderson School of Management); Martín Leites (Universidad de la República (Uruguay). Facultad de Ciencias Económicas y de Administración. Instituto de Economía) 
Abstract:  Although different approaches and methods have been used to measure inequality aversion, there remains no consensus about its drivers at the individual level. We conducted an experiment on a sample of more than 1815 firstyear undergraduate economics and business students in Uruguay to understand why people are inequality averse. We elicited inequality aversion by asking participants to make a sequence of choices between hypothetical societies characterized by varying levels of average income and income inequality. In addition, we use randomized information treatments to prime participants into competing narratives regarding the sources of inequality in society. The main findings are that (1) the prevalence of inequality aversion is high: most participants’ choices revealed inequalityaverse preferences; (2) the extent of inequality aversion depends on the individual’s position in the income distribution; (3) individuals are more likely to accept inequality when it comes from effort rather than luck regardless of their income position; (4) the effect of social mobility on inequality aversion is conditional on individual’s income position: preferences for mobility reduces inequality aversion for individuals located at the bottom of the income distribution, where risk aversion cannot play any role. 
Keywords:  Inequality aversion, fairness, risk, effort, luck, redistribution, questionnaireexperiments 
JEL:  D63 D64 D81 C13 C91 
Date:  2020–11 
URL:  http://d.repec.org/n?u=RePEc:ulr:wpaper:dt1920&r= 
By:  Nail Kashaev; Victor H. Aguiar 
Abstract:  We generalize the stochastic revealed preference methodology of McFadden and Richter (1990) for finite choice sets to settings with limited consideration. Our approach is nonparametric and requires partial choice set variation. We only impose a monotonicity condition on attention first proposed by Cattaneo et al. (2020) and a stability condition on the marginal distribution of preferences. Our framework is amenable to statistical testing. These new restrictions extend widely known parametric models of consideration. 
Date:  2021–05 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:2105.11268&r= 
By:  DewBecker, Ian; Giglio, Stefano W; Kelly, Bryan 
Abstract:  We study the pricing of shocks to uncertainty and volatility using a wideranging set of options contracts covering a variety of different markets. If uncertainty shocks are viewed as bad by investors, they should carry negative risk premia. Empirically, however, uncertainty risk premia are positive in most markets. Instead, it is the realization of large shocks to fundamentals that has historically carried a negative premium. In other words, we find that the return premium for gamma is negative while that for vega is positive. These results imply that it is jumps, for which exposure is measured by gamma, not forwardlooking uncertainty shocks, measured by vega, that drive investors' marginal utility. In further support of the jump interpretation, the return patterns are more extreme for deeper out of the money options. 
Date:  2020–08 
URL:  http://d.repec.org/n?u=RePEc:cpr:ceprdp:15239&r= 
By:  Peter A. Streufert 
Abstract:  This paper introduces Gm, which is a category for extensiveform games. It also provides some applications. The category's objects are games, which are understood to be sets of nodes which have been endowed with edges, information sets, actions, players, and utility functions. Its arrows are functions from source nodes to target nodes that preserve the additional structure. For instance, a game's informationset collection is newly regarded as a topological basis for the game's decisionnode set, and thus a morphism's continuity serves to preserve information sets. Given these definitions, a game monomorphism is characterized by the property of not mapping two source runs (plays) to the same target run. Further, a game isomorphism is characterized as a bijection whose restriction to decision nodes is a homeomorphism, whose induced player transformation is injective, and which strictly preserves the ordinal content of the utility functions. The category is then applied to some gametheoretic concepts beyond the definition of a game. A Selten subgame is characterized as a special kind of categorical subgame, and game isomorphisms are shown to preserve strategy sets, Nash equilibria, Selten subgames, subgameperfect equilibria, perfectinformation, and noabsentmindedness. Further, it is shown that the full subcategory for distinguishedaction sequence games is essentially wide in the category of all games, and that the full subcategory of actionset games is essentially wide in the full subcategory for games with noabsentmindedness. 
Date:  2021–05 
URL:  http://d.repec.org/n?u=RePEc:arx:papers:2105.11398&r= 
By:  Bianchi, Francesco; Ludvigson, Sydney C.; Ma, Sai 
Abstract:  This paper combines a data rich environment with a machine learning algorithm to provide estimates of timevarying systematic expectational errors ("belief distortions") about the macroeconomy embedded in survey responses. We find that such distortions are large on average even for professional forecasters, with all respondenttypes overweighting their own forecast relative to other information. Forecasts of inflation and GDP growth oscillate between optimism and pessimism by quantitatively large amounts. To investigate the dynamic relation of belief distortions with the macroeconomy, we construct indexes of aggregate (across surveys and respondents) expectational biases in survey forecasts. Overoptimism is associated with an increase in aggregate economic activity. Our estimates provide a benchmark to evaluate theories for which information capacity constraints, extrapolation, sentiments, ambiguity aversion, and other departures from full information rational expectations play a role in business cycles. 
Keywords:  beliefs; Biases; Expectations; Machine Learning 
JEL:  E17 E27 E32 E7 G4 
Date:  2020–07 
URL:  http://d.repec.org/n?u=RePEc:cpr:ceprdp:15003&r= 
By:  Stéphan Sémirat (GAEL  Laboratoire d'Economie Appliquée de Grenoble  INRAE  Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement  Grenoble INP  Institut polytechnique de Grenoble  Grenoble Institute of Technology  UGA  Université Grenoble Alpes  CNRS  Centre National de la Recherche Scientifique  UGA  Université Grenoble Alpes); Francoise Forges (CEREMADE  CEntre de REcherches en MAthématiques de la DEcision  CNRS  Centre National de la Recherche Scientifique  Université Paris DauphinePSL  PSL  Université Paris sciences et lettres) 
Abstract:  We consider a senderreceiver game, in which the sender has finitely many types and the receiver's decision is a real number. We assume that utility functions are concave, singlepeaked and singlecrossing. After the cheap talk phase, the receiver makes a decision, which requires the sender's approval to be implemented. Otherwise, the sender "exits". At a perfect Bayesian equilibrium without exit, the receiver must maximize his expected utility subject to the participation constraints of all positive probability types. This necessary condition may not hold at the receiver's prior belief, so that a nonrevealing equilibrium may fail to exist. Similarly, a fully revealing equilibrium may not exist either due to the sender's incentive compatibility conditions.We propose a constructive algorithm that always achieves a perfect Bayesian equilibrium without exit. 
Keywords:  Approval,cheap talk,senderreceiver game,participation constraints,singlecrossing 
Date:  2021–05 
URL:  http://d.repec.org/n?u=RePEc:hal:wpaper:hal03231673&r= 
By:  Panunzi, Fausto; Pavoni, Nicola; Tabellini, Guido 
Abstract:  This paper studies electoral competition over redistributive taxes between a safe incumbent and a risky opponent. As in prospect theory, economically disappointed voters become risk lovers, and hence are intrinsically attracted by the more risky candidate. We show that, after a large adverse economic shock, the equilibrium can display policy divergence: the more risky candidate proposes lower taxes and is supported by a coalition of very rich and very disappointed voters, while the safe candidate proposes higher taxes. This can explain why new populist parties are often supported by economically dissatisfied voters and yet they run on economic policy platforms of low redistribution. We show that survey data on the German SOEP are consistent with our theoretical predictions on voters' behavior. 
Keywords:  Behavioral political economics; populism; prospect theory 
JEL:  D7 D9 H00 
Date:  2020–08 
URL:  http://d.repec.org/n?u=RePEc:cpr:ceprdp:15213&r= 
By:  Angrisani, Marco; Cipriani, Marco; Guarino, Antonio; Kendall, Ryan; Ortiz de Zarate Pina, Julen 
Abstract:  We study whether the COVID19 pandemic has impacted risk preferences, comparing the results of experiments conducted before and during the outbreak. In each experiment, we elicit risk preferences from two sample groups: professional traders and undergraduate students. We find that, on average, risk preferences have remained constant for both pools of participants. Our results suggest that the increases in risk premia observed during the pandemic are not due to changes in risk appetite; rather, they are solely due to a change in beliefs by market participants. The findings of our paper support the traditional view that, at least on average, risk preferences are not affected by economic or social circumstances. 
Keywords:  COVID19; Experimental economics; financial markets professional; risk aversion 
JEL:  D81 D91 N0 
Date:  2020–07 
URL:  http://d.repec.org/n?u=RePEc:cpr:ceprdp:15108&r= 
By:  Bonnefon, JeanFrançois; Shariff, Azim; Rahwan, Iyad 
Abstract:  Autonomous Vehicles (AVs) promise of a multitrilliondollar industry that revolutionizes transportation safety and convenience depends as much on overcoming the psychological barriers to their widespread use as the technological and legal challenges. The first AVrelated traffic fatalities have pushed manufacturers and regulators towards decisions about how mature AV technology should be before the cars are rolled out in large numbers. We discuss the psychological factors underlying the question of how safe AVs need to be to compel consumers away from relying on the abilities of human drivers. For consumers, how safe is safe enough? Three preregistered studies (N = 4,566) reveal that the established psychological biases of algorithm aversion and the betterthanaverage effect leave consumers averse to adopting AVs unless the cars meet extremely potentially unrealistically high safety standards. Moreover, these biases prove stubbornly hard to overcome, and risk substantially delaying the adoption of lifesaving autonomous driving technology. We end by proposing that, from a psychological perspective, the emphasis AV advocates have put on safety may be misplaced. 
Keywords:  autonomous vehicles; automation; algorithm aversion; safety; illusory superiority 
Date:  2021–05 
URL:  http://d.repec.org/n?u=RePEc:tse:wpaper:125618&r= 
By:  Rick van der Ploeg (University of Oxford); Ton van den Bremer (University of Oxford) 
Abstract:  The social cost of carbon is the expected present value of damages from emitting one ton of carbon today. We use perturbation theory to derive an approximate tractable expression for this cost adjusted for climatic and economic risk. We allow for different aversion to risk and intertemporal fluctuations, skewness and dynamics in the risk distributions of climate sensitivity and the damage ratio, and correlated shocks. We identify prudence, insurance, and exposure effects, reproduce earlier analytical results, and offer analytical insights into numerical results on the effects of economic and damage ratio uncertainty and convex damages on the optimal carbon price. 
Keywords:  precaution, insurance, exposure, economic and climatic and damage uncertainties, skewness, mean reversion, correlated risks, risk aversion, intergenerational inequality aversion, convex damages 
JEL:  H21 Q51 Q54 
Date:  2021–05–24 
URL:  http://d.repec.org/n?u=RePEc:tin:wpaper:20210046&r= 
By:  Chowdhury, Shyamal; Sutter, Matthias; Zimmermann, Klaus F 
Abstract:  Economic preferences are important for lifetime outcomes such as educational achievements, health status, or labor market success. We present a holistic view of how economic preferences are related within families. In an experiment with 544 families (and 1,999 individuals) from rural Bangladesh we find a large degree of intergenerational persistence of economic preferences. Both mothers' and fathers' risk, time and social preferences are significantly (and largely to the same degree) positively correlated with their children's economic preferences, even when controlling for personality traits and socioeconomic background data. We discuss possible transmission channels for these relationships within families and find indications that there is more than pure genetics at work. Moving beyond an individual level analysis, we are the first to classify a whole family into one of two clusters, with either relatively patient, risktolerant and prosocial members or relatively impatient, risk averse and spiteful members. Socioeconomic background variables correlate with the cluster to which a family belongs to. 
Keywords:  Bangladesh; Economic preferences within families; Experiment; family clusters; Intergenerational Transmission of Preferences; risk preferences; social preferences; socioeconomic status; Time preferences 
JEL:  C90 D1 D64 D81 D90 J13 J24 J62 
Date:  2020–07 
URL:  http://d.repec.org/n?u=RePEc:cpr:ceprdp:14998&r= 
By:  Broll, Udo; Pelster, Matthias; Kit, Pong Wong 
Abstract:  Abstracting from selfprotection and selfinsurance e ects of export production choices, exporting rms usually have access to a number of risk sharingmarkets that have an efficient risk management role. Two of the most strikingresults achieved from the existence of risk sharing markets are the separationtheorem and the and fullhedging theorem. This note examines the optimalproduction for exports and hedging decisions of a riskaverse rm facing bothhedgeable exchange rate risk and nonhedgeable (background) risk. While theseparation property holds in this context, the fullhedging property does not.The correlation between the nonhedgeable income risk and the hedgeableforeign exchange rate risk is pivotal We show that the concept of expectationdependence is useful in determining the optimal nancial risk management. 
Keywords:  Export,Background Risk,Exchange Rate Risk,Expectation Dependence,Hedging,Hintergrundrisiko,Wechselkursrisiko,Erwartungsabhängigkeit,Absicherung 
JEL:  D81 D84 F11 F30 F31 
Date:  2021 
URL:  http://d.repec.org/n?u=RePEc:zbw:tudcep:0221&r= 
By:  Cortes, Patricia (Boston University); Pan, Jessica (National University of Singapore); Pilossoph, Laura (Federal Reserve Bank of New York); Zafar, Basit (University of Michigan) 
Abstract:  To understand gender differences in the job search process, we collect rich information on job offers and acceptances from past and current undergraduates of Boston University's Questrom School of Business. We document two novel empirical facts: (1) there is a clear gender difference in the timing of job offer acceptance, with women accepting jobs substantially earlier than men, and (2) the gender earnings gap in accepted offers narrows in favor of women over the course of the job search period. Using survey data on risk preferences and beliefs about expected future earnings, we present empirical evidence that the patterns in job search can be partly explained by the higher levels of risk aversion displayed by women and the higher levels of overoptimism (and slower belief updating) displayed by men. We develop a job search model that incorporates these gender differences in risk aversion and (over)optimism about prospective offers. Our counterfactual exercises show that simple policies such as eliminating "exploding offers" by allowing students to hold onto offers for an additional month, or providing them with accurate information about the labor market, can reduce the gender gap significantly. 
Keywords:  gender, job search behavior, risk aversion, overconfidence 
JEL:  D83 D91 J64 
Date:  2021–05 
URL:  http://d.repec.org/n?u=RePEc:iza:izadps:dp14373&r= 